Today’s chart was published by Tiho from Short Side of Long with main focus on agriculture and the COT report. Tiho last shared a video in post from the Economist showing the effects which El Nino could bring to the commodity prices. We at Octafinance wonder, could prices go down much when inventory levels are so low and there is no chance for a production flood at these prices?
While we do not know whether or not El Nino will once again occur this year (it failed to arrive last year), one thing is for sure: hedge funds believe agricultural commodities stand no chance of rising. As can be seen on the chart above, funds are net short and it wasn’t the case in a decade? So, the only chance for them to be right is if the secular bull market in commodities has really ended. But we wonder, even if it ended, how can the agricultural sector bull market also end, when inventory levels are nowhere near the bull highs of the 80s?
Corn Stocks to Production Levels
The peaks at the previous bubble highs were almost 80-90% stocks to production ratio. But now according to the International Grain Council, corn stocks to production levels are at 19.4% which is in the upper range of 1997-2015. Its because of the good weather in the last few years but this could quickly change.
While 2014/15 southern hemisphere harvests are still some months from completion, crop prospects in Brazil and Argentina remain mostly favourable and world production should exceed the previous year’s record. A fourth consecutive year of stock building is expected, with cumulative carryovers now seen above 200m t.
Wheat Stocks to Production Levels
The situation with wheat is similar as the one with corn. The bubble highs had 35% stocks-to-use ratios. According to the IGC, this ratio is now at 28%. At 200 million tonnes carryover stocks against 715 million tonnes consumption.
At 715m t, world wheat production in 2015/16 is forecast to be down by 1% from the previous year’s record. A small rise in global consumption is expected in 2015/16, with higher food use partly offset by lower feeding.
Soybean supply/demand balance is also similar. Despite the positive IGC forecasts: reflecting upward revisions for Argentina and Brazil, global output in 2014/15 is forecast marginally higher than previously, at a record of 320m t, up by 12% y/y. But we will have also growing demand for soyameal from feed sectors, especially in Asia, is set to boost processing, as world soybean use expands by 7%. Global end-season carryovers are seen rising strongly on a heavy increase in major exporters’ inventories. We have 16.4% stocks to use ratio, which is even lower than wheat and corn.
The COT positioning toward agriculture shows extreme pessimism toward food prices, which reconfirms the long USD macro theme. Managers believe that USD will go up and agricultural commodities will go down. But are they doing a big mistake? The prices have already gone down a lot and if the trend is to be sustained we must experience either a production flood and normalization of inventory levels or a crash in consumption, which is not something we see.
Of course, this analysis couldn’t be completed without looking into crops acreage trends as well as farmland and crop returns. The questions that must have answers are: are farmers getting paid enough to be happy and increase their production and acreage in the most important production regions? Is there a widespread euphoria to become a farmer? We leave to the readers to find these answers, but you probably feel what ours are.
Even though we prefer trading with the trend, we are cautious and against shorting agricultural futures. The reason is because with low to medium stocks-to-use ratios, any change in weather in the top production regions, could easily make the prices of these futures go up 50-100% quickly. Trading against weather is impossible. You have no edge. The only edge we believe in, is the cycles one. And after a few good production years and no problems with the crops, isn’t the time coming for a bad weather year and food prices going up?
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