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WPI Spotlight

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In my near 40 years in the business, no truer words have been spoken that what I've read in Ag Perspectives. WPI Client and Risk Manager

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We Have the Markets Right Where We Want Them

This article originally appeared in the 23 July issue of Ag Perspectives. 

By Mike Kreuger

The chatter surrounding the markets today was interesting. The bullish stories discussed the shrinking wheat and feed grain crops in the EU, and that included the near panic buying by EU feed manufacturers. USDA pegged the EU wheat crop at 145 MMT in its recent report, but some are now talking about a sub-140 MMT crop.

Other bullish talk was (again) about reduced yield expectations in Russia coupled with the potential for quality losses. Perhaps Russia’s explosion of cheap wheat exports is about to take at least a temporary hiatus. Canada’s crop might also be getting smaller. The map below shows the deviation from normal precipitation across western Canada for the 90 days that ended 16 July. It does take some rain to make grain, especially when subsoil moisture reserves were low to start the season.

The bearish side of today’s script included the same things we’ve been talking about for many weeks now, including the following:

  • Trade wars, especially the China problem with soybeans
  • Great U.S. corn and soybean crop ratings with no weather threats on the immediate horizon
  • The slow U.S. wheat export pace despite world supplies starting to quickly tighten

And how did U.S. futures respond to start the week? They appeared to be bored to the brink of death. Soybeans were slightly lower with corn slightly higher and wheat mixed. Volume was light. No one seems to care about the increasingly positive, possibly even somewhat bullish, outlook for wheat and feed grains and even perhaps soybeans.

WPI has penned several supportive stories about the developing corn and wheat situations in just the past week or two. Those opinions haven’t changed. In fact, it’s nice to see we aren’t alone in our analysis.

So, in a sense, we have the markets right where we want them. The speculative money isn’t yet willing to buy into the developing bull story in wheat and feed grains. That allows ample opportunity for consumptive buyers to use whatever means they can to increase coverage. Futures, options and rail freight all appear cheap, and markets are very relaxed and comfortable.

None of these bullish factors are similar to what happened five or six years ago, but world supplies are shrinking, particularly among the major exporters. Should the U.S. and China decide one night to end the trade war, it is the upside that is open rather than the downside.

Dissecting the Trade War; Squashing Losers

This article originally appeared in the 6 June issue of Ag Perspectives.

By Gary Blumenthal

Dissecting the Trade War

Wrong Goal: During this past weekend’s bilateral negotiations, China offered to buy $70 billion worth of American farm, energy and other products – but only if the U.S. immediately reversed course on imposing tariffs. The Trump administration has declined, seeing the energy purchases as merely redirected trade from other buyers and understanding the near-term limits of farm export supplies. This is precisely why the negotiation should involve the concession of improved trading terms (reduced tariffs and nontariff barriers) and not micro-management of specific transactional outcomes.

Wrong Coverage: Journalists like Margaret Brennan now regret the way they covered trade in the 2016 election. She says they focused on Hillary Clinton reversing her support of the Trans-Pacific Partnership (TPP) instead of “covering trade issues in a real way.” It is unclear what she means by a real way, but ever since the 1992 election debate about NAFTA, the media bias has been to emphasize the opponents of trade and the harm it causes. Presumably, Ms. Brennan means they will now cover the topic to reveal the harm from Trump’s supposed protectionism.

Heroes and Villains: The way the media has covered trade in recent days is to produce supportive headlines for Republican resisters to Trump’s trade war such as retiring [emphasis added] Senator Bob Corker and anti-tariff GOP financiers, the Koch brothers. It is very unusual to see praise from the media for the Koch brothers, especially since their pipeline business depends upon cheaper imported steel. Meanwhile, the headline on House Majority Leader Kevin McCarthy is that he is a “lap dog” and unworthy of rising to become House speaker due to his backing of Trump’s trade war. Reporters writing about congressional legislation to constrain Trump’s tariff powers are confusing the highly unlikely with the possible.

Base of Support: By contrast, the Washington Post’s David Von Drehle is astute in his analysis. Trump’s narrative is that he is a rulebreaker who gets results, but he is having to fight hard against the enemies of change. Those who voted for Trump want the status quo broken, and so anyone pining for him to change course back to the conventional are delusional. The conventional approach to trade policy has brought $800 billion annual trade deficits to America, so it is time to try the unorthodox. Politicians espousing a reversion to the conventional approach will be crushed at the polls.

China’s Approach: President Trump boasted to American farmers this week that “By the time I finish trade talks…,” our three largest trading partners (China, Canada and Mexico) will remove barriers to American products. And what about Europe? Brussels needs to take note of how the Wall Street Journal’s Jason Gay describes Donald Trump. He writes, “President Trump lives for the fight. Conflict is his fuel. A battle allows him to dictate the terms, stretch the drama, poke his opponents. He wants his enemies to jump into the Octagon.” Yet, going to battle with him remains the path of choice for many of his opponents.

Squashing Losers

At the start of this week, the headlines announced a “compromise” had been found on ethanol. The deal was dead within hours, crushed by the two Republican senators from Iowa, Joni Ernst and Chuck Grassley. The plan would supposedly have diverted volumes of ethanol from smaller exempted refineries to larger ones, permitted summertime use of E15 and allowed exported ethanol to qualify for RINs. The latter option would undermine the domestic market for ethanol and provoke import barriers abroad. Ernst announced that Trump “won’t sign a deal that’s bad for farmers.” Rent seekers are a formidable crowd in Washington.

