By Mark Shore, Founder www.shorecapmgmt.com
In our previous article we introduced the commodity markets. Moving forward we will discuss more specific educational topics about commodities and futures. This article discusses some of the fundamentals of the soybean market.
According to the USDA, processed soybeans are the largest source of animal protein feed in the world and the second largest source in the world for vegetable oil. An estimated 90% of oilseeds produced in the U.S. are soybeans. The remaining 10% include cottonseed, sunflowerseed, canola, rapeseed and peanuts.
Soybeans are only second to corn as the most planted field crop in the U.S. As Midwest farmers tend to produce a higher soybean yield and lower cash cost than Southern or Eastern farmers, over 80% of soybean production occurs in the upper Midwest of the United States.
Soybean futures contracts are one of the most liquid of the commodity futures markets. Soybean futures were introduced in 1936. The soybean complex (soybean meal and soybean oil) was introduced as futures contracts in the 1950s. There are seven standard expiration months for soybean futures; January, March, May, July, August, September, November. Soybean meal and soybean oil futures contracts also include the months of October and December.
The full size contracts are 5,000 bushels per contract. The CME Group also trades mini-sized contracts of 1,000 bushels per contract. Soybeans are priced at cents per bushel. Soybean meal is priced at dollars per short ton. Soybean oil is quoted at cents per pound.
Two major pricing factors of soybeans are exporting and weather. As noted in Table 1, the United States is one of the largest producers and exporters of soybeans. They are planted and grown annually. Because of the annual planting farmers may be more flexible to increase or decrease their plantings based on current levels of supply and demand. There is a tendency for farmers to plant more when the price is high and plant less when the price is low.
As noted in Chart 1, the U.S. was the leading exporter of soybeans with 94% of the market share in 1984. Soybean meal and soybean oil at 48% and 35% respectively. As the volume of production and exports has increased since 1984, the U.S. global export market share has decreased. As of 2009 soybean, soybean meal and soybean oil were 43%, 16% and 12% respectively of market share.
The two primary factors reducing the U.S. export market share: 1) Increase of foreign soybean production. Specifically Brazil and Argentina have become the largest competitors to the U.S. soybean market due to a lower acreage cost, decreasing marketing and transportation costs and eliminating or reducing the soybean export tax. The depreciation of the Argentina Peso assists soybeans to be less expensive for importing countries to purchase. (For more discussion of the relationship of commodities to currencies see Currencies in your Future Portfolio? ).
2) Increase exports of U.S. meat products caused a higher domestic utilization of soybean meal for feed, thus reducing the supply available for export.
In the United States, soybeans are planted in the spring, grown in the summer and harvested in the fall. Too much rain in the spring could impede the ability to plant due to fields flooding. Not enough rain during the summer could cause drought-like conditions. Either case may cause a decrease of supply at harvest time. The summer months tend to experience price volatility as production uncertainty increases and weather patterns change. These factors also increase the market’s probability for quick “spike” moves.
Commercials (hedgers) and speculators may hedge the volatility by going long or short soybean futures contracts. The market tends to be less volatile once the harvest is known until the next planting season the following spring.
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The soybean complex allows for spreading between soybeans, soybean meal and soybean oil. A common processing spread is the crush spread. This involves being long (buy) soybean futures and short (sold) soybean meal futures and soybean oil futures simultaneously. A processor will utilize this spread to hedge the future purchase price of soybeans and the future sale of the soybean products of meal and oil. “Crushing” is the conversion process of soybeans into soybean byproducts of oil and meal.
The crushing process will convert a 60 pound bushel of soybeans into about 11 pounds of soybean oil and 44 pounds of soybean meal.
There is an old adage “beans in the teens”. Historically when the soybean market rallies, a move above $10 per bushel was considered a large move. As seen in Chart 2, the market tested $10 a few times prior to 2005. The summer of 1988 the U.S. experienced a drought summer and pushed the beans into the teens.
Since 2011 soybeans have averaged in the lower to mid teen price range. The increasing wealth of emerging nations is a major factor for sustained soybean prices. As nations become wealthier they tend to increase their consumption of meat, thus increasing the demand for cooking oils such as soybean oil and soybeans for feed.
China is a well known example of an emerging nation’s increased wealth and increased consumption of commodities. A lesser discussed country may be Mexico. The North American Free Trade Agreement (NAFTA) caused Mexico to eliminate their soybean and canola tariff by 2003 and reform their agricultural policies. This lead to the U.S. supplying most of Mexico’s soybean imports.
Every commodity market has its specific players and natural nuances. The more someone understands the background, foundation and details of a market, the greater the ability to understand the personality and profile of a market and what impact that may have going forward.
Copyright ©2013 Mark Shore. Contact the author for permission for republication at firstname.lastname@example.org Mark Shore has more than 25 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. His research is found at www.shorecapmgmt.com
Mr. Shore is also an Adjunct Professor at DePaul University's Kellstadt Graduate School of Business where he teaches a graduate level managed futures/ global macro course and a frequent speaker at alternative investment events. He is a contributing writer for the Eurex Exchange, Reuters HedgeWorld, and the CBOE Futures Exchange.
Prior to founding Shore Capital, Mr. Shore was Head of Risk for Octane Research Inc ($1.1 billion AUM) in NYC, where he was responsible for quantitative risk management analysis and due diligence of Fund of Funds. He chaired the Risk Management Committee and was a voting member of the Investment Committee.
Prior to joining Octane, he was the Chief Operating Officer of VK Capital Inc, a wholly owned Commodity Trading Advisor unit ($250 million AUM) of Morgan Stanley. Mr. Shore provided research and risk management expertise on portfolio construction, product development and business strategy. Mr. Shore graduated from DePaul University with a degree in Finance. He received his MBA from the University of Chicago.
Past performance is not necessarily indicative of future results. There is risk of loss when investing in futures and options. Futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone. The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.
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