Executive Summary
In a very rare event the market is been subject to a strong demand pull and slight domestic supply crunch at the same time. Canadian farmers have an incredible opportunity to price all their grain at profitable levels. With the exception of wheat the S&D has tightened for each crop. By paying attention to the signs farmers can arm themselves and make wise and prudent marketing decisions.
World Commodity Stage
Now that its December most of the crop data is in. This gives us a great opportunity to evaluate the information that we have access to. In reality, we really don’t need to evaluate all information but rather take a look at a few key numbers which will set the stage until a new growing season is upon us. The numbers themselves without any context or evaluation are pretty much useless until they are properly analyzed and evaluated. Typically, a USDA or a Stats Can report means nothing to the average farmer, all he wants to know is whether or not the price is going to go up or down. And that’s fair enough, however I want to know why the market is moving and what is the driving force behind it all.
In reality, the most important number of the whole thing is the world ending stocks. This basically tell us how much is left at the end of the year. If the number is getting bigger than either production is increasing or consumption is decreasing. It is as simple as that. However, things get real complicated real fast when you start asking why? But at the end of the day the world just wants to know if there will be more or less of that commodity. Yes, it is a simple supply and demand equation. The only problem is that people have a tendency to make simple things way more complicated than they need to be. So lets take a simple approach to evaluating what is going on in 2020. Why has canola sky rocketed and wheat done nothing? The answer, my friend, is not blowing in the wind, it is in this issue of Market Insights.
Let’s examine the USDA’s world production and ending stocks for 2020 and the 5 year average. Since we really only care about 5 commodities, wheat, corn, canola, soybeans and barley these will be the ones we will be examining. Now let’s take a look at the chart above. First thing to notice is the amount of corn that is grown. It’s almost as much as the other 4 combined! Over one billion metric tonnes.
In fact, everything with the exception of canola increased in production this year. Both corn and wheat are almost 3% above the 5 year average and soybeans and barley are closer to 5%. Considering the price rally in recent months this is very interesting. Even the production of canola is hardly a major short fall - worldwide. So obviously there is something more going on in the market to justify the current rally in barley, corn, soybeans, and canola. When looking at barley it is very easy to look at the extreme export demand to justify the high price. But why? Even with the China / Australia trade spat does global arbitrage justify these high prices? To answer this question we must remove both political interference and money supply; looking strictly at the S&D to determine if this bull market has horns or not. Basically, the easiest way to do this is to look at the current ending stocks and compare them to previous years. IE. Are they getting smaller or bigger?
Without a doubt, barley, corn, soybeans and especially canola are getting smaller. Wheat is getting larger and medically speaking would be considered obese. This is why we are seeing the current prices reflect the current S&D of each commodity. Roughly speaking the soybean and corn ending stocks are 10% less than the 5 year average. Canola is approaching 20% less. Barley is basically on par with the 5 year average. However, Canadian demand is super strong. Upwards to 3.5 MMT which could be 1/3 of the Canadian crop. (the 5 yr avg is about 2 mmt).
This scenario of strong production, yet ending stocks decreasing means only one thing. It means demand driven market. There is a tremendous demand for ag commodities.
What about wheat you say. Well, wheat is incredible. Production remains super strong and both production and ending stocks have increased year over year since 2012, the exception being 2018. Just for fun, in 2010 the world produced 650,659,000 MT and in 2020 it produced 772,375,000 MT. That’s over 110 Million Metric Tonnes of wheat per year more than from 10 years ago. It takes Canada close to 4 years to produce that. Hate to say it, but the world doesn’t care about Canada’s wheat. This is why the spread between HRS and CPS will remain narrow because the HRS premium has been eroded away because everybody in the world can grow wheat plus a few other reasons.
Overall, global commodity complex is bullish and likely to remain so until demand pulls back. The cautionary tale is that production is not dropping, it is increasing year over year and when the demand pulls back for what ever reason then watch ending stocks skyrocket. When that happens then prices will plummet. However, if production starts to peak which could happen for a million different reasons, then prices will remain stable and strong. This is the reality of commodities, whether it be grain, cattle, oil, lumber or coffee. The price is always a function of supply and demand. However, the S&D formula is far from simple and when you throw things like politics, money supply and algorithmic trading just to name a few, then things get complicated really fast. Simply put, there are very few people that understand this. In fact, Ray Dalio the owner of Bridgewater investments says that its harder to beat the market then be an Olympic gold medalist. That’s something from a guy who is worth 20 billion or so. As regular people we need to hedge our bets - properly.
One of the best ways to hedge your bets is to be on the right side of the market. Update yourself with what is going on or at the very least hire Insight Ag Marketing to do it for you.
