August 19, 2014
As posted on CQG.
I believe that watching and analyzing intercommodity spreads can uncover true value. It is often a better method of interpreting current price levels when contrasted with attempting to understand the nominal prices of commodities themselves. An intercommodity spread is the price relationship between two commodities. In the world of grains, soybeans and corn can be substituted for one another. Each year, when it comes time to plant the annual crop in the US, farmers often choose between the two. They usually plant the grain that offers the greatest economic rewards.
Over the long haul, the price relationship between soybeans and corn (the corn-soybean ratio) has traded at an average level of 2.2-2.4 to 1. This means that over time, the average value of one bushel of soybeans has been 2.2-2.4 bushels of corn.
When this relationship falls below 2.2:1, corn becomes expensive relative to soybeans. Farmers use corn’s economic advantage and plant a larger corn crop in years when this occurs. In 2011, 2012, and 2013 the relationship was well below 2:1; therefore, farmers planted more corn each year, which has resulted in recent bumper crops and large inventories of corn. In 2014, the relationship switched with the corn-soybean ratio trading up over the 3:1 level. This year, farmers took advantage by planting a huge soybean crop. In April, I wrote, “farmers are indeed planting more beans this year than last. It all makes total sense: soybeans are more expensive than corn this year on a relative value basis.“
Planted in the spring, the commodity world anxiously watched and analyzed the crop of 2014. Drought, excessive rains, or any weather events could damage the crop, as we saw with the drought of 2012. This year the weather conditions have been favorable and that is good news for the crop. On August 12, the USDA issued the monthly WASDE report. The soybean and corn crops are in good shape this year. Often the prices of these commodities move based on a comparison of analyst estimates prior to the release of the WASDE and the actual figures. The August WASDE reported the following:
US production came in at 3.816 billion bushels, slightly above average estimates while yield per acre was as expected. Both numbers increased from the previous WASDE report. The real surprise came in terms of ending inventories which were above last month’s number and higher than analysts thought they would be.
The bottom line: a bumper soybean crop is justifying lower prices.
US production came in at 14.032 billion bushels up from June but lower than analysts’ estimates. Yield per acre and ending US and world stocks came in lower than was expected.
The bottom line: a bumper corn crop, but not as big as expected, suggests corn prices should remain stable to modestly higher.
So far in 2014, crop progress has caused the price of corn and soybeans to fall to the lowest levels in four years. The USDA report was negative for the price of soybeans and neutral to slightly positive for the price of corn. That means that it is quite possible that the price of soybeans will continue to fall with the price of corn staying stable or moving higher. Let us look at the short-term trend in our value tool: the soybean-corn intercommodity spread.
The daily chart illustrates that the soybean-corn spread has recently fallen from almost 3:1 to under 2.8:1. Considering the long-term (monthly) chart, it illustrated that the average for this relationship is between 2.2 and 2.4 to 1. This may be the start of a big move in this relationship – a return to a long-term mean.
History tends to repeat itself, and we can learn and profit from historical price relationships like the soybean-corn spread. This spread may be preparing to return to its long-term average level while at the same time dampening overall exposure to a market sector that has been in freefall.
CQG Article: The Soybean – Corn Spread
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