Assistant Professor/Grain Markets Specialist ECON 338C: Topics in Grain Marketing Chad Hart Assistant Professor/Grain Markets Specialist chart@iastate.edu 515-294-9911 1

Today’s Topic Price Projections and Issues with an update on the World Ag. Supply & Demand Estimates report

Source: USDA, WASDE report, April 2009

Source: USDA, WASDE report, April 2009

Source: USDA, WASDE report, April 2009

Source: USDA, WASDE report, April 2009

July 2010 Corn Futures Source: CBOT

Likely Range Example: CBOT July 2010 Corn Futures

Likely Range Based on current futures and the option premiums for options on those futures They determine an implied volatility, a measure of the expected variability of the futures price from the current point on If you take Econ 437, you’ll learn about the mathematical models used to derive the implied volatility Given the volatility, we can outline the likely range

Pricing Paths Example: CBOT July 2010 Corn Futures

Prices Could Be Higher Example: CBOT July 2010 Corn Futures

… Or Lower Example: CBOT July 2010 Corn Futures

Market Situation Reviewing recent past and the current situation in the market Using historical relationships to link changes in key variables to changes in commodity prices Evaluating if current relationships differ from historical patterns

Market Outlook Interpreting market factors that impact prices and shape marketing and management decisions Analyzing how the changing supply and demand factors will impact price Basing outlook on economic principles, statistical analysis, and market knowledge

Market Outlook Outlook depends on timing Immediate: within a day or a week Short term: few weeks to few months Long term: next growing season to multiple years Different information needed for each type

Immediate Term Outlook Market timing Any scheduled market movers (USDA reports, etc.) Example: CBOT July 2010 Corn Futures

Short Term Outlook Prices are adjusting to balance demand with available supplies One reason to need short term outlook: Storage decisions Example: CBOT July 2010 Corn Futures

Long Term Outlook Buyers and sellers have time to adjust to changes in prices and quantities. Important for investment decisions and government policy setting Example: CBOT July 2010 Corn Futures

Sources of Outlook Information Private sector market analysis firms For-profit companies that sell services Often more short-term focused May be associated with a trading company In-house analysis Outlook for the company with own staff ADM, Cargill, etc. But your local elevator may offer analysis as well

Sources of Outlook Information Land grant universities Long term Example: Food and Agricultural Policy Research Institute (FAPRI) Intermediate to short term Examples: Iowa Farm Outlook (Grain, Livestock, Dairy), Farmdoc.com, Livestock Market Information Center Often affiliated with university extension services Commodity organizations Typically narrowly focused on commodity May miss breath of outlook

Sources of Outlook Information USDA Data and Analysis Sources National Agricultural Statistical Service (NASS) Production, consumption, and survey statistics Agricultural Marketing Service (AMS) Summaries of local market prices Economic Research Service (ERS) Analysis of agricultural markets and government policies Foreign Agricultural Service (FAS) Trade information and analysis

Examples of Outlook Information World Agricultural Supply and Demand Estimates report http://www.usda.gov/oce/commodity/wasde/latest.pdf Iowa Farm Outlook http://www.econ.iastate.edu/outreach/agriculture/periodicals/ifo/ FAPRI Outlook http://www.fapri.missouri.edu/outreach/publications/2009/FAPRI_MU_Report_01_09.pdf http://www.fapri.iastate.edu/brfbk09/BrfBk2009.pdf

U.S. Corn Supply and Use 2007 2008 2009 Area Planted (mil. acres) 93.5 86.0 85.0 Yield (bu./acre) 150.7 153.9 Production (mil. bu.) 13,038 12,101 Beg. Stocks 1,304 1,624 Imports 20 15 Total Supply 14,362 13,740 Feed & Residual 5,938 5,350 Ethanol 3,026 3,700 Food, Seed, & Other 1,337 1,290 Exports 2,436 1,700 Total Use 12,737 12,040 Ending Stocks Season-Average Price ($/bu.) 4.20 Source: USDA, WASDE and NASS 23 23

Iowa Farm Outlook Monthly outlook from ISU Extension Other universities offer similar services 24 24

FAPRI Reports U.S. Corn Utilization World Soybean Production Source: FAPRI, 2009 25 25

Evaluating Source of Information Know the source of data and analysis Understand the motivation of the source Public institution Private analysis, for sale Private analysis, confidential What are the resources and track record

