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Alpha Factors Leading To Thin And Choppy Agricultural Markets

Third Street Ag Discusses How Chinese Tariffs, the Weather and Weak Foreign Currencies are Impacting Ag Markets

by Jessica Darmoni

Hehmeyer Trading + Investments is home to a plethora of experienced and knowledgeable managers.  One of the reasons we launched this blog was to create a space to share their expert insight and observations.  This week we are featuring commentary from Chad Burlet of Third Street Ag InvestmentsThe opinions and views expressed in this commentary are that of the author.  Hehmeyer Trading + Investments may not necessarily agree with the opinions of the author.

A month ago we wrote about the three W’s – Washington, weather, and wealth – and the expectation that they would generate considerable volatility. That clearly has been and will continue to be the case. On any given day any one or all three of those can drive price action. Surprisingly, wealth – in the form of massive capital flows and record open interest – has not led to increased liquidity. In fact, trade in the agricultural futures markets is thinner and choppier than it has been in quite awhile.

Trying to decipher the mood and direction of Washington’s trade negotiations is difficult. NAFTA was the Administration’s first trade negotiation and the lack of constructive progress there does not bode well. Since that time several other trade conflicts have arisen and none have been resolved. With Chinese tariffs set to be imposed July 6th, the USDA has said they will announce a support program for farmers on the 7th.

On the Chinese side indications are that they too are preparing for a prolonged trade war. The Chinese Central Bank has lowered reserve requirements with the intent of adding more liquidity to their financial system. They’ve also allowed the renminbi to weaken significantly. The goal there is to increase the 82% of their exports that don’t go to the U.S.

On the weather front the spring and early summer have been favorable for crop production in the central U.S. While it was the fourth hottest June on record for the continental U.S., that was more than offset by ample rain. The strongest evidence of that can be found in the record crop ratings for both corn and soybeans. There is general agreement that the first half of July will be warmer than normal and that most in the central U.S. will receive below average precipitation. The corn crop will not lose much potential during that period, but it does make the last half of July very important. Soybeans, as always, will be made (or not) in August.

Wheat ended the month of June with a bang. Despite neutral USDA estimates of acres and June 1 stocks, wheat futures exploded 5% higher on Friday. The catalyst appears to have been an unexpectedly low estimate of the French soft wheat crop by the consulting firm Strategie Grains. They lowered their crop estimate by 4.6 million metric tons (MMT) to 33.5 MMT. That type of decline was not reflected in the June estimates of other respected authorities like the EU Commission, International Grains Council, or Cocereal. Even satellite imagery has been indicating favorable crop conditions. Crops in Germany, Ukraine and Russia have been trimmed back and warrant close attention, but a poor French crop had not been on anyone’s radar.

Along with excellent condition ratings, corn’s progress has also been ahead of normal, with tasseling reported throughout Illinois. Meanwhile, one important news item for corn was EPA’s proposed Renewable Fuels mandate for 2019. They have suggested a 3.1% increase to 19.88 billion gallons. That was in line with market and industry expectations. In China, the government has sold 41 MMT of reserves via their twice-weekly auctions, a record for the end of June. Auction prices continue to hold well despite the sharp drop in world prices. The rapid expansion of the Chinese ethanol industry is given primary credit.

Soybeans suffered through their largest one-month price break in nearly four years, breaking almost 16%. The abovementioned trade war with China is given primary credit, but record June 1 stocks, the second highest planted acres ever, and excellent weather are certainly guilty of “piling on.”

The weak currencies in Brazil and Argentina have also played an important role in pushing prices lower. We are at dollar-based price levels that would have led to acreage reductions six months ago, but – thanks to the Real and the Peso – we are still expecting South America to add an additional 3-4% this fall.

Argentina’s poor crop this spring held their January–May soybean meal exports down to 7.2 MMT, a 14-year low. That has given U.S. exports a significant boost, which along with a 7.3% increase in domestic use, has given us a record board crush margin. So, while July soybeans were down 15.7% this month, July soybean meal and oil were only down 11% and 6%, respectively, to move board crush from $1.49 to $1.94 per bushel.

Turning back to the U.S.-China trade war, it has left Chinese crushers in a precarious situation. The current price spread between Brazilian and U.S. soybeans delivered into China reflects about half of the threatened 25% tariff. If a crusher buys Brazilian soybeans and the countries settle, he owns some very expensive soybeans. If he waits to buy he risks missing out on the finite Brazilian supplies. U.S. sales have been good of late, but that’s a result of Brazil switching non-China business to the U.S.

Looking ahead we are pessimistic about trade negotiations and optimistic about U.S. production prospects. That gives us a cautiously bearish bias. However, the market is already down hard and one can reasonably expect a weather scare or an optimistic trade tweet to give us a chance to make sales at better levels.

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