Trading In The Dark During A WASDE-Less January: Calm Before The Storm

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About: Invesco DB Agriculture ETF (DBA), Includes: ADZ, AGA, AGF, BALB, CANE, CORN, COW, CROP, DAG, FTAG, FUD, GRU, JJA, JJGTF, JJS, JO, MOO, NIB, PAGG, RJA, SGG, SOYB, TAGS, UAG, UBC, USAG, VEGI, WEAT
by: Andrew Hecht
Summary

Sal Gilberte weighs in with his view.

Farmers are having a cold winter.

Grains prices stable on trade and a lack of data.

Cotton and meats are in ranges.

Pent up volatility could hit the markets.

Each month, the United States Department of Agriculture reports on the state of supply and demand fundamentals in its World Agricultural Supply and Demand Estimates report. The markets prepare for the monthly missive from the USDA and analysts in a host of agricultural futures market post their assumptions on production, exports, consumption, inventories, and prices before the WASDE report. The release of the monthly data tends to cause an increase in price variance in agricultural futures markets in the lead up to and the aftermath of the report.

In post-WASDE trading, the markets adjust to both changes from the previous USDA report and deviance from consensus estimates. Agricultural data is no different than economic reports on GDP, employment, CPI and PPI, and other leading indicators for the stock and bond markets when it comes to the impact on soybean, corn, wheat, cotton, meat, and other futures in the commodities that feed and clothe the world.

The first WASDE report of 2019 was due to come out on January 11 at noon EST. However, the government shutdown caused by the dispute between the President and the opposition leaders in both houses of Congress over border security prevented the release of the January WASDE. The agricultural markets were as quiet on Friday as the halls of the USDA in Washington, D.C., as the markets are trading in the dark without the fundamental supply and demand data.

While the most direct route for an investment or trading position is via the futures that trade on the CBOT and other exchanges, the Invesco DB Agriculture ETF product (DBA) holds positions in many of the products that the USDA covers in its monthly report.

Sal Gilberte weighs in with his view

I reached out to my friend Sal Gilberte, who is the founder of the Teucrium family of agricultural ETF products and an expert in the grain markets, for his take on if the government shutdown is impacting the grain futures markets. Sal told me:

Yes, I do think the markets will be impacted by the shutdown and no WASDE release. I believe the lack of official numbers will create some level of uncertainty that will result in very quiet grain markets until USDA numbers are released again, which is exactly what has begun to happen already.

That said, I think when the numbers are finally released there could be some excitement and some volatility in the markets because private trade estimates, most especially of South American soybean production, are beginning to deviate, in some cases significantly, from last month's WASDE estimates. The resulting reconciliation of the data, when it finally comes, could provide some volatile price action, particularly in the soybean markets, because private forecasters are starting to lower their estimates of Brazilian soy production and the Chinese have apparently bought U.S. soybeans in the past week.

Until the next WASDE report is issued, official South American production estimates and the official US export numbers are likely the most important information the grain markets lack due to the current government shutdown.

I agree with Sal that we could see some pent-up volatility in grain markets when the USDA finally releases their fundamental data. This weekend in Barron's, Sal said that the "United States government-issued agricultural reports are considered the information gold standard by traders around the world." The lack of data will likely limit market participation by hedgers and speculators who will choose to stand on the sidelines rather than trade in the dark.

Farmers are having a cold winter

The government shutdown has caused the loss of paychecks for around 800,000 of the two million government employees who do not work for the military or the post office. At the same time, farmers who receive subsidies because of the trade dispute with the Chinese are also experiencing delays in payments. The US government approved $12 billion in support for farmers after China walked away from soybean and other agricultural purchases in 2018. The checks had become crucial for the survival of farmers who are not waiting for their support checks. At the same time, farmers who are still waiting for approval of their crop totals to receive aid have seen their applications sit on the desks of furloughed government workers.

Last week, the US Agriculture Secretary Sonny Perdue said his agency would extend the application deadline for support payments past the January 15 deadline because of the shutdown as he urged Congress to pass legislation the President would sign to "end the lapse in funding so that we may again provide full services to our farmers and ranchers."

