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Bull market phase 3?

Grains are giving everyone quite a ride the past 13 months. The ride started with an initial
rally from corn given what looked like an impossible task last fall to increase
acreage and cut the rapidly expanding ethanol industry down to an appropriate
size.

We first began to realize the impending 'corn problem' last fall, when we
started looking at the speed of corn ethanol plant development and profitability
of these plants. Their competitiveness in being able to purchase corn scared a
lot of people into believing ethanol plants would keep being built regardless of
how high corn prices would get. Relationships between ethanol and gasoline
prices based on energy value were assumed, and given this value things couldn't
change.

But change they did. In April 2007, corn lost its leadership role in the grain
bull market to wheat, with a huge wheat freeze in US winter wheat country
causing some huge losses. Other countries around the world also felt the sting
of smaller than expected wheat crops including the EC-27, Australia, and others.

Combined with the willingness of growers to abandon wheat for corn acres (both freeze-damaged and spring wheat acres) and we really sacrificed wheat/soybean
acres for the needed corn acres. We got 14-15 million more acres of corn (much
more than expected), so once those acres were known this spring corn lost its
leadership role in the grain markets. This completed "Phase 1" of our grain
rally, which was led by corn.

Enter "Phase 2", the wheat rally, beginning around April 2007, where wheat
prices exploded far above anyone's projections this year, with funds unloading
long positions of corn and plowing that money back into the wheat market. They
owned well over 1 billion bushels of wheat through most of the summer rally,
with some huge profits banked in the wheat market by speculators by now.

During
"Phase 2", other food crops such as soybeans, bean oil, and minor food crops
also rallied nicely due to the substitution factor for foods. The ability to
switch easily production capacity from producing specialty crops to
wheat/soybeans also influenced minor oilseed prices. Meanwhile, higher soybean prices
threatened to 'steal' acres from the minor crops if profitability didn't rise.

Wheat prices actually almost went equal to soybean prices during this phase, as
the acute problems in wheat worldwide were not being repeated in the corn or
soybean markets - mainly due to decent US 2007 corn/bean crops. We will get a
better idea of just how good these crops were Friday, in the USDA October report,
and that is likely to give the market a fair amount of direction in the coming
weeks/months.

It appears, though, that the corn 'problem' has almost had 2 check marks now
made against it indicating the problem might be solved for awhile (even into
2008). The first, was the huge corn acreage planted, with nearly 93 million
acres in 2007. It was almost unimaginable that farmers would respond
that much to the incentive to plant corn. Even after the intended acres were
announced, many argued that we couldn't get that many acres planted in such a
short period of time.

Once planted (and planted early), some argued that the
new acres were 'marginal' acres at best, and couldn't achieve trend yields of
152 bu/acre or more. But here we are in front of the Oct. USDA report, and most
analysts are projecting national corn yields from 155-160 bu! As unbelievable
as these corn numbers would have sounded in winter 2007, these are the numbers
being kicked around now (which soon might be official numbers).

It's amazing how quickly markets can accomplish what man thinks cannot be done.
With the right incentives, it's amazing what the US farmer can do!

Now we have the tough decision in evaluating markets of whether or not a 'phase
3' of this grain rally can continue. So far, it appears soybeans might be the
strong grain in 'Phase 3', as we certainly didn't plant enough acres of soybeans
in 2007 (we lost too many acres to corn), and so far soybean yields don't seem
as impressive as corn during harvest 2007. We need more acres back in 2008,
too, so for now it's uncertain if soybeans can rally or not.

Rumors of high
abandonment in the drought impact Delta/Southeast also could have an influence
on soybean production numbers. Is it enough to overcome what looks like a
further cooling off of corn? It appears we are not only getting the increased
2007 supply of corn, but also demand appears to be waning from earlier
projections. Ethanol use has already been cut 100 mb, and some expect that cut
to become much deeper in the next few months (300-400 mb more cuts?) -
starting Friday.

Announcements of delays or outright cancellations of ethanol
plant construction has been widespread the past month, so there is no question
that we are starting to get a slowdown in this process. The drop of ethanol
prices to $1 less than gas (unexpected price relationships) is leading to the
pressure on ethanol plants. Rumors of consolidation in that industry also are
widespread.

Even wheat demand seems slower, with price dropping quickly the past week.
Could the wheat top finally be printed? Is it a multi-year top? Lots of
questions, with some answers likely with the report Friday. For now, grains
have certainly cooled off, and for the first time in 13 months it appears prices
could actually drop for a period - especially corn and wheat.

Grains are giving everyone quite a ride the past 13 months. The ride started with an initial rally from corn given what looked like an impossible task last fall to increase acreage and cut the rapidly expanding ethanol industry down to an appropriate size.

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