Certainly the failure to get beyond the Brexit situation, the US government shutdown, and Chinese trade battle will create demand headwinds for all commodities. However, into the end of January there are signs of progress in the US/China trade talks, and evidence of severe slowing in China should prompt them to offer more conciliatory terms. It is a very rare case for China to admit to such significant slowing, and we suspect the markets will soon be presented with very aggressive actions on the part of their government to support their economy. It is also possible that Chinese policy makers will come to the conclusion that the most effective support would be from the lessening of trade tensions. Still, our prediction of “well defined” commodity uptrends in certain markets is primarily based upon tight fundamentals, not big-picture, macroeconomic prospects.

The markets that are capable of consistent uptrends include copper, corn, natural gas, soybean oil and gold. Markets that appeared to be overdone and vulnerable to corrective action are cattle, sugar, cocoa and palladium.

Strategy over Opinion!

Given the prospect for slow, grinding gains in certain tight markets, we think strategy will help to facilitate long-term positions. Traders should consider purchasing futures, protecting that position by buying a just out-of-the-money put, and financing part of the long put by selling an out-of-the-money call.

Given that the last significant inflation period was decades ago, it is not surprising that the marketplace has become convinced that a return to inflationary conditions is extremely unlikely. In the wake of the subprime debacle, many economists suggested that a return of inflation would be decades in the making. But looking at current events, it would appear that a classic prescription for such a return has already been written and that it is coming to fruition quicker than many would have expected.

Cheap goods and cheap labor from China have been the primary deflationary impetus over the last 15 years, but the recent series of events suggests that China could become the inflationary spark in the future. China continues to consume ravenous amounts of commodities as it modernizes and pushes toward an economy more reliant on domestic consumption. Business as usual on trade relations no longer seem acceptable by China’s largest trading partner, the United States. Consequently, both countries have launched into a cycle of tariffs that will not only raise costs to US and Chinese consumers but will also result in international prices rising to match the tariff-adjusted levels of Chinese and US goods. Increased raw material prices should lead to higher wholesale prices, higher retail prices, and should eventually put upward pressure on wages.

Furthermore, China has recognized the potential threat to their economy from the cycle of tariffs and is moving aggressively to expand infrastructure activity, which should add to wage pressures and to physical commodity demand. However, China’s ability to contain inflation has moved beyond its borders and has become difficult for them to control.

Another issue that could contribute to the inflation environment is recent evidence that key foreign investors of US Treasuries are beginning to reduce their purchases. This has pushed certain US mortgage rates up to their highest levels in several years. The importance of foreign investment to the US Treasury market is magnified by the fact that US debt continues to expand. Evidence of the rotation away from US Treasury holdings was seen last month, when Japanese holdings of US Bonds fell to their lowest levels since October 2011. Even a slight removal of foreign buying in the face of expanding supply should mean US Treasury yields will have to increase that much further to attract buyers.

The record US debt is mirrored around the world, as many nations loosened money and borrowed heavily to survive the subprime crisis and have yet to work it off. A slight rise in US yields would likely result in wave of higher yields in non-US debt as well, as governments and central banks are forced to compete.

While the energy space isn’t a glaring inflationary force yet, it should be noted that US oil production continues to post new all-time highs at the same time that US crude stocks in the US have maintained a sizable, 78.6 million-barrel deficit relative to year-ago levels. Record US production is being swallowed up by domestic demand and by expanding exports. US and China refinery throughput levels continue to operate at record levels, which suggests the demand for gasoline and other petroleum products remains high. Demand for energy worldwide is such that extremely low prices in corn and soybean oil are ramping up biofuel production. This may soon provide a floor to grain prices.

The classic definition of inflation is “money chasing money,” and the cycle of tariffs, rising energy prices, rising developing-world wages, and rising interest rates sets the stage for the start of something.

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1) The USDA Outlook Forum in February pegged corn planted area at 90 million acres, but most traders are looking for the Prospective Plantings report on March 29th show corn plantings coming in 500,000 to 2.5 million acres lower.

2) The USDA pegged Argentina’s 2017/18 production at 36 million tonnes in March, down from 39 million estimated in February. We expect the crop to eventually come in at 31 million tonnes or lower.

3) The USDA pegged Brazil’s production at 94.5 million tonnes in March, down from 95 million estimated in February. We look for the crop to come in at 88 million tonnes or lower, and we have seen some estimates as low as 85.5 million tonnes.

