While an expected record crop has pushed grain prices lower, it will take time to translate to livestock, and the dollar rally throws a wildcard into the demand picture.
The strong U.S. dollar (NYBOT:DXZ14) has put the United States at a disadvantage to most of its key competitors. The U.S. economy has stabilized when compared with Europe. The Federal Reserve has moved to end its easy monetary policy. Political tensions run across several continents. Now that harvest is nearing completion the trade’s focus will shift from guessing supply to the question of moving the product. U.S. dollar pricing will play a key role in this issue for the months ahead (see “Dollar strength raises prices,” below).
With good weather we can grow a good crop. With great weather we can grow a record crop. Over the past 40 years we have broken trend yield by 10% or more five separate times. As the last instance of this feat was in 2004, we were due. Every one out of eight years we are due for record yields. While this is a record crop, we can’t say it is burdome on a nationwide basis. Because we lost acres this year, this only represents a 5% increase in production.
The question now turns to how the market will take these supplies. From 2005 to 2011 ethanol was a superstar. Blenders were struggling to secure supplies to meet the Federal mandate. That situation has changed. We are now producing above the EPA requirement with the market relying on exports to move the excess product. This means corn for ethanol is dependent on low Brazilian exports, U.S. dollar values, ethanol pricing and corn pricing. The shocker for the grain industry is that ethanol will be of almost no help in alleviating these heavy corn supplies. The fall in ethanol prices has more than offset the lower corn prices. In early September ethanol producers were seeing profits of 50¢ per gallon. Currently it is only at breakeven. This is the worst margin situation in more than a year-and-a-half.
The “big” question mark for traders here is a category of demand that we don’t have any short-term government data on: feed and residual. We have to consider that U.S. Department of Agriculture’s calculation of this category is dependent on both livestock numbers as well as quantity fed per animal. Despite another expected year-over-year decline in beef production that will be offset by the gains made in chicken and pork. The USDA’s current assumption of a 1% increase in numbers is adequate. In the previous five years where yield exceeded trend by over 10%, we saw an average quantity fed increase of 5.0%. The USDA’s current estimate of a 5.6% corn per animal unit gain is very reasonable.
We have a mixed stance on exports right now. This new crop year started without the interest from China. China’s ban on U.S. corn and distillers grains is a problem for us. That is a missing category of demand that would have taken almost 200 million bushels this year. On the one hand China has a burdensome supply domestically. Even with a large supply, after the government reserve program is considered, it is just not large enough. Their interior pricing at this time is $11 per bushel. As it stands now without China’s participation, and with a strong U.S. dollar, and with many world feed buyers waiting for lower prices, export sales of corn are running 1% behind last year and 2% behind the five-year average for this date. This is despite a record crop (see “Missed opportunity,” below). Any changes in three factors could add support to this market.
Traders should monitor the charts for a fall low in October or November. Our downside target for this move has been filled. After the low is confirmed we cannot argue with an eventual moderate rebound in the March to $3.80. Other trades to consider over the winter would be new crop/old spreads playing on the idea that 2015 production may be smaller.
Just like corn, this year’s yields will be a record, but with beans we are dealing with record acreage as well so we have some tonnage issues. The increase in U.S. production will run 20% over last year. Our current ending stock estimate, 464 million bushels, is the largest since 2006/07. On a world basis we cannot ignore the record crops for Brazil and Argentina this past spring, and the forecast for new records to be posted for the spring 2015 harvest. For the first time in years we will not just meet the rising demand story but actually overcome it.
On the export side the window of opportunity for the United States is between September and January. This period now makes up 85% of our annual sales. The good news is so far this year’s export push has been good. Year-to-date sales are running 9% higher than last year and a full 34% over the five-year average. Chinese crush margins currently are at their best level since October of 2013.
This is quite a reversal from the low levels that concerned the trade in August. U.S. domestic use also has been stronger than expected. There is still some residual demand for soy products, which should keep domestic crush rates at high levels. The U.S. pricing situation would be even worse than it is now if it were not for a strong demand sector waiting for this supply.
The wildcard here is South America. Soybean planting is still going on there. The trade will be eager to change its mind on pricing if weather concerns show in the coming weeks. If there is no weather problem then we are expecting new records for Brazil (95 million tonnes) and Argentina (57 mt). Brazil has made some slight infrastructure improvements over the past year and has learned how to manage their port backlogs for the spring and early summer. It is likely another four to five years will be needed to seriously improve their situation.
