The September Soybean Squeeze

Something remarkable occurred in the September soybean futures contract last Friday--the last day of trading for this lightly-traded, widely ignored contract. September beans surged to a one-day record of $2.74 per bushel to end its life at nearly $15 per bushel. In contrast, the active November contract closed an unremarkable 26 cents higher at about $3 per bushel below the final September price.

What in the world went on here? And what is this market telling us? In this issue, we’ll discuss this interesting market development, the common wisdom regarding what happened, and why I believe this one-day surge in this expiring contract is actually a canary in the coalmine.

The common wisdom is this remarkable price action in the September soybean contract was a one-day event that won’t be repeated anytime soon; it’s a classic short squeeze. There were relatively few contracts traded in the September contract Friday. On that day, a total of 143,010 soybean contracts changed hands, a mere 256 of these in the September.

By contrast, the active November contract had 107,486 contracts changing hands. Most brokers will caution their clients, who generally aren’t interested in taking--or making--an actual delivery of soybeans, to be out well before the last trading day.

First, here’s the common explanation of Friday’s action. Because of wet conditions this spring, the soybean crop was planted later than expected this year. The September contract is normally a transitional month between the “old crop” and the “new crop,” which is generally harvested now through the coming six to eight weeks. Normally, some new crop bean harvest would be coming to market from southern locations right now, but because the crop was planted later this year, old crop supplies are scarce.

The shorts couldn’t come up with the actual soybeans to deliver, which is their obligation if they remain short when the contract expires, so they had to cover or buy back at the prevailing market price to liquidate their shorts. Long investors “squeezed” short investors, who had no choice other than to pay up. The November contract also closed higher--but only modestly--and remains at a large discount to the expiring September contract since the market believes the current shortage will be alleviated by the upcoming harvest.

This certainly was a panic condition, but the market is telling us something more important regarding the overall soybean situation and their future prices.

Now we’re getting a little technical, but please follow along with me here. There was also a crop report released Friday morning. In this report, the US Dept of Agriculture (USDA) lowered its estimate of soybean yields and the size of the upcoming crop. It also estimated that soybeans stocks for this year’s crop will be only 140 million bushels. This is a very small supply, representing only about two weeks of usage.

With 140 million bushels out there somewhere and about 200 September contracts open on the last day--representing about 1 million bushels--why couldn’t the shorts have found some of these beans to deliver and prevent losing more than $10,000 to the longs in one day for every 5,000 bushel contract they had? Apparently they weren’t able to find any of these beans, but the common wisdom is that they’ll tell us these remaining bushels are spread out around the country and aren’t currently available at the delivery points for the Chicago contract.

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If the shorts couldn’t get the beans into position for delivery, they had no choice but to pay up to get out. But I see this price action as indicating the shortage is perhaps more severe than the government estimates. After all, the shorts would have taken any measure possible to avoiding paying up.

What if the carryover is actually minimal or already used up? This is important because the USDA estimated next year’s ending stocks to be a mere 135 million bushels. The carryover is going down by 5 million bushels because our government estimates total production of 2.934 billion bushels with demand higher than production at 2.949.

In other words, we need every bean out there. Here’s where it gets interesting and potentially explosive. That 135 ending stocks estimate for next year includes the 140 that’s supposedly brought forward from this crop year. Since we’re theoretically using more soybeans this coming year than the total crop size, if that 140 isn’t really out there, the US will run out of soybeans prior to the end of the next crop year, Sept. 30, 2009.

Other than the September contract, soybean prices have dropped dramatically in the past few months because of hedge fund liquidation of all commodities. In early July, the November contract was trading above $16 per bushel, and it’s currently near $12 per bushel. In actuality, we never really run out of anything. What generally happens is prices will rise to the point where demand starts to falter, but that target is higher than $12 per bushel.

As harvest accelerates, I plan to look for an entry point to buy the July 2009 soybean contract for Futures Market Forecaster subscribers.