Despite Dry Weather in the Northern Plains, Fundamentals Remain Bearish
In both our corn and soybean articles from May and June, we highlighted a burdensome supply picture. However, you might have noticed that for both markets, we suggested summer weather rallies might offer opportunities for selling inflated call premium.
If you've been waiting for one of those, you now have it.
Over the past 2 weeks, soybean prices have rallied roughly 13% while corn prices jumped over 10%.
But not where you might think. A ridge over the Dakotas has brought a spell of hot, dry weather to crops grown there. And while you may not think of North and South Dakota as soybean country, over 14% of the US crop is grown there.
Does that mean that the US corn or soybean crop is in danger of a substantial loss?
The irony of this summer's weather is that while Dakota crops are certainly stressed, crops in core growing regions of the cornbelt (think Illinois, Indiana, Ohio) are experiencing near ideal conditions.
That has not, however, stopped the weather bulls from blowing their annual trumpets.
The Fundamental Facts
The fact of the matter is this: Yes, there is a weather issue in the northern plains. At present 72.8% of North Dakota and 72.4% of South Dakota are in a drought. Wheat, soybeans and corn have all rallied as a result.
For this piece, we'll focus on soybeans. Corn will likely be the least affected of the 3 (less grown in the Dakotas) and wheat more-so, but wheat is a different animal that will be covered in a later update.
The fear is this. Although only 14% of the US Soybean crop is grown in the Dakotas, even a slight drop in yield could have a noticeable impact on ending stocks. For instance, the USDA's projected average yield for the 2017 soybean crop is 48 bushels per acre. If that drops only by 2 bushels per acre, soybean ending stocks could drop by nearly 40% of current projected levels.
Worthy of consideration? Of course. But it will take one heck of a crop setback in the Dakotas to have a 2 bushel per acre impact on the entire crop - especially with a virtual greenhouse effect occurring in the central and eastern growing regions.
The market could be starting to realize that. Soybean prices were sharply off their highs as the week ended. This is largely the result of a moderating near term weather outlook and a "ho hum" USDA supply demand report on Wednesday.
The USDA projected US Soybean Ending stocks for the 2017/18 crop at 460 million bushels - slightly lower than the average estimate of 485 million bushel, but still at their highest levels in since 2006/07. This largely was the result of crisp demand.
The July 12th USDA crop report projects US Soybean Ending stocks at their highest levels in over a decade.
More importantly, USDA raised global ending stocks to 93.53 million tons, up from 92.22 million tons last month. This largely was the result of higher production out of South America.
The key is this: While it is true that the USDA estimate does not yet reflect any yield loss to the 2017/18 crop, the market is likely already in the process of pricing its end.
Worlds don't end because the crop gets a bit of yield shaved off. What happens is that prices will adjust higher to reflect the slightly lower supply. The problem with weather markets is, nobody knows how much lower that supply will be and thus, they just buy buy buy - often blindly.
The result is that weather markets will often price in a worst case scenario - producing a surge in both prices and volatility - only to come tumbling down later when the damage turns out less than worst case.
Thus, trying to time or short term trade weather markets is futile and not recommended.
But for option sellers, these can be the best of times.
Surges in volatility can make the "ridiculous" strikes discussed in The Complete Guide to Option Selling available to traders.
Common traders get whipped into a frenzy and bet on a worst case scenario. The option seller positions himself to profit from anything less - and in some cases - even if a worst case scenario occurs.
Conclusion and Strategy
While the short-term weather forecast is moderating, longer term Dakota weather models remain unclear. We are not here to predict the weather (nor should you be.) What is clear is that to get a 2-acre per bushel reduction in total US yield, it will take a nearly 50% loss of the Dakota soybean crop. This would put 2017/18 US ending stocks somewhere between 240-290 million bushels. This appears to be the worst case scenario the market is pricing now. While that would almost certainly require a price adjustment higher, it would still be the second largest ending stocks in 10 years.
As discussed earlier, worst case scenarios are most often unlikely scenarios. If weather moderates in the next two weeks ahead of soybean podding in August, soybean prices will likely adjust lower. Another spate of hot weather could give prices another jolt.
We would view such rallies as opportunities to sell over inflated call premium to weather speculators unfamiliar with the core fundamentals.
Last week's weather rally was such an opportunity in both soybeans and corn. Keep alert for another one in the coming weeks.
March 2018 Soybeans
Selling the March Soybean 13.00 calls
Self-directed traders can consider the March Soybean 13.00 call on rallies and even the 14.00 call should prices break above last week's highs.
Weather rallies are tough on short-term traders. But they can bring the gravy for fundamentally informed option sellers. Use the public excitement to the benefit of your bottom line.