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Where Does Today’s Grain Market Volatility Stand Historically?

Today’s high volatility in grain markets still doesn’t match the levels found in 2008, though new tools have emerged to manage risk more efficient…

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Today’s high volatility in grain markets still doesn’t match the levels found in 2008, though new tools have emerged to manage risk more efficiently.

Corn, wheat, and soybean implied volatility and CVOLTM have been high in recent weeks relative to recent years. Implied volatility for some grains and oilseed contracts was even higher, however, during parts of the commodity boom of the early 21st century. How do the supply and demand fundamentals of 2008 compare to 2022, and what can we learn from the past to inform our expectations for the future?

Present Volatility Driven by Fundamentals

The figure below shows corn, wheat, and soybean CVOL for the past 12 months, with a clear spike in volatility following the February 2022 Russian invasion of Ukraine. Because the Black Sea region produces more than one-quarter of the world’s wheat, uncertainty around supply has led to a significant spike in wheat volatility in recent weeks. Corn, which is also produced in the Black Sea region, has also experienced heightened volatility.

Graphic: Corn, Wheat, and Soybean CVOL, April 2021-2022. 

Corn and Wheat Domestic Supply Uncertain

The March 31, 2022, USDA Prospective Plantings report, which reports the intended acreage for principal crops in the United States, serves as the benchmark predictor for the upcoming crop year. This year’s report espoused the intentions of the nation’s farmers to move increasingly from corn to soybeans, with record-high soybean acreage recorded. Many attribute that crop shift to high fertilizer prices. Domestic wheat acreage, which had already been planted at the time of the survey, marked what the USDA stated will be “the fifth-lowest all wheat planted area since records began in 1919.” The department also noted that low intended acreage defied the expectation that high wheat prices would incentivize planting.

Read More About Short-Dated New Crop Options

Spring wheat, which is planted in regions where winters are too harsh for the overwintering process required of winter wheat, is not expected to fill the supply deficit with increased planting in 2022. Low supply increases sensitivity to weather, and cold weather in the Northern Plains and Western Canada is said to be adversely affecting intended acreage among spring wheat farmers. In addition to geopolitical tensions and weather-specific to the present crop year, farmers are experiencing supply chain issues held over from the Covid-19 pandemic, such as high labor costs and low labor supply, as well as hampered logistics.

These factors have resulted in record-high nominal prices. The figure below shows the nearest December Corn futures average settlement prices by week, throughout H1 from 2007 to 2022. In nominal value, December Corn futures saw an average weekly settlement price of $7.417 per bushel in the 17th week of 2022: the highest new-crop weekly average that corn futures had ever reached at that time of year. In inflation-adjusted real value, however, that price was exceeded by both December 2008 and December 2011 Corn Futures, which in the 17th week of the year saw respective average weekly settlement prices of $8.134 and $8.516 in 2022 nominal value.

Graphic: New Crop Corn Prices Seasonally, by Year

Volatility and the Commodity Boom of 2007-2009

Volatility for December 2008 corn exceeds December 2022 corn by 5-10% in March of the respective years, and overall at-the-money (ATM) 360-day volatility in 2022 is 25% less than during the 2007-2009 commodity boom. Comparing call skew over the two periods, the 15-delta risk reversal (which takes the difference between a 15-delta call minus a 15-delta put) trades at substantially different levels to puts in the present day vs. 2007-2009. Calls are now trading at an 8%-9% premium vs. 5%-6% during the commodity boom. 

Graphic: Corn 360-Day Constant Maturity Volatility

BRICs Demand

Like in the present-day, volatility in 2008 was caused by a supply-demand imbalance. But in addition to some supply-side commonalities to the present, 2007-2009 was characterized by a demand-side burst (on top of a global recession that complicated access to credit). The figure below, for example, shows global production vs. usage of soybeans. The crop years 2007/2008 and 2008/2009 exhibit usage exceeding production to the greatest degree since the beginning of record.

Graphic: World Soybean Production vs. Usage 1991-2021

Though the period of 2007-2009 is generally associated with the Great Recession and the U.S. subprime mortgage crisis, the ascent and accelerating growth of emerging markets, in particular the BRIC nations of Brazil, Russia, India, and China, shared economic precedence. 

The BRIC nations were characterized by large and young populations, vast natural resources, rapid industrialization and urbanization, and what economists determined to be an intermediate stage of economic development. Expectations for the BRIC nations were so high that in 2006, Goldman Sachs released a report titled BRICs and Beyond, in which it projected that in 2050, the top 10 largest economies would include China, the United States, India, Brazil, Mexico, and Russia. Under this prediction, China, India, Brazil, and Russia would see real growth of up to 4,000% during the period 2006-2050. While China, India, and Brazil have largely proved worthy of the economic confidence imparted to them, in growth to date, Russia has been a notable underachiever

Indicative of the country’s urbanization and increasing wealth, China’s soybean imports skyrocketed in the 2000s, from annual imports totaling only hundreds of thousands of metric tons in the 1990s to 50 million metric tons in the 2009/2010 crop year, to over 90 million metric tons in the most recent crop year.

