Market Commentary from Kottke Commodities – Commodity Capital CTA – Kenneth Stein

kottke-Logo-300x61This fall – the initial quarter of the 2014-15 crop year – has seen more extraordinary and “record” supply/demand events in more separate categories than any such period in memory. Soybeans left over from the previous year’s crop had dwindled to the tightest availability ever relative to pace of usage, followed by the largest soybean and corn crops in history, generating export business in the largest volume of soybean-equivalent (i.e., including soymeal) in history, resulting in the largest U.S. soybean export-loading week in history – to name just a few.

The managers’ opinion was that futures and spreads had overly discounted record-large soybean supplies, insufficiently considering that initial demand for soymeal would actually exceed total capacity of U.S. processing plants, simultaneously with port capacity being taxed to limits. This proved correct, but while maintaining a 50% winner/loser ratio of trades, we did not stay with winning positions long enough, partly because we could not: most of the profit generated by our core soybean bullspread position occurred after the November contract delivery (i.e. expiration) period began. We do not hold overnight positions for customers after that time.

Commodity Capital seeks positions felt to represent a high skew between reward and risk. The fine differential between safety and low potential is one that we try to navigate, in this case not with success. October was a month of potential that was not exploited.

The direction of price remains subject to large-scale uncertainties in supply/demand. The conventional view is that as a result of five years of spectacular price shocks kindled by government grain-to-fuel mandates, sufficient new land was brought into production that a period of world surplus and sustained low price is ahead. Opposing this is the fresh injection of lower grain and protein-meal cost into meat-industry profitability, extending the steep demand-growth trajectory of China and other Asia. But the mirror image of sharply reduced farmer profitability looms as a potential future supply limitation.

The sharp decline in the petroleum market might be considered as a rough parallel, reflecting new production stimulated by an extended period of high price. Those who invested on that basis suddenly inhabit a discouraging environment. New investment in drilling will be sharply curbed, but increased efficiencies will also result. Yet while it’s not possible to turn off flowing oil wells, agricultural producers can shift to other crops and refrain from planting less-productive land whose viability disappears at reduced rates of return.

The current lower-price regime will reduce area planted to corn in both traditional large exporters and recent entries. This encompasses the U.S., Argentina, Brazil, and Mediterranean exporters such as big newcomer the Ukraine, and probably Russia. Foreign-exchange weakness in the latter two and Argentina is pronounced, casting doubt over financial wherewithal of both credit and farming sectors. The U.S. still stands as the primary reliable supplier, where transactions in CME futures and options contracts offer the high-risk food business a legitimate guaranteed basis for price and execution.

Finally, because in growing crops “It’s the weather, stupid,” it must be said that giant expansion of world production this year owes much to an uncanny coincidence of near-greenhouse growing conditions in most big producing nations. A reversion to more-typical climatic divergence in the form of adverse harvest weather and planting delays is already apparent in Russia, Brazil, and Australia.