Schwieterman: Good demand, tight supplies as China buys corn

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GENERAL COMMENTS:
There were several interesting developments in the markets this week. First of all the natural gas market moved higher for the first time in ages. We still have an over abundance of natural gas, but it looks like the fundamentals have finally stopped getting worse so it is possible that the market may have scored a bottom.

Another interesting move came in the May – July corn spread, which closed at a record high 27 ½ cents Friday. This is very similar to the way the March – May spread traded and the only reason I care about these huge inversions in the market is because we often see new all time highs when it happens. The reason for that, is the only reason that the spreads move like that, is very strong up front demand for the remaining supplies. It is interesting to note that the May – September spread is at the second widest level ever, but still about 28 cents short of the record, which is near $1.30. The May – December spread is more than 70 cents short of the 1996 record which was just over $1.80, so there may be more bull spreading yet to come.

Lastly the May corn moved over the May Kansas City wheat for the first time since 1977. July KW is still 24 cents over the July corn and the December KW is $1.60 over the December corn. I fear that those spreads will eventually go to zero as well.

CORN:
Trend:
Short Term Up – Long Term Down
Sentiment: Chinese buying

The corn market showed some decent strength for the first time since the March Quarterly Stocks Report and the July contract gained 22 ½ cents, nearly all of which came on Friday. The December contract only gained 2 cents.

Chinese demand for both old crop and new crop corn is one of the big reasons for the bull spreading in the corn market. We have strong basis, which is a symptom of good demand and tight supplies, in a huge part of the country which tells us that the front month futures are too low and we won’t have any deliveries unless they are forced. We also have a lot of concerns about the size of the new crop, which is keeping the December contract from keeping pace with the front months. There are analysts that believe USDA will use a yield of 166 bu/ac in the May supply and demand report due to the fast planting pace. USDA has a history of making adjustments to the trend line yield based on planting pace, so that fear is certainly justifiable. I do have a problem with USDA adding bushels to a trend line yield that is already inflated by dropping the 2011 yield from the equation and I have a problem with making yield adjustments based on planting pace, since there isn’t a very good correlation between planting pace and final yield. There have been two occasions in the past 20 years, 1994 and 2004, when relatively fast early planting coincided with record yields. However, the record yield in 2009 was achieved despite a very slow early planting pace, as was the 3rd highest yield ever in 2008, and the fastest start to planting so far, which was in 2010, led to a sub-trend line yield. Nonetheless, USDA likes to make adjustments based on planting pace and we have to take precautions accordingly. It will be very difficult for the December corn to ever get above $5.56 ahead of the May supply and demand report no matter what the front months do.

Action: I like bull spreading the market by buying July and selling December. I also like buying $5.50 puts and selling $6.50 calls in the December contract ahead of the May supply and demand report, which is May 10th.

WHEAT:
Trend:
Short Term Up – Long Term Down
Sentiment: Hoping the corn moves higher.

The July KW gained 23 ½ cents for the week, which was a little better than the July corn, but I wonder how much longer that can last. With tightening supplies of corn and wheat harvest coming on I don’t see any reason not to expect the July KW to fall below the July corn at some point.

Right now my biggest fears of being more aggressive with short positions in the wheat are the fact that the wheat – corn spreads are at extreme levels and any strength in the old crop corn should be very supportive to the wheat. Also, we are dealing with a huge net short trading fund position in Chicago and I wonder who is left to be a seller? If the corn can build on this week’s gains it is certainly possible that we will see short covering by the funds in the Chicago wheat market. Farmer selling and lack of demand will then limit any rally potential, so don’t expect to see much strength.

Action: My favorite trade is selling the December KW $8.00 call.

SOYBEANS:
Trend:
Short Term Up – Long Term Up
Sentiment: Stocks are getting tighter.

July soybeans traded over $15.00 at one point Friday and gained 44 cents for the week. Bull spreading was very active and the November contract only gained 6 cents.

The soybean market is undergoing a very interesting and very bullish fundamental shift. In the March supply and demand report USDA estimated old crop ending stocks at 275 million bushels. In the April report that was cut to 250 million, which is still way more than adequate. In the meantime the July soybeans have moved nearly $4.00 higher since December despite the large stocks, why is that?

The reason is twofold; first, early projections for new crop stocks are very tight, which tells traders that they should secure supplies sooner, rather than later, to avoid supply problems. Second, Chinese demand has improved enough and S. America production estimates have been cut enough, that private forecasts are beginning to project old crop ending stocks at 140-150 million bushels. USDA has a tendency to underestimate soybean exports and I have been saying for quite some time that they could be 50-100 million bushels too low with their old crop export estimate and now it is more likely 75 – 125 million. More and more traders are realizing this and that is what keeps the market moving higher and probably will until USDA prints a realistic export and ending stocks estimate.

Action: Be very patient with hedges.

CATTLE:
Trend:
Short Term Down – Long Term Down
Sentiment: Beef is still rising.

The beef market is still on the rise, but we haven’t scored a bottom in the live cattle futures yet. With choice beef back around $190 packer margins should be more than adequate to pay up for cattle in the coming weeks.

On the charts I am still confident that the March/April lows will hold in the August feeder cattle and I think owning call options is the right move in that market. In the live cattle the charts aren’t giving me much confidence. There are some signs of the June live cattle making a bottom, but we probably need a close above $113.50 to confirm that.



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