The next chart that should be explored is the ratio between ending stocks and production. Like the previous chart, the number is just a number until it is compared against something else. In this chart the measuring metric is against the five-year average. What this will tell me is the relationship between todays information and the five-year average. Basically, if the ratio (ending stocks / production) is bigger than the 5-year average than production is growing / consumption is shrinking. Again, take a look at the chart titled “Ratio of world Ending Stocks to Production” and notice how, with the exception of wheat, this year’s crop (blue line) is getting shorter. At first glace one or two percentage points don’t seem like much; however, a few percentage points means difference between comfortably sailing into new crop or running out of supplies. Take canola for example, on the surface it looks like it has only dropped 2% points. In reality, these 2% points mean that Canada is most likely going to run out of canola by June or earlier. It could easily make the difference of $200/mt or more. It’s quite obvious that these little changes in percent have huge implications. Look at wheat. This year the ending stocks are closer to half of the world production than to ¼, that is amazing. Good job farmers you sure know how to produce!!
The final chart called “World ratio of current year/ 5 yr avg.” looks at divergence between this year and the 5-year average. Basically, what it means is how far away is the current number form the 5-year average. Let’s look at canola. The ending stocks (orange) is minus 23%. This means that the ending stocks is only 3 quarters of the 5-year average. From the first chart we can see that the 5 yr avg is 6.761 MMT and this year it will be about 5.205 MMT or in other words this year’s ending stocks will be 1.089 MMT smaller than average.
And as Sylvester the cat says, Suffering succotash! We’s a goin’ a run out of canola. Then everyone jumps on the canola band wagon. Exciting times!
What this ratio can do is that it can almost represent scarcity because when the numbers are large it means a large change from the normal and people typically get excited about those kinds of things.
Examining wheat will reveal two things. One is that 2020 production is higher than 5-year average and ending stocks are also higher than 5 year average. Because both are above the 5-year average it means we are in an excess supply situation. At the farm level this means that wheat prices are not likely to increase much and if they do increase it will probably because the commodity complex is rallying than standard S&D behavior. As a professional farmer it is important to understand that wheat is likely to be a poor performer for the rest of the crop year. With wheat it is extremely important to pull money off the table when there is a profit. Not just this year, but also the next crop year. Reality says that wheat must reduce its ending stocks before it can have a stable rally. Don’t give up on wheat, just change the way you market it.
Another great example is soybean, corn and barley. Production on these three increased compared to the 5 yr average. Yet, the ending stocks decreased. This is the classic strong demand driven market. This is a recipe for strong prices and if the production decreased like it did with canola than prices could technically go parabolic. The real worry with this scenario is over production the following year coupled with decreased demand. What ends up happening is the same situation as with wheat except it is worse. That means in years like this year it is very important to be pre pricing new crop at profitable levels. Remember the S&D can flip into an excess supply scenario just as easy. When that happens, farmers get grouchy.
Bulls and Bears
Canola
With the data that we currently have, it can be assumed that Canada will basically run out of canola by June. The scenario is very bullish, yet at some point the price becomes prohibitive and the market simply stops. We should expect a very large spread between old crop and new crop pricing.
Barley
With the export market so strong one should expect the barley market to remain strong. With barley there has been a fundamental shift in the Canadian landscape. The elevator system is now heavily involved in the barley trade. This essentially means that barley will become a profitable crop across prairies because it is no longer land locked. What an export program really means is that good quality barley is no longer destined for cattle feed, but rather human consumption. This fact is a fundamental shift. Although nobody is getting rich off barley, it does pencil quite nicely.
Wheat
As mentioned above wheat stocks keep on growing, year after year. Nobody really knows when this trend will end as wheat can be grown in all 4 corners of the earth. As quality farming practices are adopted across the world wheat production will continue to increase. Thats the reality of it – just look at Russia, which has gone from a net importer to the worlds number one wheat exporter in under 30 years.
We know the S&D of wheat is on the wrong side of a bull market. Strictly speaking don’t expect wheat to mimic canola, soy or even corn. But what we can do is sell the rallies. This means that we pick a price that is reasonable and sell. Stop with the whole Twitter blah blah blah and just sell it. This is not the time to be speculating on wheat. Although, the time is coming where the S&D of wheat will roll over and a bull market will begin. Personally, I believe that bull market is just around the corner - cause, once she comes into heat, this bear market is all but over.
wrap
As 2020 draws to a close it’s a good time to plan and evaluate the next 6 months in the marketing year. This is the time to evaluate the balance between risk and reward. The risk of not pricing anymore grain vs the reward of waiting. Each crop and each farm have their own unique challenges and considerations. Remember, 4 months ago the world was NOT in demand pull market and the Canadian prairies looked as if a bumper crop was on the way. That all changed pretty quick. Something happened that spurred on this demand pull market – I have my theories, but that’s for another time. I will leave you with this very wise saying, “There is room for the Bull and Room for the Bears, but the Pigs always get slaughtered.”