WRITTEN MARCH 8, 2009
The past year and a half has been like no other we have seen in the grain markets. We’ve experienced rallies to never before seen heights and then the rapid and long liquidation with price plunges that at times had us all frozen like deer in the headlights.
At market outlook presentations I have given at various events across the Prairies this winter, considerable time has been given to the process of sorting what the heck happened in 2008 and what it means for the year going forward.
I am a fundamentalist at heart. Details making up the supply/ demand balance sheets provide the core of PFCanada’s market analysis, with technical considerations on price charts dictating the timing of marketing initiatives. But it increasingly seems many of the traditional barometers of grain market analysis have been cast aside in recent months in favour of indicators not normally associated with grain markets.
So when asked at these meetings, “Where’s the bottom of this?” or “How low can grain and oilseed prices go?” I find myself often talking about things I don’t normally spend much time on as it pertains to grain markets. I want to share some of those ideas with you again.
First, these days a discussion of grain market price direction involves not so much grain market fundamentals. Rather, the first questions to determine what canola will do on any given day are what’s the Dow doing? What’s energy doing? And what’s the U. S. dollar doing? These are all broad signals of the level of global economic health and willingness of investors to assume risk.
These features have certainly emerged as the dominant issues affecting ag commodity prices these days. Sure, on any given day, talk of South American drought or political conflict, weather elsewhere, and surprisingly strong (or disappointing) Chinese buying can exert some independent influence on grain markets. But not for long it seems. Then the long arm of the equity and energy markets inevitably re-exerts its overwhelming influence.
DOW JONES INDUSTRIAL AVERAGE
Stocks markets are influencing grain and oilseed prices. We hear daily of the barrage of bearish news bombarding equity markets. It seems relentless. Looking at a chart of the Dow Jones Industrial Average Index, the trend lower has been inexorable with only slight pauses to give what so far has been false hope before falling again into new low territory for the move.
With the recent plunge into 12-year lows below 7,000, the Dow now theoretically has the technical potential to retrace back down to the acceleration point of where the 1990s bull market really got started — down to 4,000. The likelihood of that happening quite frankly is unfathomable to me. But so too, the market collapse from the October 2007 high around 14,000 on the Dow, to below 7,000 today, would also be thought preposterous some 14 months ago.
Poor retail sales, doubts about GM’s viability, a banking system with yet unresolved/disclosed difficulties and a clarification by the Chinese government this week that it would not add to its current US$585 billion stimulus plan all helped push the market down to close out the first week of March. As a result, the Dow closed at a new bear market low.
The Dow is currently down 53.4 per cent since peaking in October 2007. To put the magnitude of the current correction in perspective, the graph included with this article illustrates the 15 worst corrections of the Dow since its inception in 1896. The current Dow correction already ranks as the second worst on record. Only the correction that began in 1929 was worse.
So how low is finally low enough? It’s really impossible to say. The world is on fire sale, and these are either the bargains of our lifetime, or — I would rather not even wish to contemplate what “or” means.
All I can say at this time, based on what we see on the charts above, there’s no real sign of a low, yet. Does the “public” have to chuck everything overboard in one last climatic purge in order to make a low? We have thought that all along, but truthfully, I’m surprised it hasn’t happened by now.
In an attempt to lighten this rather doomsday mood, there is a rather amusing story floating around the Internet this week which explains the global financial crisis in terms even I can understand.
THE FINANCIAL CRISIS EXPLAINED TO THE LAYPERSON
Heidi is the proprietor of a bar in New York. In order to increase sales, she decides to allow her loyal customers — most of whom are unemployed alcoholics — to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).
Word gets around, and as a result, increasing numbers of customers flood into Heidi’s bar. Taking advantage of her customers’ freedom from immediate payment constraints, Heidi increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively.
A young and dynamic customer service consultant at the local bank recognizes these customer debts as valuable future assets and increases Heidi’s borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral.
At the bank’s corporate headquarters, expert bankers transform these customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are then traded on markets worldwide. No one really understands what these abbreviations mean and how the securities are guaranteed. Nevertheless, as their prices continuously climb, the securities become top-selling items.
One day, although the prices are still climbing, a risk manager of the bank (subsequently of course fired due his negativity) decides that slowly the time has come to demand payment of the debts incurred by the drinkers at Heidi’s bar. However they cannot pay back the debts and Heidi cannot fulfill her loan obligations and claims bankruptcy.
