Financial Sense "Market Turmoil Affecting Commodity Prices" by George Kleinman 03/18/2008

MARKET TURMOIL AFFECTING COMMODITY PRICES
by George Kleinman
Editor, Commodities Trends
March 18, 2008

In this issue, I’m covering the outlook for three major food markets--corn, soybeans and wheat--and I’ll answer the following question: Should food futures be a component of your investment portfolio?

Bear Stearns announced Friday its cash situation had “significantly deteriorated.” The stock dropped 50 percent in one day, but what does this have to do with food? Bear is a large clearing firm for many commodity hedge funds. No doubt rumors of (and actual) margin calls had something to do with the poor performance of all three food commodities.

Soybeans closed down the 50-cent-per-bushel limit. Corn, despite a bullish acreage forecast by a major food guru, closed down 10 cents per bushel, and wheat was off more than 50 cents.

The most important crop report of the year, the March Seedings and Stocks Report, is due to be released March 31. It reports not only supplies available but also what farmers intend to plant. Some years the report sets the tone for the entire crop year. Of course, upcoming weather developments, an unknown at this time, will also affect prices as the growing season unfolds.

Now on to our analysis; below are the main fundamental points I see for these markets at this time.

Soybean Bull Points

Very tight projected carryover supplies, only 160 million bushels at the end of this crop year. This represents merely a two week supply.
Domestic demand for soybean products year-to-date is running at a record-high pace despite historically high prices.
World demand for US soybean products, particularly from China, is also at a record-high pace despite high prices. Reasons have to do with the growing global livestock numbers and high demand for vegetable oil.
We know nothing about the new crop; it hasn’t even been planted yet. The unexpected will likely be bullish. For example, what if there’s a drought or other crop problem in the US or elsewhere this coming growing season?
The index funds that invest in hard assets and pay for these assets in full will likely continue to accumulate long positions in soybeans.

Soybean Bear Points

Money problems in the financial markets will result in the need for trading funds to sell off soybeans and other commodities to raise margin money for stock market and subprime losses.
A record large Brazilian soybean crop is being harvested right now with these supplies hitting the market shortly. Argentina is right behind Brazil with another big crop.
Sharply higher soybean acreage is projected for this coming growing season. Although the official numbers will be released on March 31, preliminary estimates call for up to 8 million additional planted acres versus last year.
Technically, soybean futures just broke below the 50-day moving average for the first time since last August, a bearish signal (represented by the green line on the following chart).

July Soybeans

Source: Commodity.com

Wheat Bull Points

Stocks of wheat on hand are at 40-year lows.
Although the new crop is in the ground and growing, it’s months away from harvest. What if there’s a drought, premature freeze or other crop problem in the US or elsewhere this coming growing season?
The index funds that invest in hard assets and pay for these assets in full will continue to accumulate long positions in wheat.

Wheat Bear Points

Money problems in the financial markets will result in the need for trading funds to sell off wheat and other commodities to raise margin money for stock market and subprime losses.
Sharply higher wheat acreage is projected for this coming growing season. Although the official numbers will be released on March 31, preliminary estimates call for up to 3 million additional planted acres versus last year. Spring wheat, the bull leader this past year, could see acreage up 4 to 5 percent; this is a big number. Stocks of wheat may be at 40-year lows, but in just two to three months, a huge new crop harvest will replenish current tight supplies.
To date, weather has been favorable for the newly planted winter wheat crop.

July Wheat

Source: Commodity.com

Corn Bull Points

Sharply lower corn acreage is projected for this coming growing season. Although the official numbers will be released on March 31, preliminary estimates call for up to 8 million fewer planted acres versus last year.

We know nothing about the new crop, it hasn't even been planted yet. What if there’s a drought or other crop problem in the US or elsewhere this coming growing season?

Corn exports are up 30 percent this year versus last, with no evidence higher prices are hurting demand.

The index funds that invest in hard assets and pay for these assets in full will continue to accumulate long positions in corn.

Corn Bear Points

Money problems in the financial markets will result in the need for trading funds to sell off corn and other commodities to raise margin money for stock market and subprime losses.

July Corn

Source: Commodity.com

There’s the argument that the recession will hurt consumer spending, which will also hurt demand for commodities. I can buy this argument for oil consumption (with gasoline at $4 a gallon, many people will find ways to use less) but not for food products. Food demand is relatively inelastic, and with the world population rising at the rate of 80 million people per year, demand is only going up. So it’s the vagaries of supply that will determine price moves.

Also, although many people only look at traditional supply and demand fundamentals for food products, it became increasingly evident as I listed the above bullet points that the funds are as important a fundamental as weather or exports. Cash flows both in and out of commodities need to be monitored closely by traders.

Here are my predictions. (They’re subject to change, of course, based on developments, but it’s my best guesstimate based on today’s situation.)

Soybeans will continue lower in the short term as a result of the big South American crops and technical considerations. November futures are trading at just less than $13 per bushel. A target would be somewhere just less than $12. Longer term, based on relentless demand, prices will recover and could make all-time new highs if any weather problems develop.

Wheat is the most overpriced of the three. It’s trading at high numbers based on the current tight supply, but a big new crop is coming. Barring any weather problems, I target July futures (currently more than $11) to trade somewhere in the $9 range, bottoming out when harvest is approximately half over in early July.

Note: I could only find one bear bullet point for corn. December corn is close to $6 per bushel, and I could certainly see it trading lower in coming weeks in sympathy with weaker soybean and wheat values, but not much lower. A move back under $5.40 at this time looks to me to be a real value area. With the sharply lower acreage, everything will have to go just right to keep prices in check. Any weather wiggle and corn prices could easily shoot up to all-time highs.

That's the way I see it, but decide for yourself if this is an asset class you should consider.

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