ECON 338C: Topics in Grain Marketing

1. ECON 338C: Topics in Grain Marketing Chad Hart Assistant Professor/Grain Markets Specialist chart@iastate.edu 515-294-9911

2. Price Projections and Issues with an update on the World Ag. Supply & Demand Estimates report Today’s Topic

3. Source: USDA, WASDE report, April 2009

4. Source: USDA, WASDE report, April 2009

5. Source: USDA, WASDE report, April 2009

6. Source: USDA, WASDE report, April 2009

7. July 2010 Corn Futures Source: CBOT

8. Likely Range Example: CBOT July 2010 Corn Futures

9. Likely Range Based on current futures and the option premiums for options on those futures They determine an implied volatility, a measure of the expected variability of the futures price from the current point on If you take Econ 437, you’ll learn about the mathematical models used to derive the implied volatility Given the volatility, we can outline the likely range

10. Pricing Paths Example: CBOT July 2010 Corn Futures

11. Prices Could Be Higher Example: CBOT July 2010 Corn Futures

12. … Or Lower Example: CBOT July 2010 Corn Futures

13. Reviewing recent past and the current situation in the market Using historical relationships to link changes in key variables to changes in commodity prices Evaluating if current relationships differ from historical patterns Market Situation

14. Interpreting market factors that impact prices and shape marketing and management decisions Analyzing how the changing supply and demand factors will impact price Basing outlook on economic principles, statistical analysis, and market knowledge Market Outlook

15. Outlook depends on timing Immediate: within a day or a week Short term: few weeks to few months Long term: next growing season to multiple years Different information needed for each type Market Outlook

16. Immediate Term Outlook Market timing Any scheduled market movers (USDA reports, etc.) Example: CBOT July 2010 Corn Futures

17. Short Term Outlook Prices are adjusting to balance demand with available supplies One reason to need short term outlook: Storage decisions Example: CBOT July 2010 Corn Futures

18. Long Term Outlook Buyers and sellers have time to adjust to changes in prices and quantities. Important for investment decisions and government policy setting Example: CBOT July 2010 Corn Futures

19. Private sector market analysis firms For-profit companies that sell services Often more short-term focused May be associated with a trading company In-house analysis Outlook for the company with own staff ADM, Cargill, etc. But your local elevator may offer analysis as well Sources of Outlook Information

20. Land grant universities Long term Example: Food and Agricultural Policy Research Institute (FAPRI) Intermediate to short term Examples: Iowa Farm Outlook (Grain, Livestock, Dairy), Farmdoc.com, Livestock Market Information Center Often affiliated with university extension services Commodity organizations Typically narrowly focused on commodity May miss breath of outlook Sources of Outlook Information

21. USDA Data and Analysis Sources National Agricultural Statistical Service (NASS) Production, consumption, and survey statistics Agricultural Marketing Service (AMS) Summaries of local market prices Economic Research Service (ERS) Analysis of agricultural markets and government policies Foreign Agricultural Service (FAS) Trade information and analysis Sources of Outlook Information

22. World Agricultural Supply and Demand Estimates report http://www.usda.gov/oce/commodity/wasde/latest.pdf Iowa Farm Outlook http://www.econ.iastate.edu/outreach/agriculture/periodicals/ifo/ FAPRI Outlook http://www.fapri.missouri.edu/outreach/publications/2009/FAPRI_MU_Report_01_09.pdf http://www.fapri.iastate.edu/brfbk09/BrfBk2009.pdf Examples of Outlook Information

23. U.S. Corn Supply and Use Source: USDA, WASDE and NASS

24. Iowa Farm Outlook Monthly outlook from ISU Extension Other universities offer similar services

25. FAPRI Reports U.S. Corn Utilization World Soybean Production Source: FAPRI, 2009

26. Know the source of data and analysis Understand the motivation of the source Public institution Private analysis, for sale Private analysis, confidential What are the resources and track record Evaluating Source of Information