Outlook Issues Efficient market hypothesis All available information is quickly factored into the markets and embedded in the price New information and/or changes in supply and demand after the outlook alter outcomes Participants react to forecasts

Seasonal Patterns A price pattern that repeats itself with some degree of accuracy year after year. Supplies and demand Often sound reasons Widely known Linked to storage cost or basis patterns in grains Linked to conception and gestation in livestock

Seasonal Pricing Patterns Source: USDA, NASS, Monthly Price Data 1980-2008

Charting Channel lines

Sell Signal A sell signal is one close below the charting lines

Buy Signal Some chartists need only one close above the charting line to create a buy signal, others use two closes above. Buy signal

Key Reversal A key reversal is when the daily high and low price range exceed the price range for the previous two days.

Gaps Gaps often occur when a major new piece of information hits the market. They are often filled in by later price movements.

Double Tops & Bottoms Double tops and bottoms show prices with major technical resistance. These can be several days apart.

Head & Shoulders Source: Figure 7, Charting Commodity Futures Ag Decision Maker, File A2-20

Moving Averages 9 day average 18 day average 40 day average Sell signal Buy signals

Relative Strength Index Looks at last X days worth of closing prices X = 9, 14, 30, etc. Summarizes upward and downward price movements during the period Record the last 14 days worth of price changes, based on closing prices Sum the positive and negative price changes and create average for each Relative Strength Index = (Up average/(Up average + Down average))*100

Relative Strength Index RSI for July 2010 Corn

Relative Strength Index RSI’s above 70 (80) are considered signals of a market due to decline RSI’s below 30 (20) are considered signals of a market due to rally

Does Technical Analysis Work? Arguments for it: Real world markets are not perfectly rational Markets may be slow to respond to new information Technical analysis works with the psychological biases It works because so many people use it Self-fulfilling Arguments against: Efficient market hypothesis The current price holds all of the relevant information

Convergence Issues Typically, as futures contracts reach maturity, futures price and cash prices at delivery points tend to converge to the same level. For several grain and oilseed futures contracts over the last few years, this has not occurred. “Poor Convergence Performance of CBOT Corn, Soybean and Wheat Futures Contracts: Causes and Solutions” Scott Irwin, Philip Garcia, Darrel Good, and Eugene Kunda University of Illinois, March 2009

Corn (Lack of) Convergence Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Soybean (Lack of) Convergence Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Wheat (Lack of) Convergence Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Why Is Convergence An Issue? Non-convergence indicates the market is out-of-balance. “When a contract is out of balance the disadvantaged side ceases trading and the contract disappears.” (Hieronymus, 1977) Non-convergence adds to the uncertainty in basis and limits hedging effectiveness. Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Factors The relationship between the spread between futures contracts and the cost of carry (think storage costs) In the settlement process for corn and soybean futures, the delivery instrument is a shipping certificate. If it is advantageous to the holder of a shipping certificate, they can delay delivery and effectively store the grain, paying CBOT set storage costs. Structural issues related to the delivery process Does the general trade flow of the commodity line up with the possible delivery points under the futures contract? Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Spread vs. Carry Look at the ratio of the futures spread versus the cost of carry Futures PriceNext – Futures PriceNearby Storage Costs + Interest Irwin, et al. found lack of convergence when ratio is high (> 80%) A lower ratio implies smaller returns to holding a shipping certificate and more offsetting positions are taken, lowering futures prices. If the commodity is still in storage, then cash sales aren’t happening, lowering cash prices. Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Delivery Points Corn Soybeans Wheat How much of the commodity is moving through the delivery point areas? Corn Soybeans Wheat Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Convergence vs. Carry - Corn Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Convergence vs. Carry - Soy Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Possible Reasons for High Ratios CBOT storage rates below commercial storage rates Large “long-only” index funds rolling to the next contract at the same time Large risk premiums built into futures to cover uncertainty Irwin, et al. found support for #1 and arguments for #3, but did not find support for #2. Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Possible Remedies Increase CBOT storage rates Done for corn and soybeans in late 2008 Change delivery points to include more of the commodity shipping area Mostly an issue for wheat Other proposals: Move to cash settlement Force delivery Limit the number of certificates that can be held Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Relative Basis Change - Corn The closer this is to one, the more effective hedging is. Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Relative Basis Change - Soy The closer this is to one, the more effective hedging is. Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

Class web site: http://www. econ. iastate Class web site: http://www.econ.iastate.edu/classes/econ338C/Hart/ See you next week!