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While the wide swings in energy prices dominated headlines for much of 2006, the grain complex has quietly established its most impressive bull market in a decade. And while wheat gained from crop problems in a variety of producing nations, corn prices have spiked primarily as a result of ethanol production finally ramping up in the US. With US ethanol production widely expected to increase in 2007, specs and funds alike have continued to buy corn, driving up prices in anticipation of steadily building demand eating away at available supply.

Soybeans have experienced what many feel is a “sympathy rally” with corn. While soybean oil is a component in bio-diesel fuel, it is ethanol that seems to be getting the media attention and new production facilities.

The ethanol story, however, is one with many questions yet to be answered. While it is true that new production facilities are going up quickly, there are many questions as to how much demand for ethanol there will actually be, especially with oil prices back near $55 a barrel. While much of the corn buying has been from speculators betting on increased ‘07 demand, soybeans have rallied from the theory that higher corn prices will mean US soybean acreage switching over to corn production in 2007.

Ethanol story or not, it is the bottom line supply/demand numbers that will eventually determine the price of any commodity. And the figures for 2007 soybeans do not paint a bullish picture.  

Despite all the corn/acreage/ethanol hype, the US is facing the highest soybean ending stocks ever. For investors not familiar with soybean supply terms, ending stocks are a measure of supply left over after all usage (demand) is satisfied for the crop year. Crop years for US soybeans run September-September. Therefore, ending stocks (also known as carryout) in September 2007 will be the number of soybeans the US has left over from the 2006 crop when the 2007 harvest begins.

As of the latest USDA estimates, the US will have 575 million bushels of soybeans left over in September of 07. This is due in large part to the massive 2006 US harvest that yielded approximately 3.188 billion bushels of soybeans – another record. The US has produced three consecutive years of bumper crops. As a result of this and heavy production from South American producers, world ending stocks are also expected to hit a record in 2007, pegged to come in at 56.15 million metric tons.

This figure alone makes $7.00 soybeans appear overpriced in our opinion. But speculators who bought soybeans off of the ethanol media coverage might be in for another rude awakening next month. For just as the US is busy trying to unload it’s soybean supplies on the world market, it’s main competitor, Brazil, is gearing up for it’s own harvest which begins in March. It is not uncommon for world importers to begin switching forward orders to Brazil this time of year as pre-harvest Brazilian beans will often offer lower prices.

Historically, this price competition has often meant US producers will lower prices to compete – at least temporarily. This has come to be known as the February break in reference to prices. While there is no guarantee that this type of break will occur this year, we see every reason why it should.

Brazil is expected to harvest 54.9 million metric tons of soybeans in 2007. This production would not only eclipse last year’s bumper crop by 5.1%, but would mean a record Brazilian harvest if realized.

These figures clearly indicate there is no shortage of soybeans at this time.

Bulls will argue, however, that the market is pricing a future shortage, based on US farmers switching acreage intended for soybeans over to corn to meet growing ethanol demand.

Let’s examine this argument.

While the USDA has not yet released its planting intentions report for the 2007 US crop, private estimates have US planted soybean acreage pegged at 70.878 million acres. If realized, this would indeed mean a 6.1% decline from last year’s 75.35 million planted acres. Given the expected sizable 07 ending stocks and assuming an average 42 bushels per acre yield, this would still result in a roughly 336 million bushel ending stocks figure for 2008. This would certainly be well below 2007 ending stocks as the bulls will eagerly point out. But 336 million bushels of beans would still be higher than in each of the six previous seasons ending with the 04/05 season. In other words, even if soybean acreage is reduced by the amount that private analysts are forecasting, 2008 ending stocks will still be hefty by historical standards.

To summarize, while the ethanol issue is bound to bring a few treasure hunters into the soybean market, longer term fundamentals should serve to keep a lid on any runaway price moves. In the shorter term, we are approaching a time of year when supply and price competition are typically at their apex.

Figure 1: Soybeans, May 07

James Cordier & Michael Gross
Contributing Writers, Liberty Trading Group
Optionetics.com ~ Your Options Education Site
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