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Stay aware of global grain risk

There are a lot of factors that impact grain prices. The fundamental factors -- the supply and demand of grain -- have always been obvious and easy to understand. For example, when the weather turns hot and dry, supplies are threatened and prices move higher. (Just think of last summer and how the drought rallied prices!) Another example is when a USDA report shows a lot more acres than expected. All that extra anticipated supply triggers a drop in prices.

In general, prices will change when demand is much better -- or worse -- than expected.

When I started trading grains in 1974, supply and demand were the dominant forces in the markets. Indeed, for over 30 years, every seminar I gave kicked off with a review of the latest supply-and-demand numbers from the USDA.

In 2005, this changed. There was a landmark study that showed that a portfolio of stocks, bonds, and commodities outperformed stocks and bonds alone, and it had less risk than stocks and bonds alone. Wall Street traders also embraced the move from pit trading to electronic trading.

As a result, traders and investment firms on Wall Street began to look at commodities as an investment class. All of a sudden, a well-diversified portfolio would now have to include stocks, bonds, and some commodity-related investments.

For the investors who jumped into land and commodity investments early, it has been a great ride. Their investments outperformed the stock and bond market consistently from 2005 through 2012.  

Today, all the seminars and webinars that I conduct start with the new set of market forces -- and that set does not include supply and demand. Although, in a way, it does. It’s the supply and demand of money. Who has money on this day? Where on the globe are they? Where are they putting money today?

Tracking and analyzing the flow of money has been a great challenge. Every morning when I am preparing my early morning email update, I look at five market forces and ask these questions:

  1. What are the global stock markets doing?

  2. Where are the U.S. stock indexes trading?

  3. What is the value of the U.S. dollar?

  4. What is the price of crude oil?

  5. What is the price of gold?

Once a week, I also check what the commodity funds are doing by studying the Commitments of Traders report. Are they selling grain? Are they buying? Or are they sitting on the sidelines?

What’s been happening

Here’s how those five market forces have performed over the last several years.

1 & 2. The U.S. and global stock markets have made an impressive run since the last major low in November 2012. In the long term, this rally is positive for commodity prices.

3. For the last two years, the U.S. dollar has bounced around between 73¢ and 84¢. The dollar rallies whenever a financial crisis develops somewhere in Europe, then it drops back when there’s a temporary fix.

4. For the last 18 months, crude oil has traded between $74.95 and $100.42 per barrel. Retail gasoline has traded between $3.20 and $4 per gallon during that time period.

5. Gold prices have dropped from the high at $1,912 an ounce in September 2011 to the low in April 2013 at $1,323 per ounce.

When I look at these five market forces and study their possible impact, I am nervous. This is especially true as I look ahead to the third and fourth quarter of 2013.

As a student of history and the markets, I have noticed that most of the major economic crises have developed in September, October, and November. These crises have usually been negative for the stock and commodity markets.

If you look at the commodity markets (gold, silver, crude oil, corn, and soybeans), you can see a pattern. The pattern during the last two years has been to put in a high in late August, then to keep dropping to hit lows in October, November, and December.

What you should look for

So, how will you know when things are turning south? Here are four indicators and important price levels to note:

  1. Watch for the first month the S&P 500 closes below the two previous months’ low. That is a long way away right now, and it may not occur. If it does happen, then it is a negative signal.

  2. Watch whether the U.S. dollar index has a monthly close above resistance at 84¢. A strong U.S. dollar will slow down U.S. ag exports and will usually take commodity prices lower.

  3. Watch crude oil. A close below $73.42 would be a negative signal for the crude oil, ethanol and grain markets.

  4. Watch to see that gold holds above the major support at $1,323. A close in the gold market below $1,323 would be a negative signal for the entire commodity complex and lead to more fund liquidation.

What you should do

What can you do with this information? Here are three specific actions that you can take.

Be aware of the potential risk. Don’t assume prices will only go up.

Be willing to make some sales before this fall. If you have grain prices at attractive levels that will make your farm a good operating profit, then be willing to sell some grain. If that does not work for your farm, then -- at a minimum -- buy some puts to put a floor under the bushels you will need to sell this fall.

Stay liquid. Make sure you are in a good cash position so that you are able to store your way through the low prices that may develop this fall. I am concerned about a possible wash-out sometime in the third or fourth quarter of 2013.

Know that there is a silver lining. The hard downward move will be a good buying opportunity for livestock feeders and ethanol shareholders.

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