Graphic: China Soybean Imports, 1990-2022

Such an increase in consumption put pressure on soybean exporting nations, including the United States. The growth in demand, predictably, was a tailwind for soybean pricing.

Other Uncertainties

As BRIC nations increasingly demanded imports to feed their growing populations during the 2007-09 period; weather, trade, and economic dynamics convoluted global trade. A drought in the Southeastern United States complicated the growing season for some U.S.-grown field crops. Meanwhile, the period saw a massive acceleration in the production of corn-based ethanol, fanning the flames of the “food vs. fuel” debate by diverting a significant share of corn from both exports and domestic food and feed use. Echoing present-day issues, fertilizer prices skyrocketed in 2008, driven by increased demand and the slowness of the domestic fertilizer industry to adjust to new fundamentals. 

An important difference between then and now is the availability of more sophisticated risk management tools. Times have changed since the commodity boom of the early 20th century, and so have the hedging tools available. Short-Dated New Crop Options, for example, were listed in 2012 and allow participants exposure to longer-dated contracts such as December 2023 Corn or November 2023 Soybeans with shorter time horizons. 

This allows participants to gain exposure to lower premiums than conventional long-dated options.

After the Booms

The drivers of the commodity boom of the early 20th century are considerably more ingrained with, for example, a notable deceleration of China’s consumption not beginning until 2015, when investors and supply chain players grappled with slowing Chinese demand. 

Early 2022 volatility is largely attributable to supply disruptions stemming from the Russian invasion of Ukraine. The Russian invasion of Ukraine interrupted the factors underlying what many predicted was another commodity supercycle, increasing the sensitivity of agricultural markets to more classically endogenous forces such as weather. 

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Economics

Why You Shouldn’t Worry About Costco Stock

The warehouse club’s shares have been falling, but investors have nothing to worry about.

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The warehouse club's shares have been falling, but investors have nothing to worry about.

The market crash has driven stocks into a bear market panicking many investors as strong companies with solid results see their shares tank. It's a market that seems to have no safe havens as the vague specter of inflation has cast a dark shadow over the entire market, but pandemic stocks, technology companies, and the entire retail sector.

Costco (COST) - Get Costco Wholesale Corporation Report has not been immune to the drop. Despite the warehouse club operating pretty much as it always has, steadily adding members while retaining existing members, the chain has seen its share price fall 22.83% in the past six months.

That's a big drop for a chain which has been a very steady stock, usually moving upward while also paying a dividend. Costco's share price drop, however, has nothing to actually do with the company's performance. Instead, the company has fallen victim to broad concerns about retail in general.

Target (TGT) - Get Target Corporation Report, for example, saw its shares lose over 25% in value after it reported first quarter results. The chain grew its same-store sales, which was impressive given that it had seen that metric rise by 22.9% in previous-year quarter. The retailer faltered when it came to profits as earnings were cut in half year-over-year due to rising costs and supply chain issue.

Never mind that Wall Street has taken Target's strength for weakness (making money and gaining customers under these conditions is impressive), Costco shareholders have even less to be worried about.

Ting Shen/Xinhua via Getty

Why Is Costco So Strong?

Retail stocks, including Target and Costco, have suffered due to rising prices (inflation), supply chain issues, and fears over consumer spending drops. These are real concerns, but Costco has a lot of protection from those issues. The warehouse club operates on a membership model. Its profits come largely from selling memberships, not on the goods its sells its members.

Costco offers members the promise of low prices in exchange for a membership fee. The company offers a limited selection to keep prices down and it has enormous bargaining power with suppliers.

It's possible that inflation will drive prices higher on some key Costco items, but they company can simply pass those increase on without adding a markup. That makes the chain a value proposition for shoppers as these factors impact all retailers.

Costco has been able to hold its own on gross margin, according to CFO Richard Galanti speaking during the company's second-quarter earnings call.

"Moving down to the gross margin line. Our reported gross margin in the second quarter was lower year over year by 32 basis points but up 5 basis points, excluding gas inflation," he said.

Basically, aside from gas -- which is generally cheaper at Costco than anywhere else -- the company maintained its margin. It also grew its same-store sales by 11.1% excluding gas while its income rose as well.

"Net income for the quarter came in at $1.299 billion or $2.92 per diluted share. Last year's second quarter net income came in at $951 million or $2.14 per diluted share," Galanti shared.

