In Ag Econ 101 I learned the economic principles of supply-demand economics: Increased supplies usually lower prices. Then, increased demand at these lower prices will eventually rally prices. However, in the last five years I now also evaluate what I call the flow of money.

Grain traders often evaluate this flow of money using the Commodity Futures Commission Commitment of Traders Report (COT report). It shows how the large non-commercial accounts are positioning in the commodity markets. These large funds use sophisticated proprietary trading methods that generate buy and sell signals. Most hedge funds are momentum traders, buying on strength and selling on weakness. This creates some volatile commodity markets.

Commodity index funds have entered the market in the last two years. These are funds that are long only, meaning they buy and hold commodity futures like a stock mutual fund buys and holds stocks. These funds try to take advantage of the five-year boom in commodity prices. Like many investors and investment funds, these indexes are buying in looking back — not ahead.

The total amount of money now invested in various global commodity funds is more than $120 billion. That $120 billion could buy the entire U.S. corn, soybean and wheat crop three times. In studying these funds I can identify three key market trends:

  1. The bullish phase develops when the index funds and hedge funds are both buying commodity futures. This can create a major bull market move like we had in the corn, soybean and wheat markets from January through June of 2006.

  2. The rollover phase develops when hedge funds are getting short and index funds are still long. You then get choppy, trendless markets like July and early August of 2006.

  3. The final bearish phase is when hedge funds add to shorts and index funds sell out positions to reduce dollars invested in commodities. This creates a hard down move in commodity prices like we've experienced from August through October of 2006.

If you're a farmer that sold new-crop corn at over $2.60 or new-crop soybeans at over $6, you have these hedge and investment funds to thank. After five years of great returns, most commodity index funds were down by 4-8% at the end of the third quarter of 2006.

Marketing Advice

Here's my conventional analysis and recommendations following the most recent USDA Supply-Demand reports:

For corn, we may use over 12 billion bushels of corn in calendar year 2007. Livestock producers and farmers who own ethanol shares should use the lower prices this fall to get at least a six-month supply locked in the cash market. Corn farmers should take the maximum LDP they can and sell part of the crop ahead for delivery into March-July 2007.

In soybeans, if we plant an additional 2 million acres of winter wheat and two million acres more corn, U.S. planted soybean acreage may fall by 3-4 million acres in 2007. This drop in acreage is coming at a time when Brazilian soybean planted acres are projected to fall by 5-10%. The current glut of soybeans will be used a lot faster than current USDA projections.

For soybean farmers, take the largest LDP possible this fall and carry your soybeans into the spring and summer of 2007.

Livestock producers should lock up at least a six-month supply of meal by the end of October. Price works, and with the international price of soybeans within 30¢ of the lows posted in 1972, it's no time to get bearish.

Tour Bahia

In January, Al Kluis at Northland Commodities and Tyler Bruch at Global Ag Investments will be hosting two farm tours to Bahia. The tours will cover soybeans, cotton, corn, cattle and fruit farming under irrigation. They'll also visit one of the largest soybean crushers in South America as well as several other points of interest related to the growing ag sector in Bahia. For a complete itinerary check out www.globalaginvestments.com.

Alan Kluis is the president of Northland Commodities LLC, based in the Minneapolis Grain Exchange, Minneapolis, MN. You can contact him at alkluis@yahoo.com or call toll free 888-345-2855.