For pricing, unlike in corn, we don’t suggest that fall lows will be the lows. Instead we may simply develop a trading range. Weather scares for South America could push the March contract up to $10. Breaks down to $8.80 could be seen with no production problems.
Wheat has had a tough time this year. While it did make some great sales earlier this year it was more from buyers avoiding countries with political tensions than our price competitiveness. Now that much of the Ukraine/Russian issues are no longer in the headlines the U.S. market will have to fight to remain competitive. About 50% of our production is exported each year. That is a huge share. It also means changes in the U.S. dollar will have a profound impact on pricing. There is a clear reason why U.S. wheat exports in August and September averaged 32% under the five-year average that is normally seen.
There will be no problem with supplies on a world basis. Though the United States and Canada posted lower production this year, Canada coming off a record last year, many others posted record numbers. Records were broken for the EU, China, and India.
With the U.S. dollar being a problem, adequate supplies from non-U.S. producers, and much lower priced corn, we see rallies in March wheat limited to $5.50.
Live cattle (CME:LEZ14)
If there is any market with the “right stuff” for a bull market into 2015 it would be cattle. The key unit of production, the breeding herd, is at eight-year lows. Years of off and on drought in the Plains, an older farm population, and high corn prices were responsible. The pricing situation has changed in the industry. We have found the level of beef production is just too tight for consumers who are feeling slightly better about the market. The strong rally from late 2013 to current has encouraged producers to begin expansion.
What is exciting about this from a market perspective is that the expansion process is a three-year undertaking. In years one and two this keeps young females on the farm and out of the feedlots. Net declines in beef production will total 6% this year. Another 3% cutback is expected for 2015. The bulk of this production cut for 2015 will likely come in the first half of the year. Our focus right now is centered on the first quarter where production could take a 4% to 5% year-over-year drop.
What has been a big surprise this year is how aggressively U.S. consumers made their presence felt. Consumer income has run 4% over last year. Excluding transfer payments it comes to a 3% increase. What is interesting is what they are choosing to do with that money. The Conference Board’s closely followed Consumer Confidence report showed an index reading of 93.4 in the month of August.
This was the highest reading since October of 2007. Though lower numbers were reported for the month of September it is clear that consumers are spending. At times during the summer consumers were not just taking higher beef prices, but even asking for more. Retail prices ran 12% higher than last year during the summer. The current market is pricing the idea that this will continue.
Our upside target for the February contract of $1.66 has already been filled. While we feel confident about out our production numbers the demand issue is the real wildcard. We could see potential pricing from $1.72 to $1.64 just from this issue alone.
Lean hogs (CME:LHZ14)
The hot topic earlier this year was all about the virus known as PED (Porcine Epidemic Diarrhea). The U.S. herd was hit hard this year with pigs weaned per litter taking a 5% cut vs. the previous year. With some natural immunity in the herd now at the end of the year the losses are not as severe. On top of this there are now two commercially available vaccines which may minimize the seasonal flare- up this winter. There are two other companies researching the issue and working on vaccines themselves.
While we did see slaughter numbers take a hit this year, most of that was offset by higher weights. Producers wanted to capture every dollar possible with this year’s record pricing. The incentive to carry hogs at higher weights was easily there given the sharp decline in this year’s corn pricing.
Producers are reacting to the current strong margin situation and have begun expansion. Pork production rates started the fourth quarter about 3% lower than last year. That will improve to about even with last year at the time of this publication’s release. By December they will likely be running 1% higher than last year. For 2015 we are plugging in a 3.5% increase year-over-year. This, and the coming moderate chicken expansion, is needed to help fill the hole left from beef.
The fourth quarter is the heaviest supply time of the year. As you would expect it also typically has the lowest prices. Over the past 15 years cash hog prices have dropped in 11 of those 15 from early October down into the settlement of the December contract (see “A run on pigs,” below). In those 11 years the decline averaged 12%. From this year’s Oct. 1 Lean Hog Index that would put December futures pricing at $96. Our pricing models are currently implying a larger than usual decline to the $88 to $90 range. Though our production numbers do suggest a decline in pricing here we must keep a wary eye on the U.S. consumer and beef pricing. We would consider our pricing model to be the low area of potential trading.
Rich Nelson Rich Nelson is Director of Research at Allendale Inc. in McHenry, Ill. Allendale is registered with the CFTC and NFA and is a member of the NIBA.