Membership Is Costco's Key Metric

 Unlike a traditional retailer, sales aren't the key metric for Target. Membership tells investors more about the health of the company than anything else. The warehouse club needs both retain members and add new ones.

 It has done that, according to Galanti.

"In terms of renewal rates, they continue to increase. At second quarter end, our U.S. and Canada renewal rate stood at 92%, up 0.4 percentage point from the 12-week earlier at Q1 end. And worldwide rate, it came in at 89.6%, up 0.6% from where it stood 12 weeks earlier at Q1 end," the CFO shared.

Costco has seen its renewal rates go up as more members auto-renew. The warehouse club has also seen more of its members opt for the higher-priced Executive Membership, " who, on average, renew at a higher rate than non-Executive members," Galanti shared.

Membership has been growing (as it steadily has) as well, according to the CFO.

In terms of the number of members at second quarter end, member households and total cardholders, total households was 63.4 million, up 900,000 from the 62.5 million just 12 weeks earlier; and total cardholders at Q2 end, 114.8 million, up 1.7 million from the 113.1 million figure 12 weeks ago. At second quarter end, paid Executive Memberships stood at $27.1 million, an increase of $644,000 during the 12-week period since Q1 end. Executive Members, by the way, represent now 42.7% of our total membership base and 70.9% of our total sales.

So, while Costco's share price has suffered due to broader concerns and general market panic, the chain's business has not suffered. In a terrifying environment for investors, you could argue that Costco's one of the safer bets as long as you're willing to be patient.

In the short-term, stock prices may not reflect actual business results. Over time, however, the warehouse club will go back to posting steady share gains while also paying a dividend (and perhaps offering a bonus special dividend).   

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Labor Looks Set To Win In Hotly-Contested Australian Federal Election

Labor Looks Set To Win In Hotly-Contested Australian Federal Election

Update (0950ET): With almost 60% of the vote counted, it appears Anthony…

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Labor Looks Set To Win In Hotly-Contested Australian Federal Election

Update (0950ET): With almost 60% of the vote counted, it appears Anthony Albanese will return Labor from the political wilderness to government, seizing power from the Coalition after it has been almost a decade in office.

While it remains unclear if Labor can form a majority, the ALP is on track to finish ahead of the Coalition and more likely to reach a minority government, the ABC has projected.

This win means Mr Albanese will replace Scott Morrison as Prime Minister, making him the 31st person to hold the nation's top job.

*  *  *

As The Epoch Times' Aldgra Fredly detailed earlier, Australian voters cast ballots on Saturday to decide the next prime minister, as well as senators and members of Parliament, after a six-week election campaign that often centred on the economy and national security.

Electoral Commissioner Tom Rogers said Friday that 7,000 polling stations have opened as planned, despite a 15 percent turnover of its 105,000 workforces across Australia in the past week.

“While this is extraordinary, it is a pandemic election,” Rogers said in a statement, thanking those who stepped up to fill positions at polling places identified as not opening due to staff shortages.

The first polling stations will close on the country’s east coast at 6 p.m. local time (08:00 GMT). The west coast is two hours behind.

Nearly half of Australia’s 17 million electors have voted early or applied for postal votes despite loosened coronavirus restrictions. Those who tested positive for the COVID-19 will be able to access telephone voting.

Voting is compulsory for adult citizens in Australia, and failing to provide a valid reason for not voting results in a fine, which can progress to court. The fine for first-time offenders is $20, and it climbs to $50 for subsequent offences, according to the electoral commission.

Incumbent Prime Minister Scott Morrison’s centre-right Liberal-National coalition is vying for a fourth three-year term, having held 76 of the 151 seats in the outgoing parliament. Opposition leader Anthony Albanese’s centre-left Labor Party is considered by most trusted polls as the favourite to win.

(L-R) Australian Prime Minister Scott Morrison, federal opposition leader Anthony Albanese. (Martin Ollman/Getty Images, AAP Image/Lukas Coch)

One possible outcome of the upcoming federal election on May 21 is a hung Parliament where no political party can achieve a majority to govern outright (a party must win 76 seats). Instead, party leaders will be forced to negotiate a coalition with another minor party or independent to cross the benchmark to win government.

A hung Parliament has only occurred once in Australia since World War II. In 2010, both the Liberal-National coalition and Labor landed 72 seats, four votes short of a majority government. It took another 17 days before Labor leader Julia Gillard won enough support from four crossbenchers (minor party or independent MPs) after striking deals with them.

Morrison’s election campaign has focused on his party’s economic management, urging voters to support a government that delivered “a strong economy” over “a weaker one that only makes your life harder.”

He promised to lower taxes and put downward pressure on interest rates and costs of living if his government was re-elected.

