1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Alex Barrow
Alex Barrow
Articles (121)  | Author's Website |

A Corn/Soybean Spread Trade

In normal conditions the ratio helps farmers decide how much soybeans or corn to put in the ground

May 19, 2017

(The following is from Operator Jose, a member of the Macro Ops Hub.)

The corn/soybeans ratio is important to American farmers. In normal conditions it’s a key factor that helps them decide how much soybeans or corn they’ll put into the ground. Both crops compete for the same acreage area. I like to think of it like this:

Farmers have portfolios, but they have acreages instead of money. There are two assets in which they can choose to invest, corn or soybeans. This key decision is asset allocation. Whether they want more exposure to corn prices or prefer holding more soybean bushels depends on many factors, but price is a big one.

Farmers can check, even months prior to the harvest, how much money they’ll receive for every bushel they pull from the ground. This is done by evaluating the relationship between the corn and soybean futures that will be trading by harvest time.

Here is the long-term relationship for the front month futures:

Soybean Corn Ratio

The ratio is soybeans over corn. Whenever the ratio is over 3, farmers get three times more money for every soybean bushel than corn. Sometimes the ratio goes crazy due to weather risk and supply imbalances, but in normal conditions it shouldn’t be over 3.

Whenever the ratio is over 3, farmers plant a heck of a lot more soybeans than corn. And by the laws of supply and demand, this will eventually cause the ratio to go down as corn becomes scarcer relative to soybeans.

The best way to play this relationship is through a spread trade. You can use one contract of soybeans per two contracts of corn. This means you’ll have 5,000 bushels of soybeans and 10,000 bushels of corn on a notional basis.

If we’re bearish on the soybean/corn spread, meaning we think corn prices will rise relative to soybean prices, we’ll need to short one contract of soybeans and go long two contracts of corn. If bullish, meaning we think soybean prices will rise relative to corn prices, we do the opposite buy one contract of soybeans and short two contracts of corn.

Soybean Corn Chart

You’ll notice that this chart is very similar to the previous spreads chart, but the Y-axis is now quoted in points instead of in a ratio. Every point on the Y-axis is worth $50 per the spread trade.

The reason we use a spread instead of playing the commodity straight up is to hedge weather risk. Weather is the principal risk factor in grain commodities. Weather produces a largely asymmetric effect; while bad weather alone could completely destroy a crop yield, good weather by itself won’t produce a bumper harvest. Good weather is just one factor involved in a successful growing process. By taking the spread we’re strictly betting that corn futures will do better than soy futures no matter the other general conditions. Weather risk is partially hedged.

I'm bearish on the spread. Here are the fundamentals that support my theory:

The chart below shows how the soybean/corn ratio went over 3 last year when farmers planted too much corn relative to soybeans (soybeans became scarce and therefore fetched a higher price). Since December the ratio has been falling.

Soybean Corn December Ratio

The ratio didn’t do much in February and March other than consolidate. But at the end of March the Department of Agriculture released the prospective plantings report. This report shows how many acreages farmers intend to commit between corn and soybeans. The keyword in this report is “intention.” Following our portfolio analogy, the farmers are telling you the percentage of their portfolios they’re willing to invest in corn or soybeans.

But keep in mind that the grains aren’t in the ground yet. These farmers can change their planting intentions. There’s a small portion of corn being planted right now, but there’s still time to switch acreages in later stages. Farmers aren’t forced to stick to what they reported in the prospective plantings report.

On March 31 the report was released showing a decline in corn acreages of 4% and an increase in soybean acreages of 7%. Less corn supply means each kernel is worth more. And more soybeans means each is worth less. This confirmed my bearish bias on the spread. All that was left was price action to follow.

What do you think the big funds did on the day of the report? They shorted 11,000 contracts of soybeans and went long 20,000 contracts of corn a big 10,000 spread trade.

Amazing! It was almost like forecasting the future.

Here´s a chart with the net contracts position of managed money in the soybean market. Notice the downtrend. They are finally net short!

Net Positions of Managed Money On Soybeans

The spread went from around 230 per bushel to 168  a 27% move in seven days. Report day was the biggest red candle of almost 30 points.

November Bean December Corn Spread

There’s still downside potential to this trade. Price has retraced almost completely since the day of the report, and as I said, I don’t think the market has fully discounted a big soybean crop this year. If you check the long-term historic spread, there’s still downside potential.

I am short the New Crop Spread ZSX17- 2*ZCZ17 (Short 1 November Soybean Future and Long 2 December Corn Futures.) These are the futures at harvest time when the market should be overflowing with soybeans relative to corn.

To learn more about how we trade at Macro Ops, click here.

Start a free seven-day trial of Premium Membership to GuruFocus.

About the author:

Alex Barrow
I spent over a decade working for the U.S. military and government as an intelligence professional, including both collection and analysis. I specialized in covering the economic and political spheres of the Asian-Pacific region.

I eventually left the public sector to work as a consultant for a leading Silicon Valley firm that creates advanced data software for intelligence and finance. I then went on to pursue my passion for markets, working at a global-macro hedge fund.

Recently, I co-founded Macro Ops with two other former hedge fund analysts with the goal of helping friends and family navigate these volatile markets.

Visit Alex Barrow's Website


Rating: 0.0/5 (0 votes)

Comments

Please leave your comment:


Performances of the stocks mentioned by Alex Barrow


User Generated Screeners


alexbernal0$$SharYieldScore
alexbernal0$$FCFScore
alexbernal0$$EarnGrowScore
fluidityinglassShort%20Squeeze%20high%20F,%20
opadovaniP Median2 No DIV
cegdevelopmentthe best managers
cegdevelopmentprof managers
cegdevelopmentguru goals
cegdevelopmentguru holding
opadovaniFCF Growth
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)

GF Chat

{{numOfNotice}}
FEEDBACK