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Market Analysis: Jan 12, 2007: USDA's Annual Crop Production Summary Moves the Markets

posted on January 12, 2007

As mentioned earlier, the government's annual production report sparked a rally in the corn market and wheat prices trended higher as well.

For the week, March wheat gained more than 9 cents. The nearby corn contract gained more than 28 cents.

USDA cut its estimate of the 2006 soybean crop by 16 million bushels pushing those markets higher as well. For the week, nearby beans gained 38 cents. The January meal contract advanced by $14.00 per ton.

In the fiber market, March cotton trended slightly higher this week, posting a gain of 28 cents.

In livestock, the February live cattle contract was down 77 cents. Nearby feeders lost more than $4.00. And the February lean hog contract lost 3 cents.

In the financials, Comex gold gained $22.00 per ounce. Nearby crude oil prices lost $3.25 per barrel. The Euro lost 137 basis points against the dollar. And the CRB Index fell more than 6 points to close at 288.25.

Here now to lend us their insight on these and other trends are two of our regular market analysts, Walt Hackney and Doug Jackson. Gentlemen, welcome back.

Market Analysis: Jan 12, 2007: USDA's Annual Crop Production Summary Moves the Markets

Pearson: Gentlemen, welcome back. Walt, good to see you. Doug, let's get right to it. Let's talk first about the wheat market this week. Wheat really triggered this rally back in the middle of September. Concerns about supplies and tight supplies certainly is a drought we had across a big chunk of the plains. And now as we look at wheat prices, are they strictly going to ride along with what happens to corn?

Jackson: Mark, we had a winter wheat planting report, of course, that shows acreage of about 3.5 million, very close to what the trade had expected with very good moisture conditions across much of the winter wheat belt in the United States. We have the probability here that we're going to rebuild stocks next year. And what we're going to do here is have enough wheat that we can increase wheat feeding, but with the out-of-control or arguably out-of-control situation on corn, Mark, what we'll do is just shovel excess wheat supplies into the corn furnace. But the wheat situation probably is the least bullish of the three grains with the big acreage increase, the largest in several years. If we maintain this moisture situation, we will be able to rebuild stocks and absorb those supplies, then, as an alternative feed grain, which will mean that we continue to narrow the wheat corn spread. We might see wheat come down another 30, 40, 50 cents versus corn. But again, the key factor here is, where does the 500-pound gorilla, the corn market want to go.

Pearson: All right. That's what we're going to focus on, Doug. Let's focus on corn prices and what's ahead. Obviously, we've had a huge run since the rally started. A lot of people thought the rally was getting kind of long in the tooth and maybe we'd start to see the market head the other way. Obviously after the USDA's report, surprising almost all the analysts in the reduction of more than 210 million bushels on the final number for corn, tightening up the amount of corn available going into next year. Let's talk about where we're going. All things being equal with ethanol demand where it is currently, with production where they're anticipating where that's going to be, these prices are -- have we seen the highs?

Jackson: Well, Mark, what we continue to see and we've talked about this, of course, for months on the show are the results of what is arguably an out-of-control burn-your-food-for-fuel policy out of Washington. Of course, this report on Friday was kind of a worse case scenario. We saw the biggest drop in production of last year's crop from November to the January report in history, just the opposite of what we really wanted to see. So now we have a situation on old-crop corn that is the second smallest carryout-to-use ratio ever, not anything like the 1996 situation, which some people are confusing this year with, which was a major rationing situation. This year is not a rationing situation. We had to cut demand about 750 million bushels with the $5 corn prices. we don't have that this year, but with the new set of arithmetic we have now, the market realizes that what we really must do now is increase acreage nearly ten million acres next year and have a good yield simultaneously to have any opportunity or chance to keep supply/demand in balance. Now, Mark, ten million more acres is nearly three times the biggest amount of acreage switch that we've ever seen in a nonprogram change year, so we're not sure that we can accomplish that. Washington continues to mandate or force ethanol usage. The new ag committee chairman, senator Harkin, is proposing doubling and tripling the use of ethanol. Again, mandated or forced usage is unrationable. If you're going to force people to use it, then market forces can't move to allay that problem.

Pearson: And by forcing it, you mean investment tax credits and so forth, the 51-cent blenders credit.