4) The International Grains Council sees corn stockpiles falling 14% for the 2018/19 season. For 2017/18, we expect the drawdown to be around 48 million tonnes, for the largest global production deficit since 1988. For 2018/19, we see stocks coming down another 30 million tonnes, a 16% decline. If this happens, the global stocks/usage ratio would drop to its lowest level since the 1972/73 season.

5) Export demand is surging. Weekly export sales for the last five weeks have averaged 1.82 million tonnes. Sales only need to average of 470,200 each week to reach the current USDA forecast.

6) US beginning stocks for the new crop season should slide to roughly 2.0 billion bushels, down 14% from last year.

7) We look for ending stocks for the 2018/19 season to be near 1.243 billion bushels, down from 2.127 billion for 2017/18. (This estimate is based on 89.8 million acres planted, the lower beginning stocks, a 174 bushel per acre yield, and 15.125 billion bushels in usage, which is up 2% from 2017/18.)

8) China’s shift to a 10% ethanol mix means their industrial corn usage could increase by 24 to 29 million tonnes per year by 2020.

9) Early spring weather in the southern Midwest is forecast to be very wet, and this could slow plantings.

10) Index and managed money fund traders may view corn ownership as a hedge against inflation for the next year. The drawdown in world and US stocks plus the possibility that longest period in history of equity markets gaining on commodity markets may be coming to an end may attract fund buying.

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Once the focus of attention shifts away from crop losses in Argentina to the new crop situation in the US, the soybean market should be vulnerable to either a bear trend or at least a significant downside correction into the spring planting season. The USDA Planted Acreage and Grain Stocks reports on March 29th will set the tone for the new crop season. These reports typically spark heavy volatility in the markets and can sometimes set a trend into the planting season in April.

The soybean market appears to have posted a significant top on March 2nd, with crop losses in Argentina becoming better known and traders suspecting that the Brazilian crop would be high enough to offset some of those losses. The weather volatility season in South America is close to an end, and traders are switching their focus to trade issues between the US and China and whether China will move to restrict purchases of US soybeans. While China will need US soybeans over the long run, they may threaten to reduce US purchases as South America’s new crop becomes available, and this would be seen as a bearish force over the near term.

2018/19 Supply Demand Setup

The USDA Outlook Forum in February pegged their initial forecast for 2018/19 US soybean planted area at 90.0 million acres. But with November Soybeans rallying 80 ½ cents (+8.3%) off of the January lows, we are looking for plantings to come in closer to 92.2 million. Yield hit a record high of 52 bushels per acre in 2016 on nearly perfect weather, whereas yield last year was down to 49.1 bushels per acre on below average conditions. With normal weather, we could expect a yield near 49.8 bushels per acre for this coming season, which would bring production in around 4.553 billion bushels. As a result of the damage to Argentina’s crop, we should see an increase in the amount of US exports over the next several months, which could pull ending stocks 2017/18 down to 525 million bushels from the current 555 being projected by the USDA. But even with this drop, total supply for 2018/19 could reach a record-high 5.103 billion bushels.

We think the USDA’s usage forecast for 2018/19 is a bit optimistic considering that Argentina and Brazil could both have record crops next year. Therefore, we are putting total usage at 4.39 billion bushels, which would bring ending stocks in around 713 million bushels, a record high and would result in a stocks/usage ratio of 16.2%, up from 13.3% for 2017/18, 7.2% for 2016/17, and 5% for the 2015/16. This is a potentially bearish factor for flat prices and also for the July/November spread.

July/November Soybean Spread

The July/November Soybean spread fundamentals continue to worsen, and the spread seems to have put in a short-term top. Historically, July has traded to a significant premium to the November contract in tight supply years, but when ending stocks have been plentiful, July Soybeans have generally fallen to a 15 to 40-cent discount to November, reflecting a carrying charge.

The USDA is currently projecting 2017/18 US ending stocks at 555 million bushels, which is only 19 million bushels below the 2006/07 record high of 574 million. More importantly, the stocks/usage ratio is now pegged at 13.3%, up from 7.2% last year.

The chart compares the stocks to usage ratios to the lows for the July/November spread since 1971/72. The study suggests that a 13.3% ratio would point to a low in the July/November spread of around -15 cents. The current year spread traded as high as +43 ½ cents as recently as March 5th, and is it trading at +14 ¼ cents as of this writing. The low for the spread when stocks/usage reached the record high of 18.6% was -35 ¾ cents.

