Hot and dry weather across the Prairies has continued to reduce canola yield estimates. Canola has shown itself to be a resilient crop, and analysts have been fooled in the past by how large the yields turn out to be even after the crop had seemingly been stressed during the season, but there is little doubt that the past month has shaved off yield potential.
Despite the decline in anticipated production canola futures prices are well off their recent July 10th peak, and can’t seem to get any upside traction even as the much needed rain proves to be so elusive in so many areas. Prices are apparently supposed to reflect the fundamentals, so why the lackluster market response to the shrinking supply?
To make sense of what’s going on we need to understand market behavior in general. Markets do ultimately go to where they fundamentally ‘should’. However, both demand and, particularly during the growing season, supply, are moving targets. So the process of determining the ‘right’ price based on fundamentals isn’t always a straight and orderly process.
Other factors come into play as well. For example, we tend to think of demand in terms of the entire crop year, but buying patterns can fluctuate. A price spike like we saw in early July may have caused some end users to temporary curtail purchases in the hope for a pullback, and some demand may have been rationed out altogether. There may also be a tendency to take a more ‘hand-to-mouth’ approach at this time of year in an effort to wait for a seasonal price decline during harvest. Eventually these patterns give way to a period of greater activity when buyers look to get more coverage on their books.
The price of canola relative to other substitutes also makes a difference. Even though the price of canola hasn’t increased in absolute terms, it has increased in value relative to the price of soybeans. Foreign exchange rates contribute as well. The July rally in the Canadian dollar alone accounts for approximately $20 per metric tonne of canola’s lag.
Finally, markets aren’t always as rational as economic theory assumes they are. Prices can swing based on information that is more ‘noise’ than substance. The market is also susceptible to focusing on specific narratives during windows of time. A key driver for all grain markets right now is the expected outcome for U.S. soybeans. Prices took a hit early this week when the Midwest forecast turned less threatening and crop reports showed conditions improving. Canola prices sank in lock-step with soybean futures, even though our own canola crop was going backwards.
As irrational as the canola market seems today based on Prairie conditions, values will eventually find their ‘right’ place. Based on current yield prospects and the generally good outlook for canola demand, this could well mean prices at a higher level then we see today. Of course, the value of the loonie, soybean prices, and other factors will also play a role in what this ‘right’ price will be. But from a growers perspective, there is a reasonable chance that higher cash prices will show up at some point, even if it requires some patience for the market to work through the many influences that affect it from one day to the next.