Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner responds to your questions
about today’s futures markets. To submit a question, post your question
at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Visit Garner at www.DeCarleyTrading.com. Her books, Commodity Options and A Trader’s First Book On Commodities, are available from FT Press.
ABOUT GRAIN PRICES
What are some of the key fundamental forces behind grain prices?
Before we look at the details, it is important to be aware of the big picture: Grain futures react to macro global economic conditions along with micro growing environments in the primary growing regions of the US, South America, China, and India. This makes sense because grain futures traded on Cme Group are based primarily on crops grown in the regions but sold to overseas buyers.
Price pressures in the grain complex, similar to any other market, come from a nearly unlimited number of factors. However, to avoid analysis paralysis, traders will likely be better off narrowing their focus of research or, better yet, knowing where to go for reliable information:
US Dollar
The value of the dollar plays a role in grain valuation. This is because a stronger dollar creates an environment in which dollar-priced assets (including grains) seem expensive to foreign buyers. Accordingly, the demand for these “expensive” assets drops and often so does the price of grain. Conversely, a weak US currency enables domestic growers to market their inventory at more competitive prices, increasing demand for the products and eventually promoting higher grain prices.
Dominant Supply/Demand Factors
Acreage planted/ending stocks
Unlike mined and extracted commodities, grains are a renewable asset, and so, supply is highly dependent on the success of the current crop year. Consequently, United States Department of Agriculture (Usda) statistics on acreage planted and ending stocks are a popular gauge measuring crop yields.
The Usda publishes planting intention reports in late March to provide insight into estimates of the current year’s planted acreage, but by late June, they can publish the actual numbers in their annual acreage report. They also release quarterly reports on grain stocks based on surveys conducted on grain producers and grain storage facilities.
Monthly supply/demand reports
Monthly Usda reports offer traders insight into the immediate fundamental environment. Included are information about crop production, monthly ending stocks, and the stocks-to-use ratio:
- Crop production. Crop production is the expected total number of bushels to be harvested in each grain. This number is generally the most important during growing seasons. Higher numbers mean higher production and typically lower grain prices.
- Ending stocks. Calculated by subtracting supply from demand, quarterly ending stocks represent the carryover into the next year. However, the Usda’s monthly version of the report uses estimates of both supply and demand to determine what they determine the ending stocks to be. Naturally, higher ending stocks indicate more supply and can weigh on the price of amply supplied commodities.
- Stocks-to-use ratio. The stocks-to-use ratio is derived by dividing ending stocks by total demand. In a nutshell, it measures how much of this year’s demand would the grain that is on hand be able to meet. Simply, if the stocks-to-use ratio were 15%, current grain supply could meet 15% of annual expected demand. As you may have guessed, a higher stocks-to-use ratio tends to have a negative impact on pricing because it paints a picture of adequate supply, low demand, or both.
Grain Seasonality
Grains such as soybeans, corn, and wheat are produced and consumed in various countries around the world; therefore, their pricing is dependent on factors other than those in the US. Nevertheless, I would argue that under normal circumstances there might be more focus on domestic events due to proximity and, therefore, many traders put more emphasis on the domestic harvest cycle.
Agricultural crops are vulnerable during planting in numerous ways, but the primary antagonist is weather. Too much moisture can make fieldwork difficult or even impossible, but too little will prevent proper crop growth.
You may have heard that old saying, “Rain makes grain.” During the grain-growing months, the Cme Group’s bias is negative if it is raining in downtown Chicago. This is because the Windy City is located in the heart of the grain belt and if it is raining on Wacker Drive, it is assumed that rain must also be getting to the nearby cornfields, promoting higher production yields. However, too much rain can have the opposite effect, washing out the fields (and downtown Chicago).
A lack of rain might prevent seeds from properly germinating at planting. However, once a crop is planted, risks persist; excessive rain or freezing temperatures can result in crop loss and higher grain prices. In the same way, excessive heat will result in low pollination of the planted seeds and result in less yield at harvest time.
Grain isn’t useful until it actually gets harvested. Even if planting and growing go well, weather just before and during harvest can wreak havoc on yields. Excessive temperatures or prolonged exposure to moisture will work against a successful harvest.
To reiterate, the potential supply of grain is most vulnerable during the planting, pollination, and harvest stages of the crop year. Accordingly, during these times of year, grain prices are subject to increased levels of volatility and often incorporate a risk premium to account for the possibility of a less than perfect production cycle.
It is imperative that grain traders are aware of the fundamental market cycles and understand the implications of them. Without this knowledge, it is impossible to measure the risk and reward prospects of being involved in a given commodity.