Soy Complex and Crushing Margin Forecasts

This article originally appeared in the June 2018 issue of WPI's Ag Review. 

By Matt Herrington

U.S. soybean crushing margins are likely to drop significantly in the next three months based on econometric forecasts of global soybean, soymeal, and soyoil prices. Soymeal and soyoil prices for the U.S. and Argentina (the world’s two largest exporters of these products) is forecast to drop substantially through early September, which will erode U.S. crushing margins. While the present U.S.-China trade war is making soybeans much cheaper for soy crushers around the world, product prices are expected to fall further than input costs. 

Econometric Methods

To obtain these results, data for the various “legs” of the soybean crush were obtained from WPI’s proprietary datasets, DTN, and USDA AMS. Initially, the data incorporated into early models included soybean, soyoil, and soymeal prices for the U.S., Argentina, Brazil, China, and the Black Sea region, along with exchange rates for relevant countries. Additionally, domestic demand variables (U.S. cattle/hog/poultry inventories as a proxy for domestic soymeal use) were included as explanatory variables. 

Various econometric methods were used to isolate the most pertinent variables that influence U.S. soybean crush margins. These tests suggest (from a statistical standpoint, at least) prices for U.S. soybean, soyoil, and soymeal; Argentine soyoil and soybeans; and Brazilian soybeans explain the greatest degree of variation in U.S. soybean crush margins. Intuitively, these results are logical as the U.S. and Argentina are competitors for world soyoil markets, while the U.S. and Brazil compete more aggressively for soybean exports. Despite the competition between the U.S. and Argentina for soymeal exports, the model selection process did not suggest Argentine soymeal exerts a significant influence on U.S. crushing margins. 

Notably, econometric tests suggest China is a price-taker in the soybean market, rather than a price-maker. Similarly, shocks in Chain’s soymeal market tend to stay isolated within that country’s borders while Chinse soymeal markets more readily absorb shocks from non-China soymeal markets (the U.S., for example). This may have important implications for world soy markets as the trade war between the U.S. and China progresses. 

The econometric methods chosen for this research suggest U.S. soybean crush margins can largely be modeled by first forecasting prices for the following variables: 

  • Argentine soybean and soyoil,
  • Brazilian soybeans,
  • U.S. soybean, soyoil and soymeal. 

Three-month forecasts were generated using Vector Autoregressive Moving Average (VARMA) models for the aforementioned six variables. VARMA models allow for modeling and forecasting of independent but correlated explanatory variables. Accounting for the correlations between the “legs” of the soybean crush around global markets is clearly important, given how shocks in one market are (typically) quickly transmitted to others. 

Results 

The results of this effort suggest U.S. soybean prices will likely rebound in the coming month before making new lows for 2018. Given the technically oversold conditions of July soybean futures as of this writing, a modest rebound is a logical (and, arguably, likely) outcome for the market. Similarly, unless the U.S.-China trade war is resolved soon, U.S. soybeans will remain priced at a discount to South American-origin product. Thus, the model’s forecast appears logical given the fundamental dynamics presently observable. 

The VARMA model results suggest Argentine and Brazilian soybean prices will also move lower over the next three months. This is somewhat surprising given the increasingly prominent role these countries will serve supplying China’s soybean needs. It is important to note, however, that model results do not suggest Brazilian and Argentine soybean prices will “fall off a cliff”, rather they will retreat to near 2017 lows. 

U.S. and Argentine soyoil prices will largely remain on the defensive over the next three months with a modest rebound beginning in September. Argentine soyoil prices will fare better and hold near present values with nearly equal chances for upward and downward price movements. U.S. soyoil prices, however, face more bearish prospects with model runs indicating the possibility of prices below 2017 lows. With U.S. soyoil ending stocks forecast to increase 400 million pounds in 2018/19, lower prices seem inevitable with a strong probability of sub-30 cents/pound values. 

Finally, U.S. soymeal prices are forecast to continue their recent fall, retreating to the $330-$360/MT range observed for much of 2017. While domestic demand should remain robust for soymeal, lower prices for competing products (e.g., DDGS) will pressure prices. Soymeal prices, however, are known to be volatile and model confidence in predicting soymeal prices is less than other commodities. 

Together, these forecasts suggest U.S. soybean crushing margins will rapidly move lower through the summer. Presently estimated at $1.80/bushel, this forecast suggests an early-September margin of $0.46/bushel, which would likely put all but the most efficient crushers in the red after accounting for fixed and non-soybean variable costs. 

The potential good news for soybean crushers is that the upper bound of the forecast’s 90-percent confidence interval suggests crush margins could remain near present values through September. 

Notably, there is a large standard error on the crush margin forecast due to the fact it is dependent on other forecast’s standard error. To put it simply, a forecast based on a forecast is fought with error. Additionally, the models have a mean-reverting pattern, where long-run average values have a significant “pull” on the forecast value. As such, the model may underweight recent, fundamental market changes and overweight historic values. This fact is submitted as a caveat to these results, as is the old saying that “All [statistical] models are wrong, but some are useful.”

Implications

This research suggests crushers should pursue aggressive risk management strategies to protect margins while they are available. Firms at risk from falling soymeal prices should be aggressively mitigate this risk while end users can procure product as needed. Soyoil and soybean prices will likely remain defensive and volatile but have a smaller downside risk profile than does soymeal. For investors, the next three months are likely to be a period when agribusinesses with crushing operations face profitability headwinds that may reduce earnings.  Prudent investors may wish to examine a firm’s exposure to crushing margins and adjust price appreciation expectations accordingly. 

 

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