Those of you who have been with me through the years will recall I’m an advocate of Chaos Theory. I was first introduced to the idea by James Gleick’s definitive book “Chaos: Making a New Science”, and later “The Misbehavior of Markets” by Benoit Mandelbrot. Mr. Mandelbrot was a mathematician who did a great deal of work in fractals, and whose study of cotton prices decades ago figured prominently in Mr. Gleick’s book.
What is Chaos Theory? By definition it is an unforeseen event at a critical time leading to a changed result. The symbol for Chaos is the Lorenz Butterfly (attached picture is from my copy of Mr. Gleick’s book), and was initially created by Edward Lorenz, a meteorologist whose work proved “long-range weather forecasting was doomed” (Chaos, pg. 17). And if true for long-range weather forecasting, so too would it be true for extended forecasting of any kind, including markets.
Chaos Theory is also described as The Butterfly Effect (partly due to the Lorenz Butterfly) which states “a butterfly flapping its wings in Beijing causes a storm in New York”. My good friend Philip Shaw and I have talked about the Butterfly Effect many times over the years, and I always know who sent in the question when it was referenced on a television program or webinar. Within Chaos Theory there is also something called the Black Swan Theory developed by Nassim Taleb that is defined as, “an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight.” My thought on the matter is too many things are considered black swan events, but when one actually occurs there is no doubt about it happening.
Monday, August 10, 2020.
Let’s set the stage. The previous Friday, August 7, saw the cmdty National Corn Price Index (NCPI, weighted national average cash price) calculated at about $2.82, with the daily average for the 2019-2020 marketing year to that point (with only three weeks remaining) coming in at $3.37. This price correlated to a stocks-to-use figure of 12.8%. The next Friday’s CFTC Commitments of Traders report (legacy, futures only), showed noncommercial traders reportedly held a net-short futures position of 149,902 contracts as of Tuesday, August 11, 2020. Fundamentally, corn was neutral with the December 2020-to-July 2021 forward curve showing a carry of 27 cents and covering roughly 45% calculated full commercial carry. A similar situation was seen in soybeans with the cmdty National Soybean Price Index calculated on August 7 at $8.18, the daily marketing year average of $8.34 correlating to a stocks-to-use of 14.5%, and noncommercial traders holding a net-long futures position of 78,289 contracts as of August 11.
Then came Monday, August 10, with the derecho (straight-line windstorm) that ripped across much of the US Northern Plains and Midwest. Prior to the storm USDA had pegged the US corn crop (for those that follow such things) at 15.3 bb and soybean production at 4.4 bb (found in USDA’s August 2020 Supply and Demand reports). By the time USDA released its “final” January production numbers, US soybeans had been cut to 4.1 bb and corn had been sliced to 14.2 bb, with much of the change tied to the Black Swan event from early August.
As we approach the one-year anniversary of the derecho, and the 2020-2021 marketing year nears its end, we see a vastly changed landscape from what existed that Friday, August 7, 2020. In the most recent Commitments of Traders report (as of Tuesday, August 3), noncommercial traders held a net-long corn futures position of 318,043 contracts, up roughly 468,000 contracts from the same time the previous year. But consider this: Noncommercial traders have spent the better part of the last four months liquidating some of their long futures position, dropping their net-position a total of about 232,000 contracts from its high of 543,286 contracts (week of April 13). This means the actual change in position over the first eight months following the derecho was just short of 700,000 contracts. With this incredible buying fueling uptrends in the corn market (apply Newton’s First Law of Motion and Newsom’s Market Rule #1) and national average basis following futures spreads into incredibly bullish territory (Grains’ Golden Rule), it’s no surprise the intrinsic value of the corn market (again the NCPI) is showing a daily average price for the 2020-2021 marketing year of $5.17. This price correlates to a stocks-to-use of 9.7%, as compared to the previous year’s numbers of $3.37 and 12.8%.
Over in the soybean market we see similar numbers, with noncommercial traders increasing their net-long futures position to 250,633 contracts at its peak (week of April 27), a gain of more than 172,000 contracts in just over eight months’ time. Also as with corn, the incredible noncommercial buying spree propelled the markets’ uptrend (both futures and basis) with the NSPI reaching a high of $16.77 on May 12 while the daily average price for 2020-2021 has climbed to $12.81. Remember where we were a year ago, the NSPI averaging $8.34 and correlating to a stocks-to-use figure of 14.5%, both incredibly bearish for soybeans. With only three weeks remaining in the 2020-2021 marketing year the daily average of the NSPI is now correlating to the second tightest stocks-to-use on record of 0.2% (yes, you read that correctly), trailing only the $13.18 and 0.1% from 2013-2014. Recall that marketing year is the only one in modern history when USDA posted a US ending stocks figure of less than 100 mb in its September Quarterly Stocks report.
Was there more to the changed results in corn and soybeans than the Black Swan event that was last year’s derecho? Yes. We have seen demand for US supplies skyrocket both domestically and globally as trade situations ebbed and flowed with the currents of politics and the pandemic. We have seen both markets (as well as many others) live up to their billing of weather derivatives as Mother Nature played havoc with production around the globe.
But I will argue it all began with the events of August 10, 2020. The five Midwest states that are highlighted in the discussion of derecho damage are Nebraska, Iowa, Illinois, Wisconsin, and Indiana. What I heard the weeks following this windstorm was that US corn planting expectations would be changed in 2021 because of volunteer corn problems across destroyed fields. In its June Acreage update, USDA estimated year-to-year planted area changes for those five key corn growing states to be Nebraska (-500,000), Iowa (-500,000), Illinois (-100,000), Wisconsin (-100,000), and Indiana largely unchanged from the previous year. This put more emphasis on the US Northern Plains, where planted acreage increases were estimated, an area that has turned desert-like since last fall.
There are two excellent descriptions of Chaos Theory to sum up all we’ve talked about. The first comes early in Erik Larson’s book on the Galveston hurricane of 1900, “Isaac’s Storm”. In it he talks about how it’s possible a puff of steam from an ocean-going freighter in the exact location potentially mixed with the perfect combination of atmospheric conditions at just the right time to form the deadly storm. It’s fascinating to think about. The other is the brilliant scene from “Back to the Future II” when Dr. Brown explains to Marty the possibility of an alternate reality due to a skewed timeline caused by a then unknown event.
Both fit with the wind of change that occurred on August 10, 2020.
Until next time,