Low Prices Cure Low Prices

You have doubtless heard the trade axiom stating "low prices cure low prices." It tends to make an appearance any time commodity markets are under pressure. The missing part of the statement, usually said in a whisper, is "eventually." Commodity bulls, including most producers, are prone to dragging it out after a 50 cent or $1.00 decline, hoping that they have seen the full extent of the damage. They typically fail to recall how volatile prices really are over a 12-month period. One could argue that low prices are those at the bottom of an average annual trading range, having moved about as far as they usually go in one direction.

Here are some of my calculations of those 12-month average moves, using nearby futures prices over the past 31 years:

Corn	$1.41
Soybeans	$2.87
Wheat	$1.85
Cattle	$18.49
Hogs	$27.92 (39 years)

With the 2014-15 corn high at $4.39 during the marketing year, the low would be $2.98, or $1.41 below that figure. The lowest third of the price range would be $2.98 to $3.44. With the spot-month futures high for soybeans at $11.11 in 2014-15, the low with an average move would be $8.24 and the lowest third of the range would be 94 cents from the low, or $8.24 to $9.18. We are clearly in the lowest expected third for soybeans.

We have to remember the mechanism for the axiom to work. Once prices are actually perceived to be low, two things tend to occur. 1) Production growth slows or even declines due to poor profitability, and; 2) Consumption increases in line with the price elasticity of the commodity with lower prices driving more use of the commodity and with less substitution of alternative goods. The combination of 1 plus 2 eventually results in consumption exceeding production and a drawdown of surplus stocks.

Wednesday's USDA numbers show the low prices axiom at work. USDA projected world ending stocks were decreased from last month for corn, soybeans, wheat and cotton.

In the case of soybeans, 2015-16 world production at 320.21 million metric tons is up only 0.05% from the previous year. That is less than a 2 mmt rise after several years with 20 mmt hikes.

Soybean consumption is also rising, with crush hiked 2.18 mmt from the February estimate. The March figure of 278.04 mmt would be 15.65 mmt larger than last year, a 5.9% increase. The 20-year average increase in soybean crush is 5.3% per year, so there is some 'extra' response to the lower prices. World soybean crush this year is still anemic compared to the growth rate from the two previous years (8.95% and 8.78%). Those were coming off of a high-price period in 2011 and 2012 when world crush use was slowed to a 3% pace.

USDA may still be underestimating the growth of annual soybean crush use, given the response in previous low-price periods. The projected global stocks-to-use ratio is already seen dropping to 24.97% at this pace, but last year is a pretty good guide. At one point, the stocks-to-use ratio estimate for 2014-15 was over 30%, but the current number for last year (still being revised) has tightened to 25.76% as consumption data has proven to be larger than initially computed. Tighter stocks-to-use ratios are correlated with higher average cash prices for soybeans around the world. Low prices cure low prices, eventually!

Alan Brugler may be reached at alanb@bruglermktg.com

(AG/BAS)

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