Reprinted from GRAIN JOURNAL March/April 2020 Issue
Diana Klemme
The arrival of coronavirus (COVID-19) in the United States has impacted every aspect of the U.S. economy, not the least of which is agriculture. With uncertainty about demand domestically and overseas, most crop and livestock prices have plunged as of mid-March. Also of concern to elevator managers, the collapse of oil prices and the reduction of key interest rates to near zero by the Federal Reserve.
The virus caps off a wild 12 months in agriculture. Prolonged wet weather throughout spring 2019 meant late planting across the continental United States. The flooding that came with that prevented some farmers from planting at all.
Late planting meant a late harvest, and many producers had to harvest crops too wet to store safely for any length of time. That wet grain went to the elevator early and dryers worked overtime in many areas. Wet grain also posed a potential hazard to anyone entering a storage bin, on the farm or at the elevator.
In spite of all that, yields were remarkably high in many parts of the country, as new, vigorous hybrids and varieties responded to timely periods of moderate weather. Yields varied widely from township to township.
Grain Journal sought out its panel of three merchandising specialists in early March to offer their forecasts for 2020 and their advice for grain merchandisers. Panelists were:
• Diana Klemme, vice president of Grain Service Corp., Atlanta, GA; 404-233-6067.
• Philip Luce, director of education for White Commercial Corp., Stuart, FL; 800-327-7000.
• Nathan Mangold, merchandising consultant for Advance Trading Inc., Bloomington, IL; 309-664-2329.
2020 Market Outlook
Klemme: The spread of the novel coronavirus (COVID-19) has upended markets and makes any forecast subject to change on nearly a day-to-day basis.
As of mid-March, corn and wheat futures are all either around multi-month lows or contract lows. Soybeans are only slightly above 12-year lows on a monthly chart, with ongoing concerns over exports. Cattle futures have collapsed to a 10-year low anticipating significant cash weakness in the months to come, as COVID-19 cuts demand, especially from restaurants. U.S. cash ethanol crush margins are negative and at multi-year lows (excluding basis and coproduct value).
China has yet to step up to the purchase obligations from the Phase One trade deal with the United States, aside from small trades. South America’s soybean and corn crops are coming to world markets with near-record production. The wipeout in global financial markets may discourage speculative investment money/funds from the commodity sector.
Potential bullish fundamentals look to be some months away. At best, U.S. spring planting is in its infancy, and it’s far too early to predict any shortfall in acreage or yields. The world does have to eat, and the old adage is that “the best cure for low prices is low prices.” And any market can rise after a large break. But for now, we expect rallies in grains and soybeans to be limited and potentially short-lived.
Luce: We got thrown a lot of curveballs this year, and the marketplace as a whole reflects that. While both domestic and world supplies appear to be sufficient, we are in the third consecutive year of decreased ending stocks for corn. Soybean ending stocks are ample but down significantly from last year, and while world wheat ending stocks are steady, domestic ending stocks are down significantly, especially for soft red winter wheat. The quality of 2019 harvested grain coming out of storage later on this season is a significant concern, too.
Curveballs make for uncertainty, and uncertainty creates both risk and opportunity. In general, a season like this calls for a more proactive grain trading approach than the previous few have.
Since early March, we’ve had more curveballs in the form of plummeting oil prices and increassing COVID-19 concerns. Corn has built carry and soybeans have lost it in the face of a dramatically shifted demand scenario. There’s no way to plan for the entirely unforeseen, but this situation underscores the need for a proactive and vigilant approach to merchandising and position management.
Mangold: The markets have a lot to digest between trade deals, coronavirus, a strong U.S. dollar, and weather. The United States also is trying to figure out where all of the prevent plant acres from last year will fit back into the acreage pie.
If the United States can plant an estimated 93 million to 96 million corn acres and achieve trendline yields, the balance sheet for the 2020-21 crop looks burdensome. There is some chatter the 2019-20 corn production is overstated. But if this is the case, and the U.S. Department of Agriculture doesn’t show the market this change until the September stocks report, it probably won’t be enough to impact the market.
Domestically, strong grain consuming animal unit (GCAU) demand and an off-quality crop should keep feed demand strong. Ethanol demand is hoping margins can turn around with Chinese demand. U.S. exports are suffering due to competition and a strong U.S. dollar. Is it possible the Brazilian farmer planted more safrinha corn acres than estimated, due to strong prices, like the U.S. farmer did this past June?