A Look At The Big Picture
DRINKBOND and ALKBOND drop in price by 95 per cent. PUKEBOND performs better, stabilizing in price after dropping by 80 per cent. The suppliers of Heidi’s bar, having granted her generous payment due dates and having invested in the securities are faced with a new situation. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor.
The bank is saved by the Government following dramatic round-the-clock consultations by leaders from the governing political parties. The funds required for this purpose are obtained by a tax levied on the non-drinkers.
I WISH IT WERE A JOKE
The above explanation sounds like a joke. It isn’t. I also want to direct you all to the Stocks Talk page of the PFCanada website, where Andy Sirski steps in with his take on the financial crisis and investing prospects going forward.
As for the influence on grain markets, we look to stock markets as perhaps a leading indicator of the general market’s willingness to assume risk. And while the Dow and other stock market induces continue to falter, one can assume investors would rather remain on the sidelines or otherwise continue to liquidate positions.
This assault from the outside is breaking down support levels in the grain markets. Speculative selling at times (many times) seems to overwhelm anything that could possibly be viewed as fundamentally bullish. Many commentators wax in-depth of individual supply/ demand characteristics of individual ag commodities and the influence on their prices. But quite frankly, we have seen on so many days, canola market (or other ag commodity) fundamentals have meant squat in the face of daily outside market influences, both up and down.
Energy markets have also encouraged an environment of negative market sentiment for the ag sector. The unrelenting pressure to go lower from the outside has spec traders selling almost every day in the grain markets. Additional pressure is coming from the continued strength of the U. S. dollar and gold markets, reflecting worldwide concern over the global economy. And the weaker crude oil market reflects the decrease in world demand for commodities in general.
Sure there was some measure of disconnect after Xmas as soybeans rallied with the prospect of threatened South American production, but as fears fade, the two markets have once again lined up in sync with each other.
I have stated it here in previous commentaries: Sure we must consider the fundamentals of our individual ag markets, but also remember that the broad macroeconomic environment continues to override all other considerations. And it remains my opinion at this time that as long as equity and energy markets remain under selling pressure, the ag sector has little to no hope of “sustained” rally potential — well, at least not until Mother Nature intervenes to provide a credible threat to new crop production.
NOT ALL GLOOM AND DOOM
I still believe that, in a general sense, much of the dramatic and unprecedented flush out of speculative long position holders from last summer’s market highs in ag sector commodities has already occurred. So that level of selling interest has largely been eroded. Getting them to buy back in, even to a fraction of its former glory though, seems out of reach in these immediate difficult times.
That said, the crude oil market is showing signs of base-bottoming. That doesn’t mean the energy market is immediately poised to sustain a rally higher, as it could (likely will) float around down here, trading a range maybe for months yet for all I know. But that said, forays down to $32 or $35 a barrel serves as a source of support. That is likely as far down as oil needs to trade.
There remains in the world lots and lots of oil. It’s just that the easy and inexpensive oil has been found and is largely already in the process of being or has already been extracted. What’s left is the more inaccessible and expensive oil to retrieve. And $35 oil longer term just won’t provide the financial incentive needed to explore, drill and extract product from places such as the tar sands and deep-sea rigs. Already we have seen massive revisions lower in exploration budgets.
A time is certainly coming, probably at a time when the global economy is beginning to reenergize, when demand for oil will ramp up. This will coincide with the depletion of existing, already in-operation reserves where easy oil supplies are being drawn down. Then the incentive, within an inflationary environment, needs to be put back into the market before industry will go for the tougher-to-pull oil.
The global credit and demand crunch still needs to fix itself, but the time lies ahead when we are back at $100-plus per barrel oil. It might be sooner than most believe.
Along about the time when troubles in the stock market start to balance out and turn higher — maybe not soar upwards right away, but at least stabilize and slowly turn up — when such a pattern also takes hold of the energy market. Then we can say that demand and the fortunes for all sectors (including ag) may start turning higher.
Timing of such things is so difficult to call, but I envision the next boom for commodities sometime in 2010 or 2011. Until then, or unless we run into a major crop production threat, rallies in the grain/ oilseed sector are only viewed from the context of normal occurrences within a broad basing pattern of sideways trade.
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