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Agricultural MarketsWritten by HardAssetsInvestor.com Despite all the attention spent on oil, copper and gold, agricultural markets were actually some of the first markets where commodities futures trading took off, and they remain some of the most important markets today. Increasingly, they've also become some of the most profitable. Futures From The Farm What do we mean by agricultural commodities? Basically, if it walks or grows on a farm, you can trade it. Take a tour around the neighborhood supermarket and everything you see is tradable, either on the spot or futures markets. Start at the meat counter (pork bellies, cattle, hog), then walk down the dairy aisle (milk, butter). Don't forget to pick up a few things for breakfast (coffee, sugar, cocoa, orange juice), and on your way home, stop at the farmers' market for a few more items (corn, wheat, oats, soybean, rice). All those agricultural goods are traded on one commodity market or another (Chicago Board of Trade, Kansas City Board of Trade, Chicago Mercantile Exchange, New York Board of Trade, New York Mercantile Exchange, etc.). It used to be that the agriculture markets got very little attention, aside from the starring role orange juice futures had in "Trading Places." Even today, you have to search the tables in the back of the business section to get any pricing information ... if the tables are published at all. Energy, gold, copper ... prices for those products are all top-of-the-news items; but unless you live in Iowa, you'll hardly ever see the financial media discussing the price of corn. Just try getting quotes for soybean prices on Yahoo Finance! If you haven't been able to follow the agriculture markets over the years, what you've missed has been a strong bull market in a wide variety of agricultural commodities. The market has been acting like a balloon: As market forces push down on one corner of the market, it simultaneously pushes up on another. Take, for instance, the tight interrelationship of corn, wheat and soybeans. Corn prices began rising sharply in 2005 and 2006, as political pressures and rising energy prices drove a boom-time in the ethanol business. Farmers, anticipating high prices, ploughed under wheat and soybean fields in order to plant more corn. Investors bid up the price of corn to match, with prices rising above $4/bushel from just $2/bushel earlier in the decade. Of course, as all the corn was harvested, corn prices fell, dipping toward $3/bushel in mid-July. But as farmers plowed under their soybean and wheat fields, the price of those commodities soared, as the expected harvests fell. Wheat prices, aided by droughts in Australia, doubled in 2007 to hit new all-time highs. All this interest in agricultural commodities has been matched by rising volumes in the futures markets. Corn futures volume has doubled in the past three years, while wheat futures have grown even faster. As discussed in "Pork Bellies and Corn, Anyone?" agricultural commodities have been rising over the past few years on a trifecta of inputs: the coattails of the broader commodities boom; high hopes for ethanol; and a rising interest among hedge funds and other traders. That last point has particular relevance to the agricultural markets, which despite growing volumes, remain often thinner and more prone to influence than the energy and metals markets. According to Barclays Capital, the amount of money invested in commodities by institutions (i.e., pension funds, endowments, mutual funds, etc.) has risen nearly 17-fold since 1999. JP Morgan Chase calculated that hedge funds, commercial banks and Wall Street firms have poured about $50 billion into the market. The influence of these traders can add volatility to the marketplace. Beyond hedge funds, however, it's easy to see why the agricultural trading pits are volatile and exciting. Ag markets, like all financial markets, react to information, news and data. But unlike the equity or fixed income markets, where information and data proliferate, the agricultural markets trade on relatively little input. So an isolated event or report can significantly impact the market. Take, for example, what happened in the orange juice pits on December 11, 2006. The Agricultural Department had previously estimated Florida's orange juice crop at 40 million boxes, but a larger-than-expected revised estimate caused the orange-juice futures market to plunge, testing the daily price limit in the process. Only two sessions earlier, the futures had set a two-week high. What caused the Agricultural Department to revise its crop estimate so much higher? Apparently, and we're not making this up, there are fewer oranges dropping from trees. So it's the old supply-and-demand factor: With more oranges on the trees, and fewer on the ground, the Ag Department concluded that supply will be much greater than expected, and that blindsided the market. But there's more to the ag markets than supply and demand, and recent history is giving investors whiplash. The Example Of Wheat Wheat is in everything you eat and drink, and it’s been a hot market for commodity traders. So think you’re ready to invest? Well, it pays to know a thing or two about what wheat is ... and what drives wheat prices. There are two main types of wheat in the U.S.: winter wheat and “normal” (or seasonal) wheat. Winter wheat gets planted in the Midwest during the fall, grows a little bit, then goes dormant until spring. If everything goes as planned, the wheat wakes up in the spring and makes for an early harvest come July. Seasonal wheat gets planted in the spring and is harvested later in the summer. So, come spring, you might guess that it would be easy to gauge how much wheat is coming down the pike, right? Not exactly. Just look at what happened in 2007, easily one of the craziest years for agriculture in decades. Heading into the end of March, expectations were that farmers