Market Matters Blog

If History Repeats, Sizable Rallies Could Be in Store

Dana Mantini
By  Dana Mantini , Senior Market Analyst
The largest combined wheat, corn and soy complex net short by managed funds on record as of last Tuesday. (DTN ProphetX)

Certainly the 2018-19 crop year is a one of a kind phenomenon. First came the "trade war" with China, where the U.S. -- and the Trump administration in particular -- attempted to level the playing field with China -- the largest soybean importer in the world. That playing field was comprised of not only agricultural issues, but many other products, including intellectual property issues, forced technology transfers and even investment by U.S. companies in China. But make no mistake, the hardest hit sector was undoubtedly the U.S. ag sector, in particular soybean farmers and exporters, as the U.S was coming off a few years of record yields on both corn and soybeans.

As negotiations began in July of 2018, and are still ongoing, China turned to other exporting nations, most notably Brazil and Argentina, to secure supplies that would normally come from the U.S. As the U.S. and China imposed tariffs on each other, U.S. soybeans lost its biggest market and Brazilian soy sales benefited. As the negotiations were/are said to be nearing the "end game," China made token soybean purchases from the U.S. a few months ago in hopes of reaching an agreement. Thankfully, other nations imported nearly 10 million metric tons (mmt) of U.S. soybeans than they had in the previous year, which lessened the blow. However, U.S. soybean export sales, in the face of what will be a record large U.S. carryout of near 900 million bushels (mb), were still lagging badly from year-ago levels, and still are, with sales down 17% and shipments down 26% from a year ago.

Then, to make matters worse, the dreaded and heretofore relatively unknown "African swine fever" showed up in China and decimated pig herds, along with the resulting demand for feed that those herds require. African swine fever has now been found in every province in China, with more than 120 cases reported thus far, and it is still not contained; it has even spread to neighboring countries Vietnam and Cambodia. The disease is fatal to pigs, and China is well known to have by far the largest pig herd in the world. The toll on Chinese feed (and soy demand) is difficult to assess and USDA expects China's soybean imports to drop from 94.1 mmt in 2017-18 to 88.0 mmt in 2018-19. The jury is still out on the ultimate Chinese soy demand and some say it could go lower.

As if that weren't enough, Brazil and Argentina have had very favorable weather -- and in the throes of harvest -- look to have bumper soybean and corn crops again. The latest estimate for combined South American soy crops is 11 mmt to 12 mmt more than the previous year and as much as 30 mmt to 31 mmt more corn compared to last year. That will lead to not only record soybean ending stocks in the U.S., but also in the world -- and it means plentiful and cheaper corn supplies from major U.S. competitors. Even though China has not been a big buyer of corn and wheat in the past few years, the larger South American corn crops -- and a recently revised U.S. corn carryout of over 2 billion bushels (bb), along with a 1 bb U.S wheat carryout -- has pressured crop prices lower.

The widely-watched managed futures funds jumped on the bearish news above and built record large net-short positions. As of last Tuesday (April 16), funds held a combined 601,000 net-short position in corn, the soybean complex and all three U.S. wheat futures contracts. That surpassed the old record of 487,000 net shorts back in January 2018. The net effect of fund selling has sent spot soybean and wheat futures 54 cents lower since the end of March and corn futures 38 cents lower in the same time.

Although the 2018-19 crop year is unique as explained above, with a host of bearish inputs, such large fund short positions are a risky proposition. The managed funds appear confident that we are unlikely to see a China trade resolution any time soon and they are confident that -- with undersold U.S. and South American farmers likely awaiting the same resolution -- there will be plenty for sale when they do choose to exit their shorts. Weather is the only other primary input that can foil such a plan to remain short ahead of perhaps the most volatile period of the year. A look at history tells us that this plan's success can be short-lived.

What happened in 2018 when funds last held record net shorts? July corn went from $3.62 on Jan. 12, 2018, to $4.03 on March 13, 2018, -- that's 41 cents in just two months and went on to a high of $4.12 in late May of 2018. New-crop December corn rose from $3.80 on January 12 to $4.12 on March 14 -- a gain of 32 cents, and added another 27 cents in mid-May of 2018. Likewise, July soybeans went from $9.65 on Jan. 12, 2018 to $10.90 per bushel by March 2, 2018, -- a gain of $1.25 per bushel in just seven weeks. In that same time period, new-crop November futures rallied 80 cents per bushel. The managed funds had flipped their position from a combined net-short of 487,900 contracts on Jan. 16, 2018, to a net combined long of 529,600 contracts on March 13, 2018. In other words, the funds bought over 1 million contracts combined in less than two months, adding to the market rally.

A look back at 2016 shows a similar pattern when the funds built a sizable combined net-short position. On March 1, 2016, the managed funds held a short of 427,800 contracts, and by June 14, 2018, had flipped that to a net combined long of 513,800 contracts. In effect, they had bought 941,000 contracts during that period. July corn moved from $3.59 on March 3, 2016, to $4.07 on April 21, 2016, -- up 48 cents in just six weeks, but rallied up to a high of $4.39 on June 18, 2016, when they reached their peak long. July soybeans moved from $8.62 on March 2, 2016, to a high of $12.08 on June 10, 2016, -- a rally of $3.46. In that very same time frame, new-crop December corn moved 76 cents higher and new-crop November soybeans rallied $3.18 per bushel.

I know this paints a bearish landscape: a record large ending stocks, major gains in competitor production, a China trade war, a demand-stealing swine disease and lots of speculative money that seems convinced we are headed even lower. This year is certainly an exception to the other years -- we have more of a cushion for crop losses, we have unknown bearish demand forces at work and we have a trade deal ongoing, with the final conclusion an unknown. If a trade deal is consummated, and if it does include corn, its byproducts and wheat, the aftermath could be much more powerful. Managed futures funds seem confident there is no resolution in sight. However, history has shown that funds will eventually buy their contracts back, and when they do, sizeable rallies can occur.

No one can guarantee how 2019 will turn out, but the first half of this story has been seen before. Stay tuned for how the second half turns out.

Dana Mantini can be reached at dana.mantini@dtn.com

Follow Dana Mantini on Twitter @Mantini_r

(BE/BAS)

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