We expect ending stocks to remain fairly high for the old crop season, but we do not expect the stocks/usage ratio to get much higher than 13.3%, so a target of -5 to -10 for the spread may be appropriate. However, if producers in the US plant 92.2 million acres and the yield reaches 49.8 bushels/acre for the upcoming crop, ending stocks could surge to 713 million bushels and the stocks/usage ratio could reach 16.2% for 2018/19. In years when the stocks/usage was above 16%, the lows for the July/November spread have been -33, -21, -45, -40 -21 ¾, -14 and -35 ¾. The July19/November19 spread is currently trading at +35 cents.

With managed money fund traders holding a net long position of 183,711 contracts as of March 6th, the market is overbought and vulnerable to a long liquidation sell-off if traders turn bearish. Open interest is at the highest level since June 2016, so the market may experience increased selling if support levels are violated.

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For the upcoming USDA reports, soybeans could be the market with the most volatility. The recent dry weather across a large portion of the Midwest has been accompanied by very mild temperatures. Traders have become familiar with the old mantra that corn yields are made in late July and soybean yields are made in late August. The last three years have illustrated how advancements in seed technology have boosted yields, with average yields of 47.6 bushels per acre in 2014-15, 48.0 in 2015-16 and 52.1 in 2016-17. In all three years, precipitation in August was normal or above normal.

While we do not feel that soybean yields will be significantly lower than the August USDA estimate of 49.4 bushels per acre, the recent drier trend may be detrimental to soybean pod development, and that could drag yields down a shade. Indiana, Illinois, eastern Iowa, eastern Missouri, Kansas and Wisconsin all had 50% of normal or less precipitation during August. This is reflected in recent analysts’ estimates, which averaged 48.7 bushels per acre. (Estimates ranged from 47 to 50.) However, the USDA may not have the data to take down yields that much in this report given that surveys and field analysis could be only 7-10 days old.

A dry outlook for the next ten days for most of the Midwest will continue to drag on yields, and this may be reflected in the October report. Our supply/demand table indicates that an eventual 2.4-bushel-per-acre decline from the August estimate would take ending stocks down to 263 million bushels. This could take soybean prices back up to $10.50 or higher.

Any significant weakness resulting from a neutral number next week’s report could present a buying opportunity.

CORN

Corn demand data has been positive recently, with ethanol production this past week pointing to a possible 50-100 million-bushel upward revision in the USDA’s corn usage for ethanol estimate and US exports getting a boost from the weaker dollar. The recent crop tours have for the most part come in slightly below the USDA’s August yield forecast of 169.5 bushels per acre. The Farm Journal’s corn yield came in at 167.1 bushels per acre, and other private estimates ranged from 166.7 to 166.9.

The key variables in the various tours’ estimates were the Illinois and Iowa yields. The USDA has both Illinois and Iowa at 188 bushels per acre. Together these states account for 28% of the U.S. corn planted area, so a significant decline in either state’s yield could significantly affect the nation’s overall production. Crop tour estimates put Illinois’ yield anywhere from at 177 to 181 bushels per acre and Iowa’s at 181-184. The bottom line is that if the USDA takes both states down by 8-10 bushels per acre, a 3 to 4 bushel decline in the US yield is possible.

The average analyst estimate for yield in the report is 167.9 bushels per acre, with a range of 165.5 to 171.2. Our supply/demand table for corn shows that a yield on the lower end of estimates does not really push the ending stocks into a tight situation. Still, with strong ethanol use, a cheaper dollar, stronger Brazilian real, and China’s new policy of marketing old corn stocks for industrial use while boosting soybean planted area and reducing corn planted area, the peak in ending stocks may have passed.

WHEAT

U.S. all wheat ending stocks are coming down in 2017/18, but the overall supply outlook is still quite large. The average estimate for the upcoming report has 2017/18 US ending stocks coming in at 914 million bushels, down from 1.184 billion bushels in 2016/17, but the stocks to usage ratio is expected to be around 43%.

Winter wheat acreage was the lowest in more than 100 years, but the Chicago and Kansas City futures are trading back to levels seen last year. The drought in the spring wheat areas caused the Minneapolis contract to rally nearly $3.00 dollars per bushel in July, but the market has fallen $2.00 dollars off its highs.

The real issue in the wheat market is that world ending stocks are forecast to be a record 264.7 million tonnes, which would bring the stocks to usage ratio to around 36%. For Tuesday’s USDA report, the average estimate for world ending stocks is 264.3 million tonnes, little changed from last month. Private estimates have put Russian production anywhere from 80 to 85 million tonnes this year versus the August USDA forecast calling for 77.5 million tonnes. This type of increase has and should continue to be a bearish influence on world wheat prices as well as US wheat exports. Until there is a significant weather event that curtails production in one of the world’s top producing areas, wheat prices will be subdued.

