November 2017

November 2017

GRAVITY – Pretty much everyone, (and I hope everyone reading this) would agree that a force called gravity exists all around us.   It pulls us to its center and we have to exert energy to break its bounds.   We can experience it even though it is considered the weakest of the four fundamental interactions in nature.   Physicists, however, can not accurately calculate the probability of a particle existing at a certain time and space without by considering all four of the fundamental forces.      In quantum calculations, gravity is also fudged number.  The thing that we can most feel is unproven and its value is made up.

Thinking of supply and demand in calculating markets is kind of like calculating gravity.   It’s an idea that can be experienced, but it is incomplete and mostly made up.   Making market calculations on this idea alone will often lead to incorrect answers about the actual trajectory of a certain market.   

Green lentils in 2017 are a perfect example of inaccurate results given considering a S+D chart.   The logic seemed obvious.  If a commodity was trading between 35 – 55 cents, with a median price of 45 cents and carryout ratio’s below 5%.  If next year’s ratio is forecasted to be below 1%, how can it be possible to have a market trade below the median price?   Looking at S+D ratios makes the analysis appear easy.   Taking a long position below 45 cents should result in a profitable trade.   Yet, within 30 days of a harvest that was significantly reduced by drought and void of any backup stocks the market is now trading at levels seen when the stocks to use ratio was over 50%!   To get the answer we need to consider the other fundamental forces in our markets.

In keeping with the quantum physics theme, let’s get out of our vacuum and consider two other strong forces and a weak one to help explain what is going on.

Strong Force  (India)   –    India is a natural force of nature that can provide but also take away.   Complex and unruly.  As the largest producer and consumer, she sets her own rules about how to manage her relationship.  India must be fed, but how when and with what is always to constant fluctuation.      India can follow its own logic which is not necessarily linear in nature.   In 2017, her plans did not include Canada.    While domestic pigeon pea prices crashed left no opportunity for Canadian green lentils a more substantial negative force has come from Indian government policy to control prices by bolstering domestic prices while reducing prices for retail consumers.   The result is an interesting menagerie of incentives and restrictions which has often done the opposite of what was intended.     

Strong Force (Wheat/Canola Prices)   –  This year we have realized the importance of how other markets set the relative tone pricing lentils.   “If Durum was $10 bucks, Lentils would be $40” is the most accurate quote told to me this year.   While canola has stayed relatively flat, Within 3 months of 2017 harvest, the Durum market has fallen around 20%.   Relative to durum, lentil bids were highly overvalued (and unsustainable) in a declining world commodity market.   This occurs even though the commodities have almost nothing to do with each other on the S+D stage.   In year’s past, the opposite is also true.   When Obama mandated a minimum ethanol percentage in gasoline corn and feed wheat prices skyrocketed.   Future lentils prices had to keep pace in relative producer profitability to be considered for planting in the spring.   A 5-year bull market was unleashed.

Weak Force (Competition) – It’s one of those often overlooked economic rules: If you start a company and become successful, others will notice.   For all of Canada’s commendable cultural politeness, we had a hard time downplaying the ‘good thing’ we had going on with the rest of the world.   Maybe it’s a human nature thing.   Fear and Greed, and the inability to recognize the transient nature of both these things and tone it down a little.   Canadians were making a killing but also making sure the rest of the world knew about it.   Enter Russia, Enter USA, Enter Argentina, ……..  with high prices and lots of opportunities to practice the trade.   On the demand side, Exit India, Exit Europe, Exit North Africa, Exit Middle East…..as these countries look for other opportunities to reduce costs.    While this relates to adjusting to supply and demand, the weak element is that trading countries outside Canada are willing to operate outside of the traditional pricing rules surrounding the lentil trade.  Their inability to carry stocks creates a market where anyting goes.   Unfortunately, Canada often ends up at the losing end of that battle.

In summary, strong forces determine the market trend, weak forces determine the market range.   

For Green Lentils:

S+D (Weak Force): Current stock/use ratio under 5% = market will tend to high end of range

Competition (Weak Force): Russian traders undercutting market price = neutralizes strong S+D from Canada

India (Strong Force):  Low need for Canadian products = establishes negative trend

Wheat/Canola (Strong Force):  Durum = down 25%.    For LGL  75% of $45 = $33.75 which is where we are today.

A more thorough analysis would clearly have pointed to the necessity of re-adjusting lentil prices to remain in balance with the rest of the market forces.    

Going forward,  if wheat markets continue to stagnate prices will continue to decline through 2018.   It will take production troubles in India could reverse this trend.  Russia will sell out will give more weight to our current grower’s price demands.   However, because it is a weak force it will start adding resistance but can not change the trend.

Have a great month

dgn 11/03/2017