Newsom on the Market

Griswold's Knot

One look at fundamentals suggests cash corn is still overpriced. Different studies suggesting otherwise create a tangled knot of a problem. (DTN chart)

It's likely you've all seen the holiday movie "National Lampoon's Christmas Vacation." If not, where have you been, under a logging truck or something? Anyway, over the course of the movie, the main character, Clark Griswold, stumbles and bumbles his way through a long list of holiday headaches, including lights hopelessly knotted.

A discussion about grain market fundamentals reminded me of Clark's problem. A major ag college posted price analysis discussing the value of looking at historic high and low ends of ranges over a set period of time. The theory is that, if looking to sell, one should wait until market price moves toward the high end. Buyers look for opportunities near the low end.

While I know this isn't anything new -- unless our president just came up with the old adage of "buy low, sell high" (recall his "prime the pump" claim) -- it is an important part of making risk-management decisions. Those familiar with DTN's Six Factors will recognize it as similar to our price distribution study. This analysis places weekly close data within the range of the last five years (or 10 years) to see what percentage of weeks the market closes above the current price. While originally intended to signal upper and lower thirds of price ranges, it is more often used as a filter for buying or selling at what could be the wrong time (DTN Marketing Rule #3: Manage risk with filters).

It could be argued that price distribution is one of the most basic fundamental readings that exists. Economics 101 tells us market price is lowest when supplies outnumber demand, highest when demand outpaces supplies. Therefore, applying the idea of "buy low, sell high," if we have something to sell when prices are low, we would want to hold it and not sell. Conversely, if we are needing to buy something and the market price is high, we'll want to wait until the market comes back to the lower end before locking it in.

Looking at a price distribution chart for the DTN National Corn Index (NCI.X, national average cash price), Thursday evening's price of approximately $3.41 puts the NCI.X in the lower 18% over the last 10 years. Using this alone would suggest those holding cash corn should continue to hold and not look at making sales anytime soon.

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But what about that other fundamental tenet seen in grain markets, that USDA's ending stocks-to-use ratio directly influences price? As a side note: Most of you may not know that ending stocks-to-use was what I originally used as the fundamental component of Six Factors before changing, for a number of reasons, to futures spreads. Anyway, I've continuously updated my ending stocks-to-use studies over the years. The most fascinating has proven to be corn dating back to the beginning of its demand market with the 2006-2007 marketing year.

I've used the chart for that study as this week's column illustration. Note that there is a strong 78% correlation between U.S. corn ending stocks-to-use percent and the marketing-year average price for the NCI.X. The green dot far off to the right-hand side marks USDA's June projection of 2016-2017 ending stocks-to-use at 15.7%, and the current average weekly close of the NCI.X of $3.19. Note that this looks to be almost 50 cents above what the trend line shows cash should be averaging.

Now consider that in its May Crop Production and Supply and Demand reports, USDA released its "initial" look at the 2017-2018 crop. The bottom line, ending stocks-to-use, for the next corn marketing year was 14.8% with trend line indicating an average NCI.X price of $3.05.

Lastly, keep in mind that pure fundamental analysts still worship at the altar of USDA reports. Nothing matters as much to them, or is as infallible, as weekly, monthly or quarterly releases for the all-knowing, all-seeing USDA. I myself have pointed out that the last two years have seen USDA's May new-crop corn ending stocks projection be spot-on with its Sept. 30 quarterly stocks number 15 months down the road.

So do you seen the problem? A fundamental analyst's Griswold's Knot?

Theoretically, one can't sell because the price is in the low end of its historic distribution range. However, one has to view this year's market as overpriced based on USDA's latest ending stocks-to-use projection. Furthermore, USDA has already told us what next year's ending stocks-to-use are going to be with a trend line average price still well below where the NCI.X is currently priced.

From a fundamental point of view, what can one do? Do we do as Clark did and quickly hand the wad of unusable lights to his son Rusty, saying, "Here, you work on that."

Or do we recall that price distribution is just one of the filters we use, with the others being volatility and seasonality. Price distribution can't be the only deciding factor on whether or not it's time to sell. One doesn't have to think too hard to remember markets going to new 10-year highs or 10-year lows. The latter is freshest in the mind of winter wheat producers, the former occurring in live cattle back in late 2014.

Ranges aren't set in stone, and if fundamentals -- meaning ending stocks-to-use -- of U.S. corn don't change, the low end could be re-established sooner rather than later.

Finally, I'll leave you with one last quote from Clark. "Nobody's leaving. No, no. We're all in this together. This is a full-blown, four-alarm, holiday emergency here..."

I'll let you look up the rest.

Darin Newsom can be reached at darin.newsom@dtn.com

Follow Darin Newsom on Twitter @DarinNewsom

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