By Todd Hultman
With USDA now estimating U.S. ending soybean stocks at 150 million bushels for 2013-14, the stocks-to-use ratio is at 4.6%, the third lowest ratio in the past three decades. Knowing that tight supply of any commodity translates to higher prices, it's fair for producers to ask: just how high will soybeans go? That is a difficult riddle to solve, but I decided to give it a try. I looked at the highest closes for July soybean prices for each year from Jan. 1 to June 25 as far back as 1989-90. To compare prices over time, I divided the highest closing prices by USDA's cost of production estimates and arranged them on a scatter chart according to the U.S. ending stocks-to-use ratios for their corresponding season.
The resulting chart showed a wide scatter of values that trended slightly lower as it moved toward the right, from lower stocks-to-use ratios to higher ratios. In other words, the highest prices that July soybeans traded at in relation to their cost of production were associated with the lowest ending stocks-to-use ratios, as any good economics student would expect. With USDA estimating a U.S. ending stocks-to-use ratio of 4.6% in its December 10 WASDE report, the chart suggests that the July soybean contract should trade at 40% above USDA's cost of production, or $14.07 ($10.05 x 1.40) a bushel, sometime between January 1 and June 25 in 2014. However, before we start handing out high-fives, there are additional factors to consider.
First, this chart is based on past data, but the future does not always cooperate with the rules of the past. Second, no matter how much analysis we perform, we can never rid the markets of the risk of uncertainty. Surprises can and do happen, and I have seen plenty in my short 28-year career. If China announced tomorrow they were changing their plans and cancelling soybean sales, this prediction would die a quick death.
Finally, there is wide variation in the historical data described above, even among years with similar ratios. Fundamentally speaking, the ending stocks-to-use ratio represents the classic interaction of supply and demand at work, but prices reflect more than just fundamentals. In addition to the traditional factors of supply and demand, prices also have a large emotional component that makes forecasting extremely difficult. I point that out because it is important to notice that soybean prices are not reflecting the kind of emotional excitement that we would normally see if the tight-supplies were due to drought, for example. The current tightness of soybean supplies is being driven by China's insatiable appetite, and that is more difficult for U.S. traders to assess. Also, the market is currently being reassured that a record harvest from South America is just months away and that is also easing the sting of tight supplies.
I was reading an article recently about Lars Peter Hansen, one of this year's three Nobel Prize winning economists. The article quoted Hansen as saying:
"The thing to remember about models is they're always approximations and they will always turn out to be wrong," he said. That shouldn't be a surprise, he said, and it doesn't mean that the models are useless.
I found his remarks to be a refreshing contrast from the usual line of know-it-alls. Models, like the chart I constructed to help us understand where soybean prices might go, are not infallible, but they can be helpful. If you understand the risks cited above and the shortcomings of trying to squeeze the future into a mathematical box, July soybeans have a credible, fundamental reason to trade as high as $14.07 before June 25, 2014. On a more practical note, the current fundamental situation, as we understand it, should continue to help July soybeans trade higher into early 2014. Whether beans actually make it to $14.07 or not, no one can say for sure -- not even a Nobel Laureate -- and that is why we keep a vigilant watch at DTN.
* http://www.nytimes.com/…. "Lars Peter Hansen, the Nobel Laureate in the Middle" by Jeff Sommer.
Todd Hultman can be reached at firstname.lastname@example.org
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