Odds are high that both soybeans and wheat have established the highest price levels they're going to trade at for quite some time. Corn has likely made a major top, but still has significant upside potential if planting delays continue. As concerns over the crop materialize this spring and summer, corn prices could rally sharply. But the question really is: From where?
Rather than price direction, we should all be more concerned about the structure of the markets themselves. In the last year, index funds (the funds that can only be long) have taken over commodity markets. In rough numbers, as I write this article, index funds are long over 2 billion bushels of corn (approximately twice the carryover), approximately 1 billion bushels of soybeans (nearly 40% of last year's production) and approximately 1 billion bushels of Chicago wheat futures (nearly 2.7 times this past year's crop).
While the growth of the ethanol industry and demand from China have been crucial for building a long-term demand base for grains, the impact of index funds is even greater.
To clarify their influence, let me use the S&P Goldman Sachs commodity index fund as an example. It has approximately $114 billion in it. Seventy-four percent of that is to be invested in long energy futures and 8.2% in long grain contracts. That is nearly $85 billion to be long energies and over $9 billion to be long grains.
The funds need to be balanced monthly. As crude oil goes up in value, at the end of the month — in order to maintain the percentages as outlined in their perspective — more grain contracts need to be bought. So the higher crude oil goes, the higher grain prices go. With such a lopsided percentage being allocated to energies, grain prices are significantly tied to crude oil. This is purely a money game — forget the fundamentals of corn and soybeans.
This may well turn out to be a double-edged sword. If crude oil prices drop sharply, then index funds will have to liquidate long grain contracts to balance the portfolio. Or if more money flows into their funds, they could buy more oil contracts to maintain the balance.
What needs to be done? In my opinion, the Commodity Futures Trading Commission (CFTC) has to step forward and get the index funds under control. Allowing them to have unlimited position sizes where they literally can buy more than we actually produce is ridiculous. Legislation needs to be changed to go back to the way it was before with all speculators adhering to maximum position limits so that no one can have a major influence on a market.
My biggest concern over the impact of index funds is that the futures market has now lost its purpose for existing. A futures market is a means of price discovery where buyers and sellers “vote” on prices on a daily basis. With a non-fundamental influence like index funds pushing prices higher than they should have gone, the market has lost this price discovery method.
The result has been a separation between the cash market and the futures market. During March, even some of the largest grain companies stopped offering bids for new-crop delivery based on futures prices. One has to question whether or not the futures market is now a legitimate market to hedge commodity prices.
This has been devastating for the grain elevator business, the livestock industry and the food industry. As the market continues a price spiral downward, the question now is whether some individuals and companies within these industries will survive.
Richard A. Brock is president of Brock Associates, a farm market advisory firm, and publisher of The Brock Report. For a trial subscription and information on Brock services, call 800-558-3431 or visit www.brockreport.com.