Jackson:Well, to force people to not use it with higher prices. Once you mandate that demand, you can't change that level of demand. And the market is afraid that this kind of proposal, which is discussed and projected within the context of a technology that we don't have yet, the cellulosic production potential is unreasonable and unattainable on a corn-based model. Can we get 12 million more acres of corn and beans annually, which is what we need to keep this in balance? And we see statements that we have no interest in Washington to open the conservation reserve program. And so what we're seeing here is an unnatural intervention in the market with one of the most obtrusive government policies that we have ever seen, and yet they're asking market forces to solve the problem. And of course, that must mean more acres. Well, how do you double and triple ethanol production and find the acres to do it while satisfying other food and feed demand at the same time? The market is scared we can't do it or, if we're going to do it, we're going to need extraordinary market prices to actually start tearing up hay ground. The pressure valve has to be the 62 million acres of hay ground we have in the United States. But, of course, hay ground is not prime row crop production area. Hay is high priced. These are the kinds of extraordinary things the market is now seeking a price level that will accomplish, and how high that is, is yet to be seen. now, mark, that said, $4 December corn, which we'll have in trading early next week, with the futures implying another 30-cent higher trade in Tuesday's session, based on where the spreads were Friday, Dec corn at $4 may be high enough. A July/Dec inverse around 35 cents may enough. Nearby corn, then, around $4.35 on the July contract may be enough for now. So this move may come to a halt next week and start to trade, but you can imagine the market nervousness and anxiety we're going to have as we head into the March 31 acreage report. If you don't confirm a ten-million-acre switch, then, of course, we're going to have to move higher. of course, if you don't get those acres successfully planted, don't have a wet spring, don't have even the thought of a hot, dry summer day or, of course, then we'll need to move to price rationing levels, and that's the $5- or $6-corn scenario. But that's not going to happen until you get into the summer. This looks more and more like the 2004 price pattern, which saw successively bullish report, the stocks report, and the acreage report in March, put the highs in in April. Once that's factored in, then you start trading the weather. Now, mark, if we have 8 to 10 million more corn acres and some of the best weather we've ever had, which is possible, then there is downside at that point. If you have 165 type yield, you can solve this problem one more year. But the problem goes on and on as this ethanol demand goes on and on, and what we may have here is just an untenable set of supply/demand statistics. and if the market concludes that, that you can't get enough acres reasonably, then you've got to take prices to a level that either dramatically cuts livestock feed demand or eventually takes prices to a level where ethanol production becomes unprofitable, and that's over $5 today.

Pearson: All right. We're going to talk to Walter about the impact on what's happening on livestock and what's heading -- what's happened already in this calf market. The poultry market has already reduced production. Obviously we'll get his thoughts ahead in the pork market, but just to finish up on corn, good weather this year. And what would our acreage number have to be, 88 million?

Jackson: With the report now Friday, we need 10 million more acres to have any room to have any kind of a good -- a balance of supply/demand next year. And that assumes a 155 yield. Remember, mark, that the yield was lower to the Friday report. People are going to come away from that realizing that the yield increased the productivity increase that's the linchpin of the salvation of the supply/demand situation by the ethanol supporters is not as robust as they had thought. The heat and pest problems that we had last year reduced yield probably more than the market suspected. So now the market will be afraid to factor in these bigger and bigger yields which are required to keep this thing in balance.

Pearson: All right. I'm hearing about cash rent increases. I'm hearing about farmland prices going through the roof. But what you're saying is this could go on for another couple of years if the ethanol demand continues.

Jackson: mark, the situation almost looks like a problem in perpetuity than based on current projections out of Washington to mandate this ethanol. You're going to have to open the CRP program by 2008. That would almost look like an inescapable situation. How you are going to double or triple ethanol and not expand acres that way is beyond me.

Pearson: the irony is we had this report today. We also had oil prices dropping to the lowest levels in, what, several months, substantially lower. If that changes, could that slow this ethanol productivity?

Jackson: Well, mark, the collapse in crude oil already has bio diesel margins -- soybean oil diesel margins at negative levels. That's where that impact is being felt, but we still may have a dollar a bushel margin in ethanol even at these prices. So you're a long ways from narrowing those margins to have any effect on what we've just talked about.

Pearson: Okay. The advice to the producer is obviously stay on top of it. What would you tell a farmer right now?

Jackson: Well, the producer who is going to make pricing decisions has got to simply answer the one singular question the market has got to deal with: how many more corn acres do you believe we're going to have to have? If you believe we have 10 million more acres, which some seed corn dealers, fertilizer dealers, and others believe we have, then the upside potential of December corn may be no more than what we saw Friday. But if you don't think we're going to have three times the record switch in acres historically, then this thing may be out of control. That is the key question.

Pearson: Let's talk about soybeans, Doug. You mentioned the situation with soy biodiesel. Really not the same fundamentals at all over the soybean world except they want to create some bear acreage.

Jackson: Well, that's right. The bean market is, you know, $1.50 overpriced from where we should be. We have the largest carryout projection Friday in the history of the United States. We're not running out of beans. In fact, we have the second or third most surplus supply/demand situation we've ever had, and yet the bean market realizes it also has a long-term problem as we go forward. You lose 6, 7, 8, 9 million acres of beans next year, u.s. Stocks will be cut in half. And then as the arithmetic works into 2008-2009, what we get is a situation that is literally out of control at that point. In fact, our work would suggest that we need 15 million more bean acres in the western hemisphere, all of which will come out of Brazil by 2009 to have any chance of keeping the bean situation in balance. So the beans are trying to manage their acreage distribution by trading in tandem with the corn. But of course, we have plenty of beans right now. But what we're going to do is have bean prices at a level, mark, that stimulates greater annual acreage expansion than we've ever seen in South America, and the question is at what level we're going to do that. Beans are profitable again in south America, but we're going to need to turn around the situation in brazil from contracting acres the last year or two to expanding acres, again, as I said, faster than we've ever seen. Anything short of that acreage expansion there as they try to compensate for our lost acres in the U.S. moving to corn and the bean situation because of untenable over time. And if biodiesel margins are practically negative today, you can imagine what the situation will be if the vegetable oil situation tightens up by 08-09. We're seeing expansion of bio diesel worldwide in Indonesia, Malaysia, Europe. We're already seeing margins collapsing there, though. And, Mark, while the corn situation is compelling and is the more immediate problem now with the ethanol, very quickly, the world arithmetic can tighten up on world vegetable oil. Any commodity that we measure in pounds, that we'll now be burning up for fuel in tons, can have a dramatic shift very quickly. So bean prices stay higher here but just trade in tandem with corn.