The strong U.S. dollar and weak Brazilian real are expected to increase acres for the 2021 soybean crop. As well as the currency advantage in South America, they are also expecting record production for 2020. With China dealing with African swine fever (ASF) and coronavirus, just how many soybeans will China need?
The world wheat balance sheet for traditional exportable countries has tightened over the past couple years. The market will be on alert for any northern hemisphere production issues, but at this time, there does not appear to be anything alarming.
Merchandising Strategies
Klemme: Grain elevators have the advantage that profitability is not tied directly to price, as long as they stay hedged and have adequate credit lines. Elevators with space, money, and time can then arbitrage between holding farmer-owned inventories and holding company-owned bushels. The USDA sees U.S. corn acres potentially as high as 96 million this year, which could result in 15.5 billion-plus bushels, depending on yield, for example.
If corn demand and basis are weak this harvest, the market will build carries to reward those who can hold the grain if farmers sell. If farmers hold, elevator revenue may rely more on storage income.
Philip Luce
U.S. stocks-to-usage ratios are tightening in all wheat classes except hard red spring, and this has reduced the need for wide futures carries in Chiago and Kansas City wheat this year. We expect wheat spreads to remain relatively narrow into 2021, especially in Chicago Board of Trade wheat. This, in turn, will discourage holding company-owned wheat relative to corn – a departure for many eastern elevators that have seen significant revenue from carrying wheat in the past decade.
Carrying hedged soybeans typically offers the best returns when elevators liquidate much or most of basis ownership before the South American harvest begins in February/March. China’s Phase One obligations may alter that timing somewhat, but it’s too early to know for sure.
Managers also have the opportunity to lock in sharply lower fuel costs and should look at what may be available, either from suppliers or through futures and options. Now the Federal Reserve has lowered the key interest rate to zero, and owners and boards should monitor the cost of long-term money to manage borrowing costs.
Another factor that will affect grain merchandising this summer is the upcoming summer disruptions and/or closures of locks and dams on the Illinois River to traffic during long-overdue renovations. This may weigh on basis in Illinois, but it is unclear about the exact timing and how the closures will be managed.
Luce: No. 1 is simple situational awareness. Harvest basis levels and spread structures that are significantly different from the recent normal require an approach that is also different. Spreads are typically a good indicator of the long-term basis trend for a season, so watch those closely and adjust your approach as necessary. Keep in mind that when basis for a commodity is much higher than normal at harvest time, it usually has limited potential for improvement after harvest, especially over the course of an entire crop season.
No. 2 is to keep a wide view in mind. The harvest of 2019 involved a tremendous variety of local crop situations. There are places with almost no crops and places that harvested maybe the best crop ever. Keep in mind that the market’s job is to equalize all of these situations through spreads, basis, demand rationing, and other forces. That means that in general, both bad and good areas present a more moderate scenario than local conditions would seem to require.
Mangold: The cash market structures have changed a lot from a year ago. Corn and SRW wheat futures are inverted. Hard red winter (HRW), hard red spring (HRS), and soybeans are paying 2-3 cents over interest costs per month.
Elevators should be working toward getting even corn basis, and when the timing is right, be prepared to start a basis short. Managing basis longs and deferred price stocks is key to a successful basis short. Don’t try to fight the current market by holding onto long corn basis length. The farmer is undersold, and either price or time eventually will bring these old crop stocks into the marketplace.
Many deserve praise for finding a way to hold onto soybean basis length. There has been a lot of operational, asset, and mental stress to accomplish this task. Margins and balance sheets are showing the rewards of this hard work.
The HRW market has shifted away from cheap basis and big carries. The variable storage rate is at its minimum of 5 cents per month futures carry, and it appears spreads will trade this way until at least the new crop.
Hopefully, the old crop markets in corn, soybeans, and wheat will provide a signal either of steeper inverses or bigger carries to make the merchandising picture clearer.
Nathan Mangold
China Trade Issues
Klemme: No one yet knows how COVID-19 ultimately will change our lives. Financial markets have shown this winter, however, that as uncertainty rises, traders generally become more risk-averse. That is a sound lesson for grain merchandisers, as well. Whether the uncertainty is due to trade disputes or a virus, that which seems certain today may vanish tomorrow.
Stay hedged, and make sure your credit and alternate financing are more than adequate; then when opportunities arise, you will be able to respond.
ASF has not run its course yet, and even the sharp reduction to China’s hog herd hasn’t turned into a bull market for U.S. hogs. The biggest risk would be if ASF is detected in the United States. Let us hope that never happens. ASF in the United States would immediately slash feed demand and raise carryover stocks further, and corn basis would weaken immediately.