Albanese pushed for Labor policies that would make child care more affordable for low-and middle-income families and improve nursing home care for the elderly, pledging to “always look after the vulnerable and the disadvantaged.”

Labor also criticized the Morrison government’s foreign policy credentials following the Solomon Islands-China bilateral security pact, calling the deal Australia’s worst foreign policy failure in the Pacific since World War II.

At the same time, the Coalition at times aggressively called into question Labor’s record with the Chinese communist regime, pointing to Chinese state-run media reports in alleging that the Labor leader was Beijing’s preferred prime minister.

In the lead up to the election, Australia’s domestic spy agency also revealed they had disrupted a plot by Beijing to install candidates in the election who they deemed as friendly and pliable.

“It’s odd the Labor Party wouldn’t say China is interfering—somehow they’re saying it’s Australia’s fault,” Morrison was quoted as saying by Sky News Australia on April 20.

“What I don’t understand is when something of this significance takes place, why would you take China’s side?”

Albanese then accused Morrison of making an “outrageous slur.”

According to a leaked draft of the Solomons-China agreement, Beijing would be able to send police, troops, and naval ships to “protect the safety of Chinese personnel and major projects in the Solomon Islands.”

Many feared that China would use the accord to establish a military base 1,700 kilometres off the Australian coast and destabilise the Indo-Pacific, although Solomon Islands Prime Minister Manasseh Sogavare had said that this would not be the case.

Tyler Durden Sat, 05/21/2022 - 08:24

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Government

The Fed’s Latest Housing Bubble

Is the current housing market in a bubble that is ready to pop? If so, what is the source and magnitude of the market distortion. The topic of a possible…

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Is the current housing market in a bubble that is ready to pop? If so, what is the source and magnitude of the market distortion. The topic of a possible housing bubble has been a topic of discussion lately, especially before Fed officials went on the warpath against Consumer Price Index (CPI) inflation. I have been asked about this issue and below is a truncated response to all those inquires.

I was asked in 2005 to write a chapter about housing bubbles for a proposed book on housing economics and government intervention. Much of the book would be about matters like government planning, zoning, eminent domain, and various government subsidies. My chapter would be a “macro” topic in contrast to the many “micro” housing topics.

I had been following and writing about the then current housing bubble (HB1) since 2003, having just left a stint in the Alabama Banking Department as the Assistant Superintendent of Banking in Alabama to take a professorship of macroeconomics at Columbus State University in Georgia.

I wrote for LewRockwell.com and Mises.org about the housing bubble and in 2005 I published my article “Skyscrapers and Business Cycles” in the Quarterly Journal of Austrian Economics which made the general theoretical connection between Fed policy and real estate investments and in this case, the connection between Fed policy, record setting skyscrapers, and economic chaos.

While my chapter was submitted in 2006 it was not published in the intended book until 2009 during the aftermath of the bubble.1 Not only did the editors invite me to include material in the final published version that they had originally deleted as too controversial. They also drew attention to my chapter at the beginning of their introduction to the book:

To the extent that the media was aware of my work, especially on the skyscraper curse, the response and level of appreciation was mixed. On the one hand, CNN was positive, if not surprised, that my work was so accurate and specific:

One person who wasn't surprised by the economic woes greeting the dedication of the Burj Khalifa (renamed Monday from Burj Dubai in honor of the sheikh of Abu Dhabi, which recently threw Dubai a $10 billion lifeline) was Auburn University economist Mark Thornton.

He predicted tough times for the emirate two years ago in a blog post entitled "New Record Skyscraper (and Depression?) in the Making." He noted that economic depression or stock market collapse usually occurs prior to completion of such skyscrapers.

On the other hand, The Economist took my “skyscraper curse” model to task because it did not stand up to somebody else’s poor understanding of the data involved. The magazine did not actually use my name in their article, although my academic article is listed in their reference list although my name was missing there too. My letter to their editor was not published and after many months I was extremely surprised to receive an email from them saying that my letter to the editor had been misplaced. Despite its discovery, they did not publish it. Extremely odd?

Review of the Charts

Here I will review the charts that I used in my 2006/2009 chapter and update the charts for the current housing bubble. As you will see, the Fed clearly did not learn its lesson and stuck its fingers back into the cookie jar. Of course, much more could be said about this housing bubble, but I will mention here that the bubble in real estate is cloaked in what my friend Keven Duffy correctly calls the “everything bubble.”2

The first chart is based on the Federal Funds Rate, which is the Fed’s main policy interest rate. They can control it directly and because it is the interest rate that banks charge other banks for very short-term loans, it sets the foundation for most other interest rates in the economy.

My chapter was completed in early 2006, but I had been studying and writing about the first housing bubble since early 2004. The paper was not published