Pearson: All right, Doug. There you have it. That's the grain production side of it. Of course, half the corn that we produce in the United States goes to feed livestock. These higher prices have really hit this feeder market hard. Walter, let's talk about the whole picture. Fed cattle market, what do you see going forward?

Hackney: we came into this winter with a controllable, manageable, live-cattle inventory in the feedlots. We had a market at that time not driven by corn, necessarily, that created a need to sit on cattle more than they required for a full finish. And as a result, we ended up with some pounds in the feedlot that should have been in the marketplace earlier. That coupled, then, with the explosion literally in the corn market caught the feedlots totally unprepared for what Doug's been talking about. Our industry -- and that includes all livestock. Our industry is not prepared to handle $4 to $5 corn market. We simply have not geared our entire productivity or cost of productions. We have not geared ourselves for that kind of an operation. As a result, it appears we're going to have it. We have $4 corn in the commercial feedlot areas now that included some transportation. You know, you're looking at 75-cent gain cost. If we go to $4.50 or let's say $5 corn, we're going to be looking at $85 gain cost. So totally and completely prohibitive to the break-even value of the cattle finished that it will be a disastrous cash-flow return issue for the feedlot operations. I haven't got a good answer. I don't have a real strong answer for the future of the cattle feeding, hog feeding, or even poultry industry in the event our markets go to those levels. And it looks inevitable that we're going that direction according to what Doug's been talking here for several months. It has come to pass. We didn't seem to protect ourselves. We had ample opportunity a year ago at 2-, what, 45 corn. We had a world of opportunity to buy in at that level. We had an opportunity two weeks ago to buy in somewhere in the 3.25 area. We still haven't done it. Are we going to buy in at $4 corn and then proportionately buy the feeder cattle, the feeder pig, or the chicks -- are we going to buy that initial product proportionate to feed costs? Feed cost is going to drive this entire industry for as long as corn stays at these levels. There's no question about it now, mark.

Pearson: All right. Well, it's already happening in the feeder cattle market. What about these cow/calf people going forward? I mean we've had some excellent levels, Walter. We had about thirty months of outstanding calf prices. Obviously that's changing.

Hackney: Going forward to relate to what we've come from, four years of nice profits in the ranch community. The equity has been fairly solvent now. We've got most of the debt load relieved in the ranch country, and the ranch community is in good shape. The ranch community is the helpless partner in the cattle trend that we have in front of us. What's a rancher going to do? Should he bring that calf back and retain ownership and grow it at 4 1/2 corn or $4 corn? He can't do that. He's going to need to sell the calf to continue his cash-flow program. Well, what's the corn producer that's been a cattle feeder going to do? Many of our corn producers, mark, are making a very strong business decision as we speak to not feed some cattle to market that bin of corn they were saving into the ethanol program somewhere. Where does that leave livestock? It appears that we're going to be marketing an extremely lighter animal. Our diet in the U.S. is apparently going to have to get used to much less choice beef in our diets, much more select beef. Possibly grass-fed cattle are going to become more and more of a favorite in other areas besides Chicago. And hogs are going to proportionately, the average market weight is going to drop. They can't afford to produce a 265-, 270-pound market hog on $4.50 corn and the proportionate value of bean meal. They can't do that. That's becoming the problem that we are living with. We had some warning. I can recall sitting here with you and Doug, and I recall last fall when Doug was warning us of this exact issue that we're experiencing. But I'm not aware of very many livestock producers that took it to heart to the point of doing something about it. Now, it's not a thing like in '96, it ended and we went back to, if you will, reality. According to what I hear, that isn't going to happen. We must prepare our productivity to $4 to $4.50 corn, I suppose, at a minimum. Well, the only way you can do it, mark, and you being a cow/calf producer, would be the first to suffer. You're going to be the target of the cattle feeder to make that first cost initial feeder animal proportionate to his feed costs. The only way it can go is down. I'd be -- I'd be concerned as a cow/calf operation going into 2007 this next spring when I'm dropping those calves expecting to deliver them in October at 550 to 600 pounds instead of the $1.20 that we looked at this previous year. We have to wonder if they're not going to be closer to $1 a pound. Where is his cost to production? His cost to production, instead of being 80 cents a pound, is going to be 95.

Pearson: A lot higher. And so we're looking at higher beef, pork, and chicken prices as the corn market moves higher. Thanks, Walt, and thanks, Doug.

Tags: agriculture commodity prices corn crops markets news USDA wheat