Like last year, fund managers could end up using the Chicago Wheat contract as the short leg of a spread trade against other commodities. This could swell the managed money short position in Chicago Wheat to such levels that could result in violent, short covering trade action. If nearby Chicago Wheat trades down to the $4.00-$4.20 level, downside risk would be quite limited.

-Matt Connelly

The 2017-18 U.N. FAO soybean production estimate was raised 5.2 million tonnes to a near record level of 347.6 million tonnes on upward revisions for Brazilian and U.S. output. The Argentine Foreign Minister reported that the EU approved new duties in accordance with the WTO ruling against the anti-dumping that should open up the biodiesel market in the next few weeks. November soybeans traded up to 977 1/2 overnight, the market settled at 971 yesterday which is the highest settlement since August 9th. The trade continues to be concerned with the dry finish to the growing season that is limiting pod development. Yesterday’s National Weather Service 6-10 and 8-14 day forecasts expanded the below normal precipitation area into the eastern sections of the corn-belt through September 20th. The temperatures should remain below normal over the entire belt for the same period.

The Canadian stocks report as of July 31st showed canola stocks at 1.35 million tonnes down 35% from last year’s 2.09 million tonnes. The decrease was larger than the estimates of 1.5 million tonnes and left year end inventories at the lowest level in four years. The open interest in soybeans went down 4,981 contracts on Wednesday with soybean meal down 1,891 and soybean oil up 6,176 contracts. The average estimates from Bloomberg for next Thursday’s USDA report has soybean yield at 48.7 bushels per acre. The range of estimates is 47.1 to 50.0 bushels per acre. This also compares to the August USDA estimate at 49.4 bushels per acre. A yield on the low end at 47.1 would leave ending stocks at 294 million bushels (6.8% stocks/usage) and would rally prices back to the 1020-1050 level. A yield at the high end of 50.0 bushels per acre leaves ending stocks at 551 million bushels (12.8% stocks/usage) and would take the market below the 900 level. The November 970 straddle priced at 45 cents with volatility at 15.3% seems a little cheap given the recent dry weather and a report next week.

TODAY’S MARKET IDEAS: November soybeans have closed above the 100 day moving average at 959 3/4 and looks to challenge the 200 day moving average at 981 3/4. The 200 day moving average provided solid support for the market all through the month of July and settled below it on August 1st and has never looked back. The slow stochastics are approaching overbought territory but the RSI is in neutral territory. A 50% correction of the July/August break leaves additional resistance at 984. The drier trend could get some short covering prior to the report next week. Support is seen at 967 followed by 959. The next upside target for December oil is at 36.59.

Sinograin sold 641,628 tonnes out of 893,161 tonnes offered of 2014 corn at auction this morning. The 2017-18 global corn output could reach a record of 1.06 billion tonnes, up 5 million tonnes, according to the U.N. FAO report. They cite higher output in Latin America and former Soviet Union states. December corn traded to a high of 362 and settled at 361 yesterday, this was the highest settlement since August 21st. US exporters announced the sale of 253,300 tonnes of corn to Mexico yesterday. The average estimates from Bloomberg for next Tuesday’s USDA report has the corn yield at 167.9 bushels per acre in a range from 165.5 to 171.2 bushels per acre. The August USDA estimate was at 169.5 with production at 14.153 billion bushels. The spread between the high estimate and the low estimate is 5.7 bushels and shows the variance that crop scouts continue to find this late in the growing season. If the yield were to come in at 165.5 bushels per acre, the ending stocks would decline to 1.787 billion bushels and a 12.5% stocks to usage. In contrast a 171.2 bushels yield would put ending stocks at 2.263 billion bushels and a 15.8% stocks to usage.

A yield on the high end could take nearby corn back down to the 340 level while a yield on the low end could push prices back up to the 400-410 level especially with the trend following funds short close to 70,000 contracts. The latest 6-10 and 8-14 day outlook continues to forecast below normal precipitation for the entire corn-belt through September 20th. This is not ideal finishing weather for the corn crop especially with the maturity level in corn at only 10% compared to the five year average 18%. The open interest in corn went up 8,752 contracts yesterday. The average estimate for today’s ethanol production report is 1.039 million barrels per day in a range of 1.01 to 1.05 million. Stockpiles are estimated at 21.3 million barrels in a range of 21.2 to 21.503 million barrels.

