Market Preview : Crop Forecasts Rattle the Market

by 5m Editor
14 June 2008, at 4:53am

US - Weekly US Market Preview provided by Steve R. Meyer, Ph.D., Paragon Economics, Inc.

What a week for U.S. agriculture, in general, and the hog business in particular! Consider:
  • USDA issues its latest “Don’t Worry, Be Happy!” crop reports amid what is developing as the greatest flood in history.
  • Corn prices respond to both pieces of news with record highs. Omaha cash corn, which went above $6/bu. for the first time last week, was quoted at $6.70-$6.80 on Thursday. Chicago Mercantile Exchange (CME) Group corn futures for December gained $0.62/bu. from last Friday to stand at a record high of $7.395/bu. at Thursday’s close.
  • U.S. pork exports for April were nearly twice as large as they were one year ago, leaving year-to-date exports 52% larger than last year.
  • April pork exports accounted for over 21% of April U.S. pork production.

Let’s begin with the USDA’s May Crop Production report and World Supply and Demand Estimates. Table 1 shows USDA’s corn balance sheet based on these reports, which were released Tuesday. To their credit, USDA did lower their forecasted corn yield by 5 bu./acre in this report. It is very unusual for them to do that as early as June, since they have no information about actual plant populations, ear numbers, etc. The lateness of this planting season, though, dictated an early reduction in the forecast.

My criticism of the report is that USDA continues to forecast corn usage at levels that I believe are too low at their forecasted prices. USDA again reduced projected feed usage, this time to 5.150 billion bushels. Allowing for the DDGS from 1 billion more bushels used for ethanol, this feed usage level still amounts to a feed use reduction of 8.9%. To get that kind of reduction in feed usage, we will have to have prices much higher than USDA’s $5.30 - $6.30. This week’s futures market is making that point in spades.

Ethanol plants will operate full as long as they can cover variable costs. There will be enough capacity to use far more than 4 billion bushels of corn next year. Crude oil futures at $137/barrel imply higher gasoline prices and higher values for ethanol in the future, but last week’s drop in ethanol prices (to $2.33/gal. in Iowa) and the increase in corn prices are likely to put some plants near the point where they are not covering variable costs.

If that is a lasting situation, USDA may be okay with their 4 billion bushel usage for ethanol in the ’08-’09 crop year. If ethanol prices follow gasoline and oil upward, however, I fear that the ethanol number in Figure 1 is too low as well.

That brings us to exports. USDA reduced projected exports again this month, to just 2 billion bushels, 18% lower than last year. Higher world feed grain and, especially, wheat production is the main supporting factors for that change. The low dollar and the fact that U.S. corn is still a very good buy for many export customers argue against the decline. Given our customers’ proven record of “buying early” to secure supplies, I fear this number is too low as well.

Breakevens Ascend

And the only way to get these numbers lower is to drive corn prices higher. As I pointed out above, CME Group corn futures started that process this week, and I know of no one who really wants to venture where the process will end. With new-crop futures at $7.39 on Thursday, $8 is not at all out of the question, depending on how crop conditions develop over the next few weeks.

And what of hog feed costs? Figure 2 shows that my index of feed costs rose by about $40/ton from June 2 to June 12. I had to add $50 to the vertical axis just to fit in the most recent observations. These feed prices have driven my breakeven cost estimates for next summer to roughly $95/cwt. carcass. Who would have ever thought that June 2009 Lean Hogs futures at $91 would not be profitable?

The big factor in the grain markets is still weather. The flood (and perhaps more importantly, the cool, wet conditions that caused it) has certainly taken the shine off of this year’s crop prospects. USDA did not change its acreage forecasts in this week’s report, but virtually everyone thinks that corn acres will be 2 million or so lower than the intended 86 million acres and that bean acres will be below intended levels as well.

A Drought? Really?

In what could be one of the greatest ironies ever, some climatologists and meteorologists still believe we could see a drier than normal summer. Elwyn Taylor of Iowa State University declared that to an audience at World Pork Expo last week and Drew Lerner of World Weather, Inc. repeated it in a CME Group outlook webinar yesterday. Their concerns are based on longer-term cycles and the fact that the Southeast was very dry last year. Taylor points out that 16 of the past 17 midwestern droughts have been preceded by droughts in the Southeast the year before, and only twice has one in the Midwest not followed a southeastern drought.

We saw this pattern in 1983. Though not nearly as wet as this year, the spring of ’83 saw ample rainfall before heat and drought scorched crops throughout the Midwest. A repeat of that pattern would add insult to injury.

5m Editor