Soybeans have been in a bear market for months, with futures prices experiencing the biggest slump in 41 years.
Traded prices for the September contracts on the Chicago Mercantile Exchange (CME) have dropped over 19% in the last two months – breaking below the $11.00-per-bushel level last week for this first time in almost a year.
The reason? Excess supply…
The U.S. Department of Agriculture has projected greater-than-expected soybean harvests and stockpiles this year, due to favorable weather and soil moisture. At least four times the average amount of rain has fallen in the past month in parts of Iowa and Illinois, the biggest soy-growing states.
Have we finally reached a market bottom?
Record Inventory Pushes Soybeans Off a Cliff
The USDA predicts that soybean output will rise to a record 3.8 billion bushels on yields of 45.2 bushels per acre, with production expected to outpace demand.
This figure topped the government’s own estimates a month ago by 4.5% – and is well over last year’s 3.3-billion bushel crop.
World inventories are projected to reach a record 85.31 million tons (mt). U.S. ending stocks will total 140 million bushels (mb) by the end of August – climbing to 415 mb on August 31, 2015, before next year’s harvest. That’s up from 325 mb forecasted in June.
If realized, that would be the highest since 2006 and 2007.
The following chart shows how soybean contracts have been affected by the record inventory levels.
Now, some traders believe that we’re approaching a bottom for the soybean market. But there could be more downward pressure on prices.
For four fundamental reasons…
Reason #1: The market’s recent drop was driven by old crop data. And there’s still time before the new crop figures, which means plenty of weather factors ahead.
According to the Commodity Weather Group, generally favorable weather conditions are expected to continue through at least the end of this month in the grain belt.
Reason #2: Demand for rapeseed (the second-most produced and consumed oilseed in the world behind soy) has increased at a faster pace than that of soybeans over the past decade. This reflects a global consumer push for diversified oilseed products.
And soybean prices trade at a significantly large premium to rapeseed (more than $2 per bushel).
Plus, production of other alternative oilseeds is growing at a faster pace – such as cottonseed, sunflower seed, canola, flax, safflower, and peanuts.
Oilseed production projections for 2014-2015 are for 520 mt – with soybeans making up roughly 60%, and rapeseed accounting for roughly 14%.
Reason #3: The United States faces competition from South America – particularly Brazil (the second-largest soybean producer globally). Currently, a U.S. buyer of physical soybeans can source from the Mato Grosso state of Brazil – instead of Iowa – at about a 20% discount.
Reason #4: Soybean surpluses have been reflected in the large growth in U.S. oilseed ending stocks, which swelled from 65 mt in 2012-2013 to 78 mt last year. The surplus is set to climb to more than 95 mt in 2014-2015 – reflecting recent strong soybean production in North and South America, and the promise of another record crop in 2014-2015.
“Bean” There, Done That
One of the simplest ways to play soybeans would be to access the exchange-traded commodity (ETC) market.
The ETFS Short Soybeans ETC (SSOB.L), for instance, is intended to change daily by the inverse of the daily percentage change in the DJ-AIG Soybeans Sub-Index.
With belief that the market has finally bottomed out, one could also buy the Teucrium Soybean ETF (SOYB), a proxy for going long soybeans.
Of course, options tend to provide the best investment strategy. Futures, on the other hand, can serve as an option hedge – and a good way to profit during periods of volatility. Ultimately, soybean prices could still experience some downward pressure – but they could also experience temporary spikes – or even a market reversal.
As a result, the recommended strategy would be to go long either outright puts or bear vertical put spreads. Focus on the November contract (ZS X4), which represents the end of the old crop-new crop cycle. (By nature of the soybean term structure, it’s when lower prices are the norm.)
An outright put provides unlimited profits, whereas a put spread provides limited risk – yet costs less to initially employ. Depending on one’s level of bearish conviction, a put spread ratio such as 2:1 or 3:1 is an alternative.
You could also consider adding a long out-of-the-money call, which would serve as a hedge, should the market spike. Furthermore, selling a deep out-of-the-money call would help finance the strategy. The downside is limited at current prices, and there is the potential for future consolidation.
Bear in mind that whatever strategy is employed, ongoing attention and discipline are prerequisites, while being cognizant that commodity spikes are the norm.
It’s also important to remember that August is the most critical weather period for soybeans in the United States, as soy pods are setting and filling.
Dry or excessive heat can cause premature death. And if the season starts out wet (as it has) and ends dry, the plants are susceptible to damaging insects. Such a sign would truly foreshadow a soybean rally.