would plant a lot less wheat that spring. After all, there's a lot of competition for good soil these days from the high prices of corn and soybeans. But when the USDA released its “prospective plantings” report on wheat, investors were caught off guard: Wheat acreage was down, but it was down less than anticipated. As a result, wheat prices fell. Fast-forward two weeks: On April 13, the USDA released an update on the condition of the winter wheat crop. It turned out that conditions were worse than anyone expected, and harvests would be terrible. Needless to say, the price of wheat soared. As weather improved as spring stretched into summer, people got optimistic again, and prices fell. Then drought set in in Australia, and wheat prices in the U.S. almost doubled. Up, down, up, down: It’s the agricultural commodity trader’s lament. And while the local impacts can be staggering – in parts of Illinois, farmers lost 100 percent of their winter wheat crop that spring – the impact on investors can be just as large. More than any other type of commodity, agriculture lives at the whim of completely uncontrollable events. Here's a hit list. Investors In The Hands Of An Angry God Ah, Mother Nature. Farmers the world over live and die with an eye on the weather. Too wet or cold? Can't plant yet. Too dry or hot? The crops suffer. Early frost? The harvest suffers. The reason we are wired to genetically pay attention to the weather has nothing to do with surfing and skiing, and everything to do with farming; it’s basic survival. Drought Periods of drought not only lower crop yields, they often influence what farmers plant in the first place. In Alabama, as in other states, many farmers were tempted in 2007 to plant more corn due to record high corn prices, and many switched cotton acreage over to corn. But the massive drought in summer 2007 made that a bad bet, because corn takes more moisture to survive than cotton, and it needs to be planted earlier as well. Those farmers who made the switch counting on rain got hurt. Catastrophe Hurricanes in Florida in 2004 and 2005 damaged citrus groves so badly they still haven't recovered. Trees were uprooted and thrown across the landscape, leaving nothing but wind damage and dirt. The hurricane winds also spread citrus canker disease, which had been plaguing the industry since 1995, creating a virtual epidemic. To combat the disease, many groves had to be burned to the ground in order to try and stop the spread. To make matters worse, many of Florida's nurseries were infected, and still don't have new trees to replace the ones that were lost. The result? A long-term crash in orange production. In 2004, Florida produced 242 million boxes of oranges; that harvest will drop to just 132 million boxes this year. These kinds of stories are far from rare -- Hurricane Katrina did the exact same thing in Texas and Louisiana, spreading Soybean Rust (a nasty fungus) throughout the South. As tragic as these stories seem, smaller crops translate into higher prices for the farmers who manage to survive – if demand stays constant. In December 2006, the price for a box of oranges was about $10; before the hurricanes, boxes were going for $3. Disease Disease isn't just a by-product of hurricanes; it's often a catastrophe all by its lonesome. The fashionable cover girl of crop diseases today is the aforementioned Soybean Rust. Mostly, it’s been confined to the South, but in 2007, farmers in Iowa found a single contaminated leaf in a bin used to store and transport soybeans. Here’s how big a deal this was: This leaf couldn't possibly have impacted the 2007 crop, as Soybean Rust can’t survive Iowa winters. Still, the very fact that a contaminated leaf made its way into Iowa made front-page news, and rattled the markets. In 2004, a similar scare in Minnesota pushed soybean prices to a 15-year high. Unreasonable? Maybe. But the fear isn't without justification. In South America, where the disease has plagued farmers for years, infected fields show crop yields 50-to-80 percent lower than clean fields. And rust isn't the only disease to worry about; farmers can choose from a whole menu of bad guys. No wonder the biotech companies are pumping money into newer insecticides and genetically altered, disease-resistant crops. Soybeans aren’t alone in the infirmary ward. In 1970, corn blight shook the farmers (and the Chicago Board of Trade), as crop yields in the Corn Belt dropped 10-to-40 percent. Prices rose sharply, and speculators were quick to get in on the action. It was of such concern that on September 6, 1970, a NASA news release stated that satellites would be used to spot corn blight infestation. Sunspots Yes, sunspots. Such is the specter of agricultural influence that actual academics – real honest guys with yellow ties and pocket protectors – investigate the link between sunspots and wheat yields. No theory or connection is too wild to investigate! The Market All of this craziness is incredibly important to the futures investor. Indeed, the original futures markets were created just for the purpose of mitigating this insanity. In the 19th century, grain markets were established so that farmers could bring their crops and easily trade them to distributors. Trading for next year’s crop at today’s price – whatever price you could negotiate – offered both parties a way to take risk out of their business. Underneath all the ETFs and candlestick charts, that's still the point of the agricultural futures market; fundamentally, the business of farming is what moves prices. So what does that mean for the non-farmer who wants to get into agricultural commodities? Think like a farmer. Information is your best friend. Learn to love the weather reports. Haunt the USDA Web site. Find the spots where the market seems to be overreacting and take advantage of the fear. Because at the end of the day, there's always next year. |
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