Spread trading in the grains seems to be gaining popularity these days and for good reason. With high volatility in grain markets spread trading may be a way to take on less risk and lower margin requirements.
However, when spread trading grains it is important to understand the difference between crop years and their relationship to each other. While new crop and old crop contracts certainly are related they do have different factors influencing prices, and sometimes very different fundamentals. So, what does the relationship between the new crop and old crop tell us?
In grains we refer to last year’s crop as old crop. This is the grain supply we grew last year and currently are using. New crop is the next crop supply that we expect to grow. This is the grain that we will be working hard to produce and that will be harvested in the fall. The marketing season for corn and soybeans begins when crops are harvested starting in September and ends when the new crop harvest begins. There is certainly a lot of overlap in fundamentals between any particular grain’s old crop and new crop.
For the most part we assume demand will be fairly consistent unless a big price fluctuation were to occur because demand is sensitive to prices. We know that there will be some old crop that we carry over into the new crop marketing season. How much or how little grain will be carried over from one year to the next sometimes dictates how correlated old crop and new crop prices will be. The biggest unknown factor for the next year is supply. Grain production can vary (sometimes dramatically) from one year to the next depending on how many acres are planted and how good or bad the weather is during the growing season.
Under normal market conditions there is usually a premium to the new crop contracts because we do not know how the next growing season will go. This production uncertainty keeps new crop prices higher. In a bear market this can be exaggerated as old crop prices can go lower to try to spur demand, while at the same time keeping a premium in new crop because we still have to grow it.
In a bull market this relationship can flip. A bull market generally means that demand is strong relative to supply. In this scenario many times old crop prices will be higher than new crop prices (see “A bean in the hand is worth” below). The idea is that the balance sheet is tight now but could be better next year if production is good. When old crop prices are higher than new crop prices this is generally a good indication of a bull market. Because of this relationship old crop and new crop prices do tend to go in the same direction but that direction is usually led by old crop.
So, in a bull market the old crop usually moves higher faster and farther then new crop, and in bear markets old crop usually moves lower faster and farther than the new crop.
What is the old crop/new crop relationship in corn telling us this year?
As of May 1 there was a 9¢ premium to the July (old crop) over the December (new crop) corn futures contract. This is a rather small premium to the old crop contract for a bull market. For example July soybeans are almost $2.70 higher than the November contract (see “Old beans rule” below). Also, the May corn contract is about to go off the board with only a 3.5¢ premium over December.
This is a rather interesting relationship considering that corn has now rallied over a dollar off the lows. Back in January when corn was on the lows the new crop December contract held an 18¢ premium over July. This was a good indication of a bear market at that time.
With July now holding a 9¢ premium over December it means that the July contract has rallied 27¢ more than the December during this rally off of lows (see “Reversal of fortune,” above). This is what we would expect from a market in an uptrend, but it is not an overly impressive indicator of a bull market (see “Now there’s a bull corn market,” below). We are not seeing the strong premium in old crop over new crop as we do in the soybeans. This may be suggesting that corn is in the process of a correction in a longer-term bear market. However, it does show that there can be significant movement over a short period in this spread with much higher volatility than your typical calendar spread.
New crop corn has had its own reasons to rally and at some points has been the leader of the corn complex. The old crop balance sheet has gotten tighter but is in no way a tight situation. Old crop corn has not had to rally sharply to price ration demand like old crop soybeans have. In the meantime new crop corn planting intentions are 10% lower year over year, which could be suggesting we will produce less corn next year. On top of that, planting progress is 9% behind the five-year average as of April 28, which is causing concerns that we may not get all of the intended corn acreage planted in time.
This means more acres may be lost and later planted corn may not produce as much. So, new crop corn has had reasons to rally also. But, if we really are worried that new crop corn production may fall short then we should be putting a premium on what old crop corn we have left. The idea would be to price ration demand so that we could take as much corn (CBOT:CN14) into next year as possible. This suggests that if corn prices were to continue to push higher we would expect old crop corn to begin to rally further and faster than new crop.
What about soybeans? (CBOT:SN14)
There is a vast difference between old crop and new crop soybean fundamentals. With a record pace of exports and strong domestic usage, old crop soybeans have a bullish story. However, with a projected record world carry over, projected record U.S. acreage and a forecast for a moderate El Nino growing season, the new crop soybean situation may be more bearish than what we have seen in years. So far the bullish old crop soybean situation has taken center stage but will the new crop story get more attention as we get closer to the USDA’s first estimate of a new crop balance sheet and planting the U.S. soybean crop?
Since January, the old crop soybean scenario has been a bullish factor for the soybean complex as well as for the grain complex as a whole. Export sales were much stronger than expected and have set a record pace. It seems that global end users may have been double booking their needs, buying both U.S. and South American soybeans with the idea that if South America were to have issues getting their crop to the ports and shipped out they would already have U.S. soybeans booked to fall back on.
In years past there have been lengthy harvest delays in South America causing global end users to scramble to book their immediate soybean needs while prices rally sharply. The plan was to take the U.S. shipments if there were a delay, or to cancel U.S. shipments and take the South American beans if they were available. However, when South America was able to get soybeans moved into position for export and was able to start making shipments, the United States would not allow cancellations, possibly related to China rejecting U.S. corn cargoes because of an unapproved GMO strain.
In the end the U.S. export sales have been shipping out. The record pace of sales and shipments, along with strong domestic demand, has left the United States with a very tight soybean balance sheet and a need to price ration demand. Since February, soybean prices have rallied sharply but while export sales have fallen off in recent weeks the March National Oilseed Processors Association crush suggests that domestic demand remains strong. This could be suggesting that more price rationing is needed to avoid running out of soybeans this year. Higher prices also could draw more South American imports, and it is possible that the higher crush number is a reflection of bigger South American imports as well.
The new crop soybean situation is almost the opposite of the old crop situation. Higher soybean prices relative to corn prices have encouraged a big shift to soybean acres this year. At the current USDA projection we would be looking at a record planted acreage number for soybeans. Given a normal growing season this could translate into one of the largest stocks numbers we have seen in recent years. And, although longer term weather forecasts can be unreliable they are currently calling for a very favorable El Nino weather pattern during the growing season. On top of that, global demand seems to be slowing down at higher prices, and with a huge South American crop in the process of being harvested the world stocks number is projected to be at a record high. This might mean that the world will be flush with soybeans next year. Certainly we still have a growing season to get through but, if we don’t have a major weather issue, we may see big soybean stocks next year.
As we get ready to plant soybeans and as we start to think about what the USDA might estimate for next year’s balance sheet, the market’s focus may begin to shift from the bullish old crop fundamentals to the more bearish new crop fundamentals. This will not happen overnight, but April or May is typically when it begins.
Old crop/new crop spreads in the grains can be a valuable trading tool if you understand the dynamics of how they work. This look into this year’s situation in corn and soybeans gives us insight into how these relationships play out in real time. Old crop/new crop spreads are not always good predictors of where the market is or could be headed, but can be a good gauge of the strength of a trend in a given time period. Spreads also may provide opportunities to traders who understand the dynamics of how they work. As with anything, it is important to understand how a tool works before you begin to use it.
Ted Seifried is chief market strategist for Zaner Ag Hedge. He can be reached at: firstname.lastname@example.org.