When the unbelievable becomes reality

ProAg -- The possibility of a blow off top in either corn or soybeans (or maybe both) this month seems large given recent market behavior.

Corn futures have rallied about $1.30 in the past two weeks while soybeans have jumped $2+. These kind of moves cannot be sustained by the markets as there just isn't enough time for users/suppliers to adjust. Why do blow off tops occur?

Blow off tops accomplish something that the market has not been able to do via a typical rally. While a typical rally doesn't get the attention or eyebrow raising reaction from the world (users, suppliers, the media, and government officials) and thus changes in behavior of those participants, the blow off top phase of the market does. This accomplishes a lot of things a typical rally cannot, and it seems while allocating short supplies cannot be done efficiently in a typical rally market, it seems the blow off top phase does get it done.

The above words might not mean much until you put an example to it. HRS wheat prices from 2002 to this past winter was a case in point. Users and suppliers watched as it took from the 2002 breakout point of a $2.50-$3 price range to rally to $5 by 2006 (4 years). It took another 12 months for HRS wheat prices to move from a $3.50-$5 range, and then another 7 months to rally to above $10.

During all of these price moves, users and outsiders thought HRS wheat producers would surely respond to the price rallies by producing more, and users using less of this product. But it really didn't happen. In fact, HRS producers were actually switching acreage away from HRS wheat to corn/soybeans due to variety improvement in corn/beans and roundup ready technology which made it much easier to produce corn/beans vs. wheat.

Producers had also just experienced the 1993- 2000 period, where head scab had made wheat production a much riskier proposition. Producers used to think wheat production would provide 50 bu wheat with your eyes closed - just plant it and the crop will come. Head scab changed all that, as yield ranges went from 40-50 bu/acre to 0-50 bu/acre in top wheat producing areas. All of a sudden, corn and soybean production were less risky ventures than wheat, and the fungicide application to wheat for scab was costing $5-20/acre - effectively taking 2-5 bu/acre off the profit side immediately to pay for the fungicide. While wheat production got more difficult, corn production became routine to get 150 bu/acre corn (from 8 or 10 years ago), and the world of producers was irreversibly changed. Economics changed as the perceived world wheat producers operated in changed environments. How could the HRS wheat market get producers attention??? The blow off top which took prices from $10 to $25 took just 2 months!!! That turned many producers heads, not only in the US but in the entire world. Wheat production looked profitable again, and the world responded in earnest as wheat acres jumped considerably in 2008. The blow off top got everyone's attention, making producers want to produce more and suppliers to switch to other sources of protein (wheat gluten?). Human behavior changed, HRS wheat shortage solved!

Note in HRS wheat how blow off tops accelerate each price rise, with prices moving higher, quicker in each stage. The heads of market players also change, as the psychology of different groups emerge and meet in the marketplace.

Speculators (think spec funds) purpose in life is to educate the world about what is happening in it, forcing everyone else to accept their view of it before they change it (just when you believe $25 wheat is possible or reasonable, then it drops to $10 in 2 more months!). By buying and controlling the HRS wheat market with huge long positions and catching shorts unprepared, they were able to blow the market much higher than anyone could imagine, with the final dramatic stage (think the move from $10 to $25 in 2 months) making us all believe the unbelievable. HRS wheat will never be worth over $15, let alone $25, right? But once it ran to $25, we all had to believe it. When we did, prices dropped below $15 almost immediately!!! When the unbelievable becomes reality, funds are essentially done with their play as they've accomplished their purpose. If not for fund traders, who would have believed that users would pay $25/bushel for HRS wheat? Or, that they would pay $10/bu premium to soybeans for HRS wheat? Or, that HRS wheat was worth 2x as much as SRW or HRW wheat?

When the unbelievable becomes reality, blow off tops are usually done and the world looks at the market of a blown off top differently than it did before. The lesson taught in HRS wheat is that its worth whatever someone can believe it is worth, and perceptions change with time. Most of us (99% or more) are simply price followers, and a few (1%???) are price makers. Funds were price makers in HRS wheat last February, and they forced us all to accept that anything could happen to HRS wheat prices, as the impossible became reality, and then reality became possible again (<$10 wheat)!

Corn seems closer to the 'unbelievable' now than any other crop, as corn is now at a premium to SRW wheat. But perhaps $8 corn is similar to $10 wheat? What next can happen to corn? Can we do the blow off top in the same dramatic fashion as HRS wheat??? If so, it becomes difficult to put a topside in the market, or even measure one. Inflation adjusted highs in HRS wheat were $24, and we hit $25 in the 'unbelievable' stage of the rally. Inflation adjusted highs in corn fall around $15/bushel, while soybeans is actually closer to $40/bushel. So the top for corn could be anywhere in between $7.91 (this week's high) and $15, and soybeans between $15+ (this week's high) and $40. But remember, the spike from $8 to $15 ($15 to $40 in beans) may only take 2 months or less, not years. Psychologically, the market will blast all perceptions if the blow off top occurs.

In the past 2 years of corn rally, USDA has continually announced no intention of using CRP early out as a solution to the problem. Yesterday, USDA spokesman were saying the CRP early out consideration is being accelerated (meaning an announcement is imminent???). Pro Ag has been saying for almost 12 months that every time USDA said they won't open CRP, the market (think funds) is just saying "we need to go higher". Perhaps when the CRP announcement is made, then funds will finally decide we are high enough!!! Ironically, while governments and politicians like to believe they control markets, instead markets might control governments (the market goes up until government policy changes), and therefore the market accomplishes its purpose which is to make people change what they do. HRS wheat producers planted more, HRS wheat users used less, and the rest of the world learned the real value of HRS wheat. Is this finally happening in corn/beans??? If so, then the blow off top is occurring, and is nearly done!