27. Efficient market hypothesis All available information is quickly factored into the markets and embedded in the price New information and/or changes in supply and demand after the outlook alter outcomes Participants react to forecasts Outlook Issues

28. A price pattern that repeats itself with some degree of accuracy year after year. Supplies and demand Often sound reasons Widely known Linked to storage cost or basis patterns in grains Linked to conception and gestation in livestock Seasonal Patterns

29. Seasonal Pricing Patterns Source: USDA, NASS, Monthly Price Data 1980-2008

30. Charting Channel lines

31. Sell Signal A sell signal is one close below the charting lines Sell signal

32. Buy Signal Some chartists need only one close above the charting line to create a buy signal, others use two closes above. Buy signal

33. Key Reversal A key reversal is when the daily high and low price range exceed the price range for the previous two days.

34. Gaps Gaps often occur when a major new piece of information hits the market. They are often filled in by later price movements.

35. Double Tops & Bottoms Double tops and bottoms show prices with major technical resistance. These can be several days apart.

36. Head & Shoulders Source: Figure 7, Charting Commodity Futures Ag Decision Maker, File A2-20

37. Moving Averages 9 day average 18 day average 40 day average Sell signal Buy signals

38. Relative Strength Index • Looks at last X days worth of closing prices • X = 9, 14, 30, etc. • Summarizes upward and downward price movements during the period • Record the last 14 days worth of price changes, based on closing prices • Sum the positive and negative price changes and create average for each • Relative Strength Index = (Up average/(Up average + Down average))*100

39. Relative Strength Index RSI for July 2010 Corn

40. Relative Strength Index RSI’s above 70 (80) are considered signals of a market due to decline RSI’s below 30 (20) are considered signals of a market due to rally

41. Does Technical Analysis Work? Arguments for it: • Real world markets are not perfectly rational • Markets may be slow to respond to new information • Technical analysis works with the psychological biases • It works because so many people use it • Self-fulfilling Arguments against: • Efficient market hypothesis • The current price holds all of the relevant information

42. Convergence Issues Typically, as futures contracts reach maturity, futures price and cash prices at delivery points tend to converge to the same level. For several grain and oilseed futures contracts over the last few years, this has not occurred. “Poor Convergence Performance of CBOT Corn, Soybean and Wheat Futures Contracts: Causes and Solutions” • Scott Irwin, Philip Garcia, Darrel Good, and Eugene Kunda • University of Illinois, March 2009

43. Corn (Lack of) Convergence Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

44. Soybean (Lack of) Convergence Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

45. Wheat (Lack of) Convergence Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

46. Why Is Convergence An Issue? • Non-convergence indicates the market is out-of-balance. “When a contract is out of balance the disadvantaged side ceases trading and the contract disappears.” (Hieronymus, 1977) • Non-convergence adds to the uncertainty in basis and limits hedging effectiveness. Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

47. Factors • The relationship between the spread between futures contracts and the cost of carry (think storage costs) • In the settlement process for corn and soybean futures, the delivery instrument is a shipping certificate. • If it is advantageous to the holder of a shipping certificate, they can delay delivery and effectively store the grain, paying CBOT set storage costs. • Structural issues related to the delivery process • Does the general trade flow of the commodity line up with the possible delivery points under the futures contract? Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

48. Spread vs. Carry Look at the ratio of the futures spread versus the cost of carry Futures PriceNext– Futures PriceNearby Storage Costs + Interest Irwin, et al. found lack of convergence when ratio is high (> 80%) A lower ratio implies smaller returns to holding a shipping certificate and more offsetting positions are taken, lowering futures prices. If the commodity is still in storage, then cash sales aren’t happening, lowering cash prices. Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

49. Delivery Points How much of the commodity is moving through the delivery point areas? Corn Soybeans Wheat Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

50. Convergence vs. Carry - Corn Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02