Agricultural producers in the United States are having a cold and challenging winter as they are faced with both the trade dispute and the government shutdown that has caused their revenues to grind to a halt. Many are considering planting different crops during the 2019 season, and some could walk away from their businesses given their current economic plight.

Grains prices stable on trade and a lack of data

Meanwhile, the grain futures markets have been stable over the past few weeks as the trade issues, lack of USDA data and the government shutdown have caused prices to trade in narrow ranges. However, continued optimism over the potential for a new framework for trade with the Chinese has provided a degree of stability to the markets. The prices of all three of the leading grain futures markets have been trending higher on the back of that optimism.

Source: CQG

As the weekly chart of nearby CBOT soybean futures highlights, the price of the oilseed has been moving higher from the mid-July 2018 low at $8.1050 per bushel. However, at around the $8.90 per bushel level, the price is still around 60 cents or over seven percent below where they were at the beginning of 2018. The lower price means that farmers looking to hedge their 2019 crops are faced with the challenge of lower prices and less demand if there is no resolution to the trade dispute over the coming weeks.

Source: CQG

The price of nearby corn futures has increased from the mid-July low at just under $3.30 to the $3.80 per bushel level which is above the price last year at this time. In 2018, farmers planted more soybeans than corn which has supported the price of corn which is at its highest price in January since 2015.

Source: CQG

Meanwhile, the CBOT soft red winter wheat futures are also at their highest price since 2015 during the first month of the year. However, the KCBT hard red winter wheat futures contract continues to trade at a significant discount to CBOT futures which is a warning sign for the price of wheat. The norm for the KCBT versus CBOT wheat differential is a 20-30 cents premium for the KCBT wheat.

While prices for corn and wheat are higher than over the past two years at this time and soybeans are lower, Senator Debbie Stabenow of Michigan who is the top Democrat on the Senate Agriculture Committee said that the lack of USDA crop reports will hamper farmers as they make decisions about which crop to plant this coming spring. The corn-soybean ratio is providing no help either as the new crop contracts are trading at their long-term median level. The long-term average level for the relationship is around 2.4 bushels of corn value in each bushel of soybean value. Last year, the ratio was higher leading to more bean planting.

Source: CQG

As the chart of new crop, November soybean futures divided by new crop December corn futures shows, the ratio currently stands at 2.36 bushels of corn for each bushel of the oilseed which is virtually at the historical norm. While farmers are receiving no data from the USDA on supply and demand, the ratio is offering no guide when it comes to the historical price relationship leaving farmers in the dark as they contemplate their plans for the spring season.

Cotton and meats are in ranges

The lack of USDA data is also impacting the cotton futures market as well as animal protein prices as ranchers must make decisions for the coming peak grilling season that starts in late May.

In the cotton market, the US and China are major players when it comes to production and the trade issue continues to plague cotton producers as the price of the fiber has dropped.

Source: CQG

As the weekly chart illustrates, cotton hit a new high at 96.50 cents per pound in mid-June but declined to a low at 70.65 cents in December. At the 73.26 cents per pound level on the nearby futures contract, cotton is a lot closer to the lows than the highs and lower than the 80 cents per pound level it traded last year at this time. At the start of 2018 cotton was on its way higher but at the beginning of 2019, the trend in the market has been lower. Cotton will need to hold the 70 cents per pound level of support. In recent WASDE reports the USDA told markets that cotton production and inventories had been rising, but with the lack of fresh fundamental data, the cotton market finds itself operating under stale assumptions.

In the meat markets, the USDA had been constructive on the prices of cattle and hogs going into 2019 as the supply and demand fundamentals favored higher prices in recent reports.

Source: CQG

The weekly chart of live cattle futures shows a significant bullish price trend that has taken the price from $1.01375 in mid-May to over $1.25 per pound at the end of last week.

