Inter-commodity spreads can provide clues about the path of least resistance of the prices of many commodities. When one product can serve as a substitute for another, consumers or producers have options. In the agricultural sector, each year, many farmers have a choice of which crops they plant on their acreage. The United States is the world’s leading producer and exporter of corn and soybeans. The trade war with China weighed on the prices of the grain and oilseed in 2018 and 2019. Optimism that prices would rise jumped as the US and China signed the “phase one” trade deal on Jan. 15. However, the outbreak of Coronavirus took the place of trade as the factor that prevented prices from recovering.
As we head into the 2020 crop year in the US, the corn-soybean ratio or the price of new-crop soybean futures divided by the price of new-crop corn futures provides clues about the decisions that farmers will make over the coming weeks. The Teucrium Corn ETF product (CORN) and the Teucrium Soybean ETF (SOYB) move higher and lower with the prices of the two agricultural commodities.
Planning for new crops begins now
The winter season in the United States is a rest and vacation period for farmers as they prepare for the crop year. Preparing the soil for planting in the spring, tending plants during the growing season during the late spring and summer months, and the fall harvest is hard work.
During the winter months, farmers make plans, and many watch the prices of the agricultural products they plan to grow. When it comes to the prices of soybeans and corn, they pay particular attention to new crop prices for decision making. The November soybean and December corn futures contracts on the CBOT division of the Chicago Mercantile Exchange reflect the prices of the oilseed and grain during the coming 2020 harvest season. In mid February, many agricultural producers are watching those new-crop prices like hawks.
Farmers make wise economic decisions
The producers of agricultural commodities have choices each year when it comes to best utilizing their acreage. For many, the option of planting either soybeans or corn or the balance between the two is an important decision at this time of the year. The bottom line is that farmers plant the crop that will maximize the economic return on their land. The corn-soybean ratio is an inter-commodity spread that provides guidance, and the futures market is a mechanism where they can lock-in or hedge their price risk for the coming crop year. Farmers run businesses. Aside from expertise in producing agricultural products, they must make an optimal financial decision each year.
A pivot point at 2.4 bushels of corn
Dividing the price of new-crop soybeans by new-crop corn calculates the corn-soybean ratio.
The long-term quarterly chart dating back to 1969 shows that the midpoint of the relationship stands at around the 2.4 bushels of corn value in each bushel of soybean value over the past half century. When the ratio is below the midpoint, farmers tend to plant more corn than beans as the grain offers a better financial return than the oilseed. When the ratio is above 2.4:1, soybeans offer an optimal economic result.
The ratio says more corn and fewer beans in 2020, so far
In 2018 and 2019, the trade war between the US and China caused price distortions in the corn and bean futures markets. Protectionist policies often create gluts of a commodity in one region of the world and shortages in others. The “phase one” trade agreement that the US and China signed on Jan. 15 should take some pressure off agricultural prices in 2020. However, the jury is still out when it comes to the impact of the outbreak of Coronavirus in China. The US is the world’s leading producer, but 1.4 billion Chinese people depend on US exports as a source of nutrition. Weakness in the Chinese economy could impact demand for beans and corn if the virus continues to spread.
Meanwhile, as of Feb. 14, it appears that farmers will be slightly favoring corn during the planting season over the coming weeks and months.
At 2.37:1, the ratio was below its long-term midpoint when it comes to the prices of soybeans for delivery in November 2020 and corn for delivery in December 2020. At the current prices, farmers using the futures market to hedge can lock in a better value for corn than the oilseed, which is likely to lead to slightly more corn planting starting in March and April. However, the spread could move between now and when the first seeds go into the ground, which would prompt farmers to close hedges and, perhaps, increase acreage allocations to the oilseed. For traders, watching the ups and downs of the new-crop ratio over the coming weeks and into the planting season provides clues about price directions. The ratio is a real-time indicator of what to expect when it comes to the 2020 corn and soybean harvest later this year.
Meanwhile, hedging activity has picked up in the corn and soybean market over recent weeks.
The daily chart of nearby soybean futures shows that the open interest metric rose from a low of 715,307 contracts in December 2019 to almost 866,000 at the end of last week.
The chart of corn futures shows that the total number of open long and short positions rose from 1.473 million contracts at the end of last year to its current level at over 1.603 million contracts. The increase in open interest in both the soybean and corn futures markets is a sign of rising producer hedging as we move into the start of the 2020 crop year.
CORN and SOYB are the ETF products
As we enter the time of the year when uncertainty over the supplies of the agricultural products that feed the world peaks, volatility in grain futures prices often increase. Farmer planting behavior is a significant factor for prices. However, it’s always Mother Nature and the weather conditions across the fertile plains of the US that will be the ultimate judge for the path of least resistance of corn and bean prices.
The most direct routes for risk positions in the corn and soybean markets are via the highly liquid futures contracts on the CBOT division of the CME. For those who do not venture into the leveraged and volatile futures arena, the Teucrium family of agricultural ETF products offer an alternative.
The Teucrium Corn Fund (CORN) has net assets of $69.99 million, trades an average of 52,138 shares each day, and charges an expense ratio of 1.11%. The most recent top holdings of CORN include:
Source: Yahoo Finance
The Teucrium Soybean product (SOYB) has net assets of $25.18 million, trades an average of 39,212 shares each day, and charges an expense ratio of 1.15%. The most recent top holdings of SOYB include:
Source: Yahoo Finance
The highest level of price variance in the future market tends to be in the nearby futures contract as they attract the widest audience of speculators. The blend of three futures contracts in the Teucrium corn and soybean products tends to make them underperform nearby futures on a percentage basis during price rallies. At the same time, during downside corrections, the Teucrium products tend to outperform the nearby futures. The CORN and SOYB products can be a slightly more conservative approach when it comes to risk-reward considerations compared to the futures market.
I believe that demographics continue to favor the upside in agricultural markets as more people around the world each year with more financial resources require ever-increasing supplies of the grains and oilseeds that provide nutrition. While the demand side of the fundamental equation is always expanding, the supply side can be as fickle as the weather each year. The next time drought or other weather conditions prevent a bumper crop of corn and beans, the price action on the upside could be dramatic. The last weather event that weighed on supplies in 2012 took the prices to all-time highs. Each year is a new adventure when it comes to the agricultural commodities, and the time when uncertainty peaks is at the start of the crop year.
Anyone involved in the corn and bean markets should keep the corn-soybean ratio on their radar over the coming weeks. The price relationship is a real-time barometer of the planting intentions and behavior of farmers across the US grain belt.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.