By Elaine Kub
DTN Contributing Analyst
Corn harvest is already running a little ahead of schedule in Texas, and in short order the season will also be upon the Corn Belt. So, throughout the next month or so, it isn't too soon for a lot of farmers to start thinking about inspecting and tightening machinery belts, checking fluid levels, greasing zerks ... that sort of thing. A zerk, for any reader who doesn't know, is a fitting used to transfer grease into the moving parts of machinery. Greasing zerks is what you do when you want to get something moving or keep something from breaking down.
The Federal Open Markets Committee of the Federal Reserve Board has something similar they've tried to use to keep the U.S. economy functioning since the financial crisis of 2008: not a zerk, but a ZIRP. It's a Zero Interest Rate Policy that, by keeping target fed funds rate unchanged at the 0.00% to 0.25% range from December 2008 to December 2015, was meant to encourage corporations and individuals to invest their capital into new lines of business rather than stuffing it away into savings. Alongside three Quantitative Easing programs and "Operation Twist," the ZIRP was also meant to stabilize or bolster the overall stock market, which it probably did.
Japan, England and a few other major western economies still have a ZIRP or even a 'NIRP' (Negative Interest Rate Policy) in 2016, but in the U.S., investors are now contemplating the whens and what-ifs of another interest rate rise from the Fed to follow the one seen at the end of 2015 ... maybe as soon as this December? Maybe early next year?
The what-ifs are where the commodity markets get involved. In grains, we have some overwhelming reasons to feel fundamentally bearish about prices: a 15 billion-bushel corn crop (according to the latest USDA projections), a 4-bb soybean crop (same source), and U.S. wheat ending stocks that show we will store as leftovers nearly half as much as we use.
And yet ...
There is a real case to be made for some bullishness leading into the end of year, especially if investors decide to start directing money toward commodities.
Pretend you are the director of some investment fund with billions or millions of dollars to trade -- like a state's pension program, or a nation's sovereign wealth fund, or even just a collection of rich families' money. You and your peers have spent the past eight years lamenting how little growth has been available in stable economies, and how even the "safe" markets have been vulnerable to sudden collapses. In an effort to actually make some money in late 2016 or to position yourself to make money in 2017 (when the Fed might start to ratchet up interest rates), you have three choices:
1) Continue to horde cash. This is a popular choice -- a Bank of America survey showed that major asset managers had 5.8% of their portfolios in cash in July, the highest level since the financial crisis, or even since 2001. Buying "safe" bonds with negative interest rates would be another way to do nothing.
2) Go back into the stock market, even though the most volatility we've seen this year has been downside volatility, in the form of sudden, jarring collapses during the Chinese market troubles in January or during the Brexit surprise in June. This choice isn't very popular among the smaller class of investors who use Exchange Traded Funds (ETFs) to get whole-market exposure. Inflows into equity index ETFs in 2016 have been about a seventh of what was invested into that asset class last year by this time.
3) Seek out some more novel asset classes that might actually see some movement in the coming months. This could be: foreign stocks in countries with more growth potential, bonds with a higher risk potential, possibly real estate, or ... how about commodities?
Commodities are traditionally thought of as a hedge against inflation. Inflation, by definition, means that stuff starts getting more expensive to buy, and commodities, after all, are stuff. The Fed's dual mandate is to encourage maximum employment and to manage inflation. That is to say, any outlook for long-term growth in wages and in real prices in the economy will be paired with an outlook for growth in long-term interest rates. So any time an investor sees a headline implying interest rates may rise, that investor will automatically be thinking of owning real, physical assets whose prices should also rise, in theory, during normal inflation. That investor will be drawn to buy commodities.
Commodity markets' tendency to be more volatile than stocks will also be a draw to investors. After years of QE programs and general economic pessimism, the fund industry is eager to finally get back to competing for profits, not merely hunkering down in low-risk assets and meekly accepting whatever government-bolstered stability happens to be available.
The funds haven't jumped into the grain markets based on this bullish idea just yet, but the sector is well positioned to accept their investment. Heaven knows there isn't much to lose right now. The latest Commitment of Traders report from the CFTC showed the managed money community's net position in corn futures was long by only 5,412 contracts. Funds have a net-short position in Chicago wheat futures of 88,221 contracts, about as bearish as it's ever been in the post-QE era. The funds did build up a large net-long position in soybean futures in the second quarter of 2016, but being now long by 170,047 positions, there's still room for that participation to grow.
Interest rate rises are not typically good news for farmers. Any bump in the fed funds rate, no matter how small, will tend to encourage lenders to increase the borrowing costs for ag loans, for instance. Land values may continue to fall as the interest rate expenses or opportunity costs take up a larger portion of a buyer's calculations. Finally, an interest rate rise may also be paired with a stronger U.S. dollar, which tends to weigh against commodity prices.
But if the Fed has an outlook for the U.S. economy that is optimistic enough to justify an interest rate rise in coming months, and if large investors take that cue to anticipate more dynamic markets, especially in more novel asset classes, then that might be the silver lining for grain prices in late 2016. Watch for any positive headlines about the jobless rate or improvement in global trade (which the FOMC interprets as bullish to U.S. economic health). Simultaneously, watch for an influx of noncommercial speculative investment into the commodity futures markets.
Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.
(ES/SK)
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