Soybean Meal's Excellent Journey To The Upside

Summary

• Soybeans have rallied because of the crush.
• Dry conditions in Argentina.
• Soybean meal is the primary ingredient in animal feed.
• Meat prices could get volatile.
• A rally before the 2018 planting season gets underway in the world's leading producing nation.

Each year is a new adventure in the agricultural sector of commodities markets for three reasons. First, crops do not last forever, and even during periods where carryover from recent bumper crop years, they deteriorate and lose potency, taste, and protein values. Second, each year brings new challenges when it comes to weather and growing conditions around the world. Finally, crop disease, logistical issues, and other natural events and acts of God often cause even the best-laid plans of men to go awry.

After five straight years of bumper crops in the United States and around the world, inventories are high and at record levels in the case of some agricultural products. However, five years do not guaranty a sixth, and the future is the hands of Mother Nature over the coming months as it will be the weather that determines the path of least resistance for prices. The world has become addicted to bumper crop levels each year because of expanding population and wealth. More people, with more money, are competing for finite food supplies each year. In 1960 there were three billion people on our planet, today that number stands above 7.455 billion. Each quarter there are approximately twenty million more mouths to feed on the earth.

The United States is the world's largest producer of corn and soybeans and a leading exporter of wheat. Therefore, the conditions across the fertile plains of the U.S. will be the chief determinate of prices over the coming months. During the winter in the northern hemisphere, crop production continues south of the equator. Brazil, Argentina, and other nations in the southern hemisphere are significant producers of grains. As we head into the 2018 crop year in the United States, grain prices have been edging higher, and recently the price of soybeans has moved above its short-term area of technical resistance even though the first seeds have not gone into the ground in the U.S.

Soybeans have rallied because of the crush

The price of soybeans has rallied since putting in a bullish reversal on the daily chart back in mid-January.

Source: CQG

As the daily chart of the now active month May soybean futures contract highlights, the price of the oilseed put in a bullish key reversal trading pattern on January 12 after it fell to a low of $9.5575 per bushel. Over the past six weeks, soybean futures have rallied reaching the most recent high of $10.5950 on February 26 and settling at the $10.530 level on the February 28. The rally in soybeans has been the result of a rise in the crush spread which represents the economics of processing the oilseed into meal and oil.

Source: CQG

As the chart of the May synthetic soybean crush spread shows, it has appreciated from under 100 in mid-January to its current level around 167.25. The price of soybean meal has been the culprit as it has exploded to the upside.

Source: CQG

Soybean meal was trading at a low of $314 per ton in mid-January, and it has taken off to the upside reaching its most recent high at $399.20 on February 28, an increase of around 27% over the past six weeks. The recent weakness in the dollar increased demand for soybean meal, and so have weather conditions in Argentina.

Dry conditions in Argentina

Soybeans and soybean meal have rallied because of the prospects for a poor harvest in South America over coming weeks. Dry weather continues to plague Argentina, and while the forecasts call for some erratic and light precipitation over coming days, rains that crops need to reduce stress do not seem to be forthcoming. While the longer-term weather outlook is calling for more rain in March, it may be too late to save this year's crop in Argentina.

Meanwhile, rains in Brazil are delaying the harvest and second crop corn planting causing price strength in the futures market over recent weeks. The bottom line is that the world has become addicted to bumper crops, and when Mother Nature does not cooperate, and weather causes problems, prices move higher. If we see any weather issues in the U.S. in the coming months, we could see explosive moves in the agricultural sector.

Soybean meal is the primary ingredient in animal feed

Soybean meal has appreciated by 25% over the past six weeks, and the product of the oilseed is the primary ingredient in animal feed. Ranchers and animal protein producers are suddenly facing an increase in the cost of raising herds of cattle, hogs, and other animals that eventually make their way to dinner tables around the world.

The rise in the price of soybean meal could have a significant impact on the behavior of animal protein producers and may cause a short-term glut and long-term shortage in the cattle market. If the price of meal keeps on moving to the upside, it will become prohibitive for ranchers to feed their animals and many could head to processing plants before they have reached full weights.

Meat prices could get volatile

The drought of 2012 caused many cattle and other meat producers to cut expenses by processing their animals early rather than paying the sky high prices for feed. While hog production is a year-to-year affair, it takes years to raise a herd of cattle to the weights necessary for processing into the steaks, burgers, and other meat products the world consumes.

Feed is the primary input in the production of cattle, and we could be on the verge of lots of volatility in the cattle and hog futures market.

Source: CQG

As the monthly chart of live cattle futures illustrates, following the drought of 2012, the price of cattle fell to lows of $1.1815 per pound as producers took their herds to slaughterhouses rather than paying higher feed prices. While the animals were processed at lighter weights than usual, a short-term glut in the market pushed prices to the downside. However, since it takes several years to raise a herd of cattle and lots of feed, the price rose in the years that followed reaching a high of $1.71975 per pound, a record high, in 2014. We could be facing a similar situation in the cattle market this year if the price of soybean meal and other animal feeds continue to move higher. The potential for higher grain prices is now in the hands of Mother Nature as the 2018 planting season for grains in the United States is only a few short weeks away.

A rally before the 2018 planting season gets underway in the world's leading producing nation

South American production of grains can impact prices, but the world's number one producer of both corn and soybeans each year is the United States. The U.S. is the most influential exporter of the grain and oilseed, and a significant exporter of wheat. Therefore, it will be the weather conditions across the fertile plains of the U.S. that will determine the price of grains and if animal feed continues to move to the upside of the coming weeks and months.

If we are about to see a repeat of the price action in 2012, much higher prices could be on the way. However, carnivores will likely benefit from a short-term dip in the price of beef, pork, and other animal proteins during the 2018 grilling season which begins on Memorial Day weekend at the end of May. However, the lower prices in beef could lead to much higher levels during the 2019 grilling season as a short-term glut turns into a longer-term shortage of supplies. At the same time, rising population and wealth around the world continues to increase the demand for more complex proteins as well as grains which are all food staples. Chinese imports of U.S. beef have been rising, and that is likely to continue and maybe even pick up if feed prices continue to increase during the 2018 season.

I am considering three approaches to take advantage of the current potential in the grain and animal protein markets. One is to satisfy my carnivorous habit and the other to profit from a shortage of beef supplies in the future. If beef prices dip, I will buy a freezer to load up on steaks and burgers during the downswing in prices. When it comes to my portfolio, I will look to buy ETF and ETN products that will appreciate with the price of animal proteins.

COW was the ETN product that Barclays will delist in April. COWB will replace COW, but it currently has limited liquidity. The MOO ETN has net assets of over $905 million and trades an average of around 65,000 shares each day. While MOO is a more diversified instrument, it does have exposure to animal protein prices

Source: Barchart

MOO has traded in a range from $20.08 to $66.20 since 2007 and was trading at the $62.33 level on Wednesday, February 28.

Source: Barchart

COW, the ETN that Barclays will delist, has traded in a range from $17.38 to $50.02 since 2007 and was trading at the $22.91 level on Wednesday, February 28. COWB was at the $49.38 per share.

I will be looking for COWB to build liquidity over the coming weeks and months and if we get that short-term glut in the cattle market during the summer, it may be the perfect time to get long cattle at lower prices.

Finally, DBA is the agricultural ETF product that does a reasonable job tracking grain prices.

Source: Barchart

DBA is the PowerShares DB Agriculture ETF product that has traded in a range of $18.18 to $43.50 since 2007. At $19.17 per share as of the close of business on February 28, this vehicle will track agricultural commodities prices over coming months. DBA has net assets of around $663 million and trades more than 800,000 shares each day. At its current price, it is close to the lowest level in a decade and offers value and a way to participate in rising soybean and soybean product prices.

Keep an eye on soybean meal prices; if they continue to move to the upside, we could see lots more volatility in the meat markets over coming weeks and months. In late 2018, cattle could reach a bottom and offer tremendous opportunity for the years ahead.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.