Newsom on the Market

By Darin Newsom
DTN Senior Analyst

The U.S. grain producer is having another fitful night, his sweat-soaked slumber, though the night air is chilly, interrupted by constant tossing and turning as the recurring nightmare plays out once again in his dreams. Every night the two-headed monster reappears, smashing bins of on-farm grain, ripping and tearing into the producer as he bleeds money. At dawn the monster retreats into the deep recesses of the subconscious, leaving the producer tired as he faces another long, uncertain day.

So what is this beast, this Freddy Krueger of the grain netherworld? Forward curve, or in simple English, the series of prices -- futures spreads -- that make up a particular market. For example, the 2015-2016 marketing year corn forward curve plots the individual prices of the December 2015 through July 2016 contracts. In soybeans, the 2015-2016 forward curve covers the contracts from November 2015 through July 2016. Those of you more familiar with the futures markets are probably asking what about September corn and August and September soybeans? Think of them as hybrids, mutants from the Island of Dr. Moreau, that don't know whether they are old-crop or new.

A combined look at futures prices, you ask? That doesn't sound frightening at all. The scary part comes in trying to interpret what these price relationships are showing.

At my recent Iowa Public Television Market to Market show appearance (you can watch the episode here: http://www.iptv.org/…) host Mike Pearson and I discussed the question causing producers many a sleepless night: Should they hold corn and sell soybeans, or sell soybeans and hold corn? Most analysts who have appeared on the show have opinions which fall into the latter category.

A long time ago in a galaxy far, far away (Kansas actually), as a young broker I was given the advice that one should be able to write their rules for trading on a single index card. Over the years I was able to do that, but due to poor eyesight and constantly losing my index card, I transferred my rules to the big whiteboard behind me. Rule 2 is very clear, yet muddied at the same time: Let the market dictate your actions.

If we look again at the forward curves for corn and soybeans, we see little carry (price difference with deferred contracts holding premiums to nearby contracts) in the soybean market. November 2015 is priced at $8.76 (as of this writing) while the July 2016 was trading at $8.93. This 17-cent carry covered only 29% of the total cost of holding soybeans in storage through the end of June. On the other hand, the December 2015 through July 2016 corn carry was at 19 1/2 cents, or roughly 46% of total cost of carry. Since the market is saying, through its spreads, it is willing to pay more now (by percent) for soybeans, Rule 2 would indicate selling soybeans to a market needing supplies is the better strategy.

Or is it?

The more complete answer depends on whether or not the producer was hedged in the futures market ahead of harvest. If so, then selling the cash grain and lifting the short futures hedge in soybeans makes more sense than rolling the hedge out through a forward curve with little to no carry. Given the larger carry in corn -- again by percent -- it makes more sense to have the hedge and roll strategy in place.

In the real world, though, most production goes into and comes out of harvest unhedged. In this situation, the forward curve of the two markets would be telling you to do the opposite.

Here's why: The weak carry in the soybean forward curve (19% total cost of carry from October through June) reflects a bullish long-term commercial outlook (another phrase for market view of real fundamentals). But how is this possible given the huge ending stocks numbers, both domestic and global, force fed to us every month by USDA? As discussed in last week's column ("The Premature Burial"), the Soylent Green of monthly reports isn't necessarily manna from heaven. Through futures spreads, collectively seen as the forward curve, the soybean market shows more concern over having enough supplies to meet demand. The stronger carry in corn, though the 46% of total cost of carry is still a neutral reading on fundamentals, would suggest the market holds a slightly more bearish view of long-term fundamentals. Therefore, applying Rule 2 would suggest holding soybeans and selling corn.

In other words, the forward curves for corn and soybeans are telling producers to both hold and sell. Hence the two-headed monster that is the subject of their nightly terrors.

Do the other rules on my "card" provide any clues for solving this conundrum? Rule 3 is to manage margin risk, or in other words use filters such as seasonality and volatility. As discussed in my column from Oct. 9 ("Hit or Stay"), the seasonality of futures, cash, and basis for both corn and soybeans is bullish from early October through next summer. So that is of little help.

Rule 1 is simply "Don't get crossways with the trend," meaning to stay in step with large noncommercial investment money (you might know him as Watson). Well, trend indicators for both corn and soybeans have failed time and time again since the end of last October, leaving both markets stuck on the bottom of historic price ranges (another filter from Rule 3) like a poor schmuck in a river wearing concrete galoshes. To make matters even more confusing, if possible, weekly CFTC Commitments of Traders reports have shown noncommercial traders increasing their net-long futures position in soybeans while decreasing their net-long futures holdings in corn.

What's the solution to ending this nightmare? Rule 3 is of no use, so toss it out for now. Rules 1 and 2 can be interpreted bullishly and bearishly for soybeans and corn, though money is moving into soybeans and the market's long-term commercial view seems bullish.

What's the best answer? As the young heroine from Elm Street once said, "Whatever you do...don't fall asleep."

Darin Newsom can be reached at darin.newsom@dtn.com

Follow him on Twitter @DarinNewsom

(CZ/AG)

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