Within all the market noise, if you aren’t sure whether a news item will have a meaningful impact on prices, the question to ask is, ‘how might this affect the endings stocks?’.
Markets can have a short attention span, and get caught up in the latest fad of the news cycle. While the day-to-day news flow has substance, it’s important to filter the noise from the relevant information. In today’s 24-hour continuous chatter, that’s not always easy to do, and so we ask the question.
Fundamental analysis studies how prices respond to changes in supply and demand. Mainly it’s a look at how much of a crop there is expected to be, and how much of it is likely to be consumed. The supply side is primarily made up of production plus what was left over from the previous crop year. For most Prairie crops the primary sources of demand are exports and domestic consumption, which could take the form of processing (e.g., crushing, milling) or feed (barley and other feed grains).
The key from a market perspective is how much of a crop is left over at the end of the crop year, or what is remaining of the ‘big pile’ after everyone has taken their piece. These questions are the measuring stick of how tight a market is or isn’t. While prices tend to overshoot or underreact, or even respond in the shorter term to things that have a little lasting impact, grain values will ultimately adjust to expected changes in the size of the ending stocks for a crop.
Let’s consider canola. While estimates vary, current expectations and what we know today suggest we could end the 2018/19 crop year with roughly 2.5 million tonnes of canola left over. What does this mean for prices? Likely a market that continues to trade in a sideways range, perhaps not that different from what we’ve seen in the past few years.
However, keep in mind the different assumptions that are built into that ending stocks projection, since there are so many unknowns at this point in the cycle. Every change in the numbers on either the supply or demand side directly affects the ending stocks estimate, and in turn, prices.
Will farmers plant more canola than Statistics Canada reported? Any increase or decrease in the seeded area from estimates would add or deplete the supply. Yield is the single largest swing factor for supply. Markets are so volatile during the growing season because every weather forecast can cause adjustments to the yield outlook, which in turn affects the ending stocks estimate, and therefore, prices.
The same thing applies to the demand side. A bigger soybean crop expected in the U.S.? This means a bigger global oilseed supply, making it harder for canola to compete in export markets, hurting export demand. Any ‘loss’ of export demand adds to the ending stocks. An increased mandate for biodiesel consumption in another country? This could support vegetable oil prices, which might help canola crush margins, potentially increasing how much gets crushed domestically, but possibly reducing ending stocks.
There are a multitude of factors, both domestically and globally, that affect every item on the supply and demand table. And often it’s the second and third degree of separation from the headline event itself that can have a more significant effect on demand or supply.