Luce: I’m going to lean hard toward simplicity in most, if not all, cases. While these large-scale events require some of our attention, most of the decisions in a grain business are driven by practical needs – credit lines, cash flow needs, grain quality management, and general logistical flow being maybe the biggest ones. Since those things are driving most business decisions and actions, lining up reasonable margin opportunities with them should be the top priority.
Mangold: China and U.S. politicians have indicated the coronavirus and Asian swine fever will not slow down the Phase One agreement, but the market is skeptical.
China recently has been buying U.S. sorghum, and basis values have rallied with this new demand. With the unknown demand from China, merchandisers should not short the milo basis but look to get even the basis at current values.
China has already been a more aggressive buyer in the world of wheat, to meet their World Trade Organization obligations. In the United States, China has been rumored to have purchased HRS.
Weather Issues
Klemme: I suggest prayer.
Luce: Year in and year out, spring and summer weather scares tend to be overdone, which is a good thing. It creates a powerful, if emotionally difficult, opportunity for growers to sell new crop grain. Since farmers make the majority of business decisions based on practical things like cash flow and logistics, just like grain handling businesses, there’s a chance here for the farmer to avoid being forced into harvest sales.
The USDA says that roughly half of corn, soybeans, and wheat production is sold in the months closest to harvest. This makes sense and isn’t likely to change much, since that is the first chance to get cash flow back out of a crop. However, it’s not usually the best time to be selling. If growers can use seasonal concerns to make good forward sales for the times they know they’ll need cash flow, and the elevator can get harvest ownership bought in advance, that’s a win-win.
This year we’ve seen spreads for corn, soybeans, and wheat react suddenly and significantly to changing crop conditions. Given uncertain 2020 production, it makes sense for elevators to lock in reasonable new crop carries, if they become available.
Given that two of the three scenarios asked about earlier are potential threats to demand, and the third might be, it makes sense for grain buyers to stay out of bidding wars that cause a tremendous number of problems and do no long-term good for anyone in the supply chain – including growers.
Mangold: Another wet spring will be difficult for the elevator to manage with the current cash structures.
Until cash structures change to tell the elevator to store grain, there is not much a warehouse can do, if fewer acres are planted for a second year in a row.
If spread structures change to a carry, then the elevator can use these old crop stocks as a financial production hedge for next year’s balance sheet. If this were to develop, then these old crop stocks could be carried until one knows they have replaceability.
Adding Grain Storage
Klemme: There is no right answer to this. Cheap money does make investments attractive, and some elevators that always have large ground piles, with the resulting costs and losses, may well be justified in expanding. Other elevators may find that cheap money would be put to better use at upgrading or replacing existing infrastructure to improve efficiency, add services, and reduce costs and loss.
Other owners who already have invested heavily in space/infrastructure may just opt to refinance with cheaper interest rates and sit tight.
Mangold: As world stocks build, the United States increasingly has become the residual supplier. The United States has been used to using this terminology on wheat for years, and it now is starting to become more commonplace when talking about corn and, at times, even soybeans.
With this past year as an exception, the United States has seen several years of above-trendline corn and soybean yields. Also, the U.S. farmer balance sheet has been tightening. This is giving more opportunity for the elevator to build space, while farmers watch their expenses.
The new corn and soybean futures spread structures going from 5 cents per month to 8 cents per month will make it clearer to management and financial lenders of the opportunity to buy and store grain off the market.
Which Crops to Plant
Klemme: Generic analysis using different yields and costs for corn, soybeans, and/or wheat shows that corn appears to offer the highest net return. But that will vary significantly depending on how a specific area’s corn yield might compare to soybeans.
Corn costs significantly more to plant per acre than soybeans, which may drive some farmers to soybeans. Or the prospect of slow planting this spring could boost soybean acres.
But that decision can be affected by exactly what crop insurance a farmer has and the provisions for prevented planting.
We recommend farmers work with a crop insurance agent who has access to a farm’s financial and Farm Service Agency data and also understands cash grain markets and can lay out spreadsheets with detailed comparisons for an individual operation.
Equally important to the planting decision is how the farmer markets that production. Farmers can forward sell grain to set a price or set only a floor price by adding options to the strategy. Given the uncertainty facing all markets this year, options on ag futures look like one of the most important tools farmers have in their risk management toolbox.
Luce: Plant the crops that have a good cost/return balance for your ground and that the local market (including exporters if they are in your local market) appears to have the most use for.
Mangold: Farmers should plant what makes the best financial and agronomic sense for their individual operation.
Ed Zdrojewski, editor
