USDA Bullish Surprise: Violent Volatility Ahead

Markets ShakeI compare this week in the markets to a wild ride I had over Iran 2 1/2 years ago after leaving Dubai.  About 30 min. after the flight had left Dubai, the Emirates airliner shook uncontrollably, jostling the passengers like never before.  Your loyal scribe who is prone to motion sickness had all my defensive manifestations in place.  It was the roughest plane ride I had ever experienced, so bad people were screaming in fear.  Then, it all evened out, the captain came on and said everything was going to be okay.  The rest of the flight to Bangladesh was smooth as glass.

Rewind to this past week in the markets.  With the United States having its credit downgraded by Standard & Poor’s last Friday, it only stood to reason that global markets would tank come Sunday night and Monday morning.  That is exactly what happened as stock markets around the world plummeted on the news that the greatest economy in the world was not as creditworthy.  The grain markets were paddling upstream against this great deluge and could not maintain themselves even though our fundamentals are fairly strong.  While trillions of dollars of wealth was evaporated over a few days the grains also lost ground.  Then came the August 11 USDA report.  A bullish surprise was right around the corner.

The USDA shocked the market by actually cutting corn production down to 153 bushels per acre, 2 bushels less than trade estimates and about 6 bushels less than their July estimate.  The USDA maintained planted acreage at 92.2 million bushels but cut harvested acreage down to 84.39 million from their previous number of 88.19 million.  The corn ending stocks were raised 7% from the July estimate and the new crop stocks were cut down 18% from the July estimate.  Total corn usage for 2011 is now pegged at 13.16 billion bushels, a still huge number.  The stocks to use ratio is set to come in at 5.4%.  When this was announced on August 11th, you could almost hear a collective gasp across the Corn Belt.  The bulls broke through the gate like they have done so many times before.

This bullish USDA supplies came after a 500 point drop in the Dow Jones industrial average which was quickly followed by a 423 point increase the following day.  Equity markets were spooked from the credit downgrade in the US but also from rumors of French bank defaults as well as all the other problems in the banking system of Europe.  Strong outside market headwinds battered grains all week and producers at least by Thursday night were wondering how they would ever hedge all of this risk.

One of the most surprising numbers to me in the USDA report was the cut in soybean yield.  The USDA estimates yielded 41.4 bushels per acre down from 43.5 bushels/acre last year and below the trade estimate of 42.8 bushels per acre.  Corn seem to be getting all the attention leading up to the report, so soybeans dropping was a bit of a surprise.  In fact, it is also a little bit of a mystery because really, how can we tell soybean yield on August 1st?  It is pretty difficult.  Regardless of why, grain prices rebounded strongly on Thursday with corn almost reaching limit up.

Of course I have been watching these reports all of my life and I am very aware of the skepticism regarding USDA intentions and Canadian farm country.  It is gotten so bad now, that even private analytical firms in the United States will make predictions on what they think US crop yields will be and then they make other estimates for what the USDA will say.  It is almost like institutional skepticism.  However, as I’ve said 1000 times, the USDA sets the goalposts and they may be setting up to really surprise us in September and October.

I am thinking this way because these yield cuts seem drastic especially in soybeans.  I have also thought is this, to use a basketball analogy, the proverbial “head fake”, we usually see from USDA, which usually comes much later.  In other words, for whatever reason, have they decided to cut yields more drastically now and raise them incrementally going into fall?  Or, even more a stretch, are they right and this crop could only get worse?

Perish the thought that this crop gets worse.  Oh no, I am not lamenting $7 corn.  Many of us have worked too hard for too long in the $2.50 corn world to think that.  However, being bullish at $7 corn is hard to get used to.  It’s pretty obvious that demand is being destroyed at these price levels and if this crop gets worse, at the end of the day there will be some long-term damage to what we’re doing.  Farm inputs will also be targeted to rise very quickly.

So what’s ahead now?  In a nutshell, it’s violent volatility for crop prices.  It’s like me flying over Iran in 2009.  This past week was like the market was on that Emirates flight.  The good part is, things finally evened out.  The difficult thing was while I was flying through it, I couldn’t tell when.  As we look at our agricultural markets, it’s the same thing.  We are in for one heck of a wild ride.