TODAY’S MARKET IDEAS: December corn closed at the highest level since August 21st. With the average estimates for next Tuesday’s report showing an average yield that is 1.6 bushels below the August USDA estimate of 169.5, trend following shorts may look to cover prior to the report. The reversal action from last Thursday is also impressive and corn could continue to ratchet higher with higher highs and higher lows. The first level of support is at 358 followed by 354 with the next upside target at 366.

Obviously flight to quality and save haven are going to be featured this week in gold with other markets like silver, platinum, palladium, Bonds and the Yen figuring into the mix. Historically there might be fewer events with as much safe haven potential as the current North Korean situation. At least in the short term the dialogue and actions of North Korea is likely to be seen as slightly more important to gold, than threats from the US/allies as the market is beginning to factor in another test which the market mostly accepts will then a prelude to a US/Japanese strike. The end-game on North Korea is probably at hand and should increase volatility in gold and silver to fairly significant levels! So far we don’t think gold is “mostly bought out” yet as the Commitments of Traders Futures and Options report as of August 29th for Gold showed the Non-Commercial and Non-reportable combined traders a net long position of 262,971 contracts and a mostly bought out positioning might be 320,00 contract. However, latest reading represents a one week increase of 36,387 contracts in the net long and adjusted from the rally into the recent high we estimate the net long to be close to 300,000 contracts. Similarly the Commitments of Traders Futures and Options report as of August 29th for Silver showed Non-Commercial and Non-reportable combined traders held a net long position of 65,571 contracts and that represents a one week increase of 10,382 contracts in the net long position. The silver market is hardly overbought in our opinion and it may be able to garner more fresh buying interest than gold in the action directly ahead. In fact, silver might exhibit less volatility than gold in the coming week and might still provide safe haven gains in the event there is a historical incident! Gold derivative holdings have reached up to the highest levels since September of 2016 which is a sign of investment flowing toward gold.

MARKET IDEAS: With the Dollar not showing initial safe haven gains the bull camp is really getting the information and market action to justify a rise to the next resistance zone around and old double high of $1,353.40 with the next higher critical point coming off the weekly chart up at $1,364 and finally up at $1,399. Silver might forge less upside than gold initially but it might provide some safe haven market exposure without as much volatility as gold. Consider the purchase of 2 near to expiration just out of the money gold or silver puts for every long gold or silver futures contract!

FOREX

With very disappointing US payrolls at the end of last week the prospect of any hike in rates before the end of the year becomes much less likely. Given the lack of safe haven reaction in the Dollar last week it appears that the Dollar is going to largely miss out on a potentially major safe haven event/environment ahead. It is also possible that pre-emptive action from the US could leave the US out of favor among a large portion of the world and could also signal US instruments carry the most risk of the currency complex and that could set the stage for a fresh 2017 low! The Commitments of Traders Futures and Options report as of August 29th for US Dollar showed Non-Commercial and Non-reportable combined traders held a net long position of 2,770 contracts. This represents a decrease of 1,895 contracts in the net long position held by these traders.

FINANCIALS

While Treasuries will show some flight to quality buying interest ahead, traders need to be watchful of a currency related limitation on the prospective safe haven rally. In other words the bias might be up but in the event that the US launches an attack not sanctioned by the world community could result in the Dollar, Bonds and Notes seeing some rotation to non-US instruments. However, it is extremely difficult to take control away from the bulls this week after the disappointing US payrolls, Geopolitical issues and also because of bullish charts. The week could bring a fantastic blow-off top in prices. The Commitments of Traders Futures and Options report as of August 29th for U.S. Treasury Bonds showed Non-Commercial and Non-reportable combined traders held a net long position of 45,536 contracts which means the spec and fund long is already overbought and might become excessively overbought this week. Similarly the Commitments of Traders Futures and Options report as of August 29th for US Treasury 10 Year Notes showed Non-Commercial and Non-reportable combined traders held a net long position of 125,105 contracts. This represents an increase of 41,876 contracts in the net long position held by these traders.

End users in corn should be on alert to take action soon. The market is probing for a short-term low, and with a minor shift in weather or psychology, a short-term low could quickly turn into a major, longer-term low. Th e corn market is currently absorbing expectations for a large harvest and massive ending stocks for the 2016/17 season that will roll into the 2017/18 marketing year. US stocks are at a 29-year high, and world stocks have reached a new record…