Todd's Take

7 Feb 2017

By Todd Hultman
DTN Analyst

Readers of this column have probably caught on by now that I like to start the year with an assessment of grain prices based on USDA's national production cost estimates.* Not knowing yet what surprises await us in 2017, the fundamental relationship between prices and costs has been a helpful guide for knowing what to expect in relatively normal times.

Starting with corn, the cost-based approach has been especially useful the past four years as corn has had good weather and not many unusual threats. A year ago, we anticipated December 2016 corn prices would trade between $2.96 and $4.44 a bushel and the actual range turned out to be $3.15 to $4.49 -- not bad for an early guess.

Corn's high came on June 17 as the western Plains experienced an early bout of hot and dry weather that did not last. The low came on the final day of August, roughly one month ahead of corn's usual seasonal schedule as the record harvest was well anticipated.

Excluding land expense, USDA estimated corn's 2016 production cost at $493.33 an acre or $2.83 a bushel. That means a relatively normal 2017 should see December 2017 corn futures trade between $2.83 and $4.24.

Will 2017 be a normal year? As far as weather is concerned, the U.S. Drought Monitor shows good soil moisture conditions so far, thanks to a recent return of rain to the southeastern U.S. Brazil also seems to be in better shape than a year ago with USDA possibly ready to estimate a record Brazilian corn crop in Thursday's WASDE report.

Turning to soybeans, the January contract has not seen the lower end of its expected range since 2004, and I chalk that up to the exceptional growth of world soybean demand. In 2016, the cost-based model anticipated January soybean prices between $7.79 and $11.68. The actual low of $8.74 came on March 2 in the depths of a bearish mood that was focused on another big harvest from Brazil.

That bearish mood, however, did not last as a surge of commercial demand took prices on a three-month rally, which saw January 2017 soybeans peak at $11.82 on June 13 -- 14 cents above its upper target. The fact that this all happened in a year when both Brazil and the U.S. had big crops was a good example of how demand can find bullish windows of opportunity, even in bearish years of big production.

Given this year's political climate and trade concerns, 2017 doesn't seem a good candidate for becoming a normal year, but at least the cost-based range gives us a good place to start the conversation. Excluding land expense, USDA estimated the 2016 production cost for soybeans at $311.03 an acre or $5.97 a bushel. Using soybean's historical pattern of trading between a 20% and 80% premium sets the expected range at $7.16 to $10.75 for January 2018 soybeans in calendar year 2017.

You may notice this year's upper target of $10.75 is a dollar below last year's target and that is no mistake. USDA's estimated production cost is only down about $7.50 an acre, but last year's jump in yield to 52.1 bushels made a big difference in bringing this year's price targets lower.

With January 2018 soybeans trading at $10.23 on the morning of Feb. 6, prices are already high enough to consider starting some form of price protection. It's no secret that many are expecting a larger U.S. soybean planting in the spring and are also expecting USDA to increase its estimate of Brazil's soybean crop on Thursday, on track for a new record high.

The big unknown in the soybean balance sheet continues to be demand, which will depend on trade relations with China and Mexico. On its face, the demand outlook is as strong as ever with U.S. soybean exports up 21% in 2016-17 from a year ago and USDA expecting Brazil to end their new season with only 129 million bushels of ending supplies.

But it seems likely that China's soybean purchases were front-loaded this year as everyone knows that President Trump is getting ready to challenge the terms of trade. The bottom line is that no one knows how soybean demand will finish in 2016-17 and one of our favorite market clues, the March/May soybean spread currently reflects a bearish commercial outlook with a 10-cent carry in the May.

In the case of Chicago wheat, December 2016 prices finished at their least profitable levels in at least three decades as U.S. wheat piles grew and business continued to shift away from the U.S. Excluding land expense, the Nov. 30 low of $3.80 a bushel was 32% below USDA's cost estimate, the least profitable price since 1980.

Because today's smaller U.S. market share bears little resemblance to the old days, I reduced the anticipated range for Chicago wheat prices from 90% to 150% of cost to a more likely 80% to 140% of cost.

USDA's landless cost estimate of $241.90 an acre or $4.60 a bushel in 2016 puts the expected range for December 2017 Chicago wheat at $3.68 to $6.44 a bushel in 2017. With December wheat currently at $4.88 1/2 and winter wheat plantings possibly the lowest since 1909, the anticipated range is reasonable, but prices will still need some kind of fundamental help as the upper end has not been reached since early 2014.

I am sure 2017 will have its own surprises and it may be fun or possibly painful to see how events unfold. Until we learn more and expectations change, the three estimated price ranges above are a good place to start.

Best wishes in 2017.

*USDA's Commodity Costs and Returns found at:

https://www.ers.usda.gov/…

Todd Hultman can be reached at todd.hultman@dtn.com

Follow him on Twitter @ToddHultman1

(BAS\SK)