Why Are Prices This High?

USDA forecasts corn carryover at the end of the 2005-06 marketing year at 2.301 billion bushels, the largest in 18 years. Soybean ending stocks are expected to be a record 565 million bushels. Assuming average or better growing conditions, most analysts expect 2006-07 corn ending stocks to be about 1.5 to 1.7 billion bushels and soybean ending stocks to remain at or near record levels. The new crop carryovers suggest average 2006-07 corn prices ranging from $2.20 to $2.30 and soybean prices potentially below $5.00 per bushel. However, current futures prices for new crop corn and soybean are much higher than this.

December 2006 corn futures have traded at prices near or above $2.70 per bushel in recent days. Historically this represents very good harvest time prices. In only 4 of the last 20 years have December corn futures prices been higher than this at harvest time! Soybean prices are more surprising with November 2006 soybean futures prices again trading above $6.00. Soybean futures prices have been at these levels or higher only about 40% of the time in the last 20 years. Harvest time prices of $6.00 or higher occurred in 7 of the last 20 years. With expectations of large or burdensome supplies, why are corn and soybean prices this high?

Strong demand and production worries appear to be supporting corn prices. High gasoline prices, demand for alternative fuels, and construction of new ethanol plants are expected to result in more than 2 billion bushels of corn used for ethanol in the coming year. Feed demand is expected to remain strong and the possibility of reduced Chinese corn exports may add strength to demand for U.S. corn exports in the Far East. While corn supplies are large, good production is needed in 2006 to insure that demand needs are met. However, USDA’s Prospective Planting Report indicates that corn acreage will be down 5% in 2006, due largely to higher input costs. Following the reports, many analysts believed stronger corn prices would encourage farmers to change plans and plant more corn. But last week’s rains in the eastern Corn Belt raised concerns about planting delays limiting opportunities to increase acres. The recent surge in oil prices makes corn irrigation costs in the west more expensive and discourages planting additional acres. These factors along with recovering soybean prices are beginning to suggest that producer’s planting intentions may not change much. Reduced corn acres and strong demand suggest the possibility that corn supplies could begin to tighten and increase the impact that weather concerns or yield potential may have on supply.

It is more difficult to make an argument for soybean price strength. There is an old market adage that says, "The market is always right!" It means that the collective action of all buyers and sellers in the market arrive at the "right" price regardless of the prevailing opinion about what prices should be. The question is, what does the market know to arrive at current new crop soybean prices? Supply/demand information would suggest lower prices. U.S. soybean supplies are expected to remain at record levels. Record production is being harvested in South America and world soybean carryovers are expected to set records. Yeartodate soybean exports have been disappointing and unlikely to improve now that the South American crop is becoming available. High fuel prices may have increased the interest in the use of soybean oil for biodiesel, but it will take time to "ramp up" production and it is not likely to add significantly to soybean demand in the coming year. About the only price positive fundamental news is that Brazilian producers are facing a severe cost/price squeeze and may reduce soybean planting next year. However, with record ending stocks and an expected 7% increase in U.S. planted acreage, it is hard to explain why November soybean futures are above $6 instead of near or below $5.

Why are new crop corn and soybean prices this high? Inflation along with uptrending prices in energy and metal futures may be supporting agriculture commodity prices at higher than expected levels. Fewer corn acres and potential weather/production worries appear to be providing some risk premium to corn prices, but with increased acres, soybean production concerns seem premature. Domestic and world demand for corn and soybeans is already large. While stronger than expected use might add to prices, large ending stocks and trendline yields would appear to insure more than adequate supplies. The list of potential market factors could go on to include a variety of world supply/demand and other economic or political factors that try to explain recent price action. Do the markets "know something" or are they just offering a rare opportunity? It is shaping up to be an interesting year that has already provided a few surprises. The most likely scenario for sustaining these prices or sending prices higher would be an extended dry period during the growing season. The "bottom line" is that it is difficult to justify November soybean and December corn 2006 futures prices at current levels, especially soybean prices.

Futures prices appear to be offering preharvest market opportunities at prices well above expected average prices for the 2006-07 marketing year. Historical corn and soybean seasonal price patterns suggest prices typically peak about this time of year (April-May) and are usually significantly lower by harvest time. Although weather patterns may indicate production risks, current prices already seem to include significant risk premium and considerable downside price risk exists. While it is possible higher prices might be offered, new crop futures prices are in the upper one-half of historical ranges and at levels that are not frequently available at harvest time. When this occurs, regardless of the possibility for a weather market or higher prices, it is usually a good idea to make or add to preharvest sales.

Weak basis does complicate sales decisions. New crop corn and soybean cash bids at elevators across Missouri reflect weak cash basis. New crop corn prices, at many locations, are from about forty cents to more than sixty cents under December 2006 corn futures prices. Soybean new crop cash bids are from forty cents under November futures to as much as seventy cents under at some northwest Missouri locations. Even prices at major corn or soybeans users and at Mississippi River delivery points indicate relatively weak cash bids when compared with historical basis levels. Weak basis signals weak cash demand, which may not be surprising due to the large carryover supplies, increasing interest rates, and high transportation costs. It also adds to the argument that new crop futures may be overpriced. The problem is that weak basis makes forward contracts for harvest delivery less attractive and opportunities for basis improvement are probably limited. In spite of the weak basis, the downside price risk in new crop futures suggests much lower cash prices are possible at harvest time.

Weak basis is often used as a market signal to avoid the cash market and use the futures market to make sales. Hedge sales using futures contracts would lock-in new crop futures prices and allow for capturing an improved basis if offered later. However, plan to manage the risk of margin calls or be prepared to lift the hedge in the event weather problems produce a significant price rally. A hedge-to-arrive cash delivery contract could avoid some of the worries associated with a futures hedge, but does require delivery of the grain regardless of production. Buying put options also would avoid the margin risk of futures and leave open the opportunity for higher prices, but expensive premiums (cost) may make them appear less attractive. $2.70 (strike price) December corn put premiums have exceeded twenty cents per bushel and $6.00 November soybean puts have approached forty cents in recent trading. These premiums, coupled with expectations for weak harvest time basis, result in floor prices that are much lower than the option strike price. However, remember there is likely more downside price risk than the amount of the put premium, especially for soybean prices. While the floor prices may not be very attractive now, they might look much better at harvest time. Similar price protection might be provided by a minimum price cash contract at an elevator.