Kottke Associates – It’s The Weather, Stupid

| | Agriculture, Grains, Kottke Commodities, Managed Futures, spread trading

Market Commentary from Kottke Commodites РCommodity Capital CTA РKenneth Stein kottke Logo

August trading results improved markedly as one of the metrics with which we track ourselves, the ratio of winning trades to losers, rose dramatically. Summer crop development was uncharacteristically dull, with unchanging, uncannily positive growing conditions. Since we refrain from exposing investor capital to weather forecasts anyway, we trained our attention on the wheat crops already harvested and the old-crop soybean market still working out its supply tightness.

One of the three-pronged analytical approaches we use is, of course, price history. Statistical history generates rules of thumb used by some traders to project reversion to the mean, i.e., if a price pattern has repeated in 9 of 10 past years, that’s taken to suggest its probability of recurring is high. We never lean very heavily on that, as reality is rarely so neat. In matters as complex as projecting raw materials prices, experience means appraising in light of the past rather than literally expecting past events to recur. The often-heard “history always repeats itself” actually never succeeds without the addendum “but not exactly.”

Even the old saw “if you don’t like the weather in the Midwest just wait awhile” hasn’t held: the entire Corn Belt has enjoyed cool, moist conditions, with next to no variability, throughout the crop season to-date. Corn pollinated and soybeans flowered under near-ideal conditions, without interruption from so much as temporary concern over an erred forecast for plant stress. The result of such freakishly favorable weather is the probability of all-time record yields, and by a wide margin. One truism that never fails in agriculture is “It’s the weather, stupid.”

The reaction of corn prices has been decline to the lowest since 2010, yet that is still uncompetitive with other origins – Argentina, Brazil, Ukraine. And despite very high profit margins, domestic industries such as ethanol, cattle, and hogs are unable to ramp up corn consumption much, at least initially. Ethanol production is limited by declining miles driven, cattle by a small herd which will require a few years to rebuild. The hog industry has been impacted by a malady which reduces litter size, but a breakthrough vaccine has just been approved.

In such bearish demand situations, where grain supply left over at crop year’s end appears large, we monitor prospects for directional change the following year. At the current ratio of prices in the fall of ’15, the area planted to corn could shrink precipitously. This bearish-to-less-bearish continuum in corn, with soybeans a mirror image, suggests one of the spread and outright-price themes we’ll likely pursue over the next several months.

U.S. grain-export competitors will react in the same fashion: outlook is for Argentina and Brazil to reduce corn plantings in favor of soybeans. The weak foreign currencies of Argentina and Ukraine, which import hi-tech seed and chemicals, will also limit their future production of corn, the most input-intensive of major food crops. Which illustrates another aphorism that never fails: “The best cure for low prices is low prices.”