Source: CQG

Nearby lean hog futures have moved from lows at under 50 cents in late August to 61.90 cents per pound on January 14. Both the beef and pork markets find themselves in the dark with the lack of data from the USDA when it comes to the monthly WASDE and other supply and demand reports from the agency. Moreover, as ranchers prepare for the 2019 peak grilling season, one of the most significant factors for their production decisions is the price of feed. The lack of data on grain prices, particularly soybean meal, means that they are also operating and making crucial decisions in the dark these days.

The longer the government shutdown goes on, the more dislocations we could see in the futures markets as producers of all of these agricultural products make plans with blinders on and cannot rely on anything but price trends and gut instinct. At the same time, as the impact of the lack of government paychecks increases and hits individuals and businesses around the nation, both the supply and demand side of the fundamental equation will change. Moreover, food inspections could cause additional concerns given the limited amount of government funding.

Pent up volatility could hit the markets

Eventually, the government shutdown will end, but the jury is still out as to whether the US and China can come to terms on a trade agreement within the 90-day window established by Presidents Trump and Xi in Argentina in early December. The potential for volatility in all of these markets is growing as the markets are operating in the dark with the lights off at the Department of Agriculture.

The demand side of the fundamental equation in the agricultural sector will continue to grow despite the government shutdown or the trade dispute. Global population continues to rise and has increased from six billion in 2000 to over 7.676 billion, an increase of almost 28 percent in less than two decades. The bottom line is that more people around the world require nutrition each day and the US agricultural sector plays a significant role in feeding hungry mouths around the globe.

I expect lots of volatility in agricultural markets in 2019 and the fact that many farmers and ranchers are thinking of walking away from their business because of the current financial plight could lead to shortages and higher prices later this year.

The most direct route for a trade or investment in agricultural commodities is via the futures markets that trade on the CME or ICE exchanges. Another avenue is via the many ETF and ETN products including the Teucrium products that include the CORN, WEAT, and SOYB products. For those looking for a macro approach to higher agricultural prices, the Invesco DB Agriculture ETF product holds positions in a diverse universe of agricultural futures products. The fund summary for DBA states:

The investment seeks to track changes, whether positive or negative, in the level of the DBIQ Diversified Agriculture Index Excess Return™ (the 'index') over time, plus the excess, if any, of the sum of the fund's Treasury Income, Money Market Income and T-Bill ETF Income, over the expenses of the fund. The index, which is comprised of one or more underlying commodities ('index commodities'), is intended to reflect the agricultural sector.

The most recent top holdings of DBA include:

Source: Yahoo Finance

DBA is trading at close to its lowest level in more than a decade these days:

Source: CQG

As the chart dating back to 2007 shows, DBA traded from lows of $16.72 to highs of $43.50 and was trading on January 14 at $17.13 per share which is just above the low. One of the reasons for the low price of the ETF is the effect of contango or the forward premium for the futures contracts, which causes the ETF to absorb the costs of rolling from one futures contract to the next active month. Another is the low level of prices and oversupply conditions of recent years where bumper crops satisfied the ever-growing level of demand.

The highs came in 2008 and 2011 years where weather-related shortages caused prices of agricultural products to move substantially higher. The government shutdown and trade dispute between the US and China could create a situation where the next rally in the agricultural markets is caused not by Mother Nature but by government policy decisions.

The current pressure on farmers and ranchers has put them in a position where they may not be able to afford the ingredients and equipment necessary to grow the crops that feed the world in the coming months. Trade with China and the government shutdown are a toxic combination when it comes to the future of the food supply for the world. Moreover, the limited operations of the USDA mean that inspections of the food available could create health hazards in the form of outbreaks of food-related illnesses such as salmonella and E. coli.

Most of the agricultural futures markets have been steady and directionless over recent weeks. However, we could be experiencing the calm before the storm that takes prices much higher. An agreement on trade is likely to ignite a rally in soybeans, and other grain markets would likely follow the oilseed. Moreover, a continuation of the government shutdown could cause economic disaster for farmers and ranchers and prevent them from growing the products that feed the world. I am bullish on agricultural commodities prices, given the current environment which threatens a crisis that will be the result of the unintended consequences of those making policy in Washington, D.C. Could a dispute over a border security wall threaten the food supply? The answer to that question is yes.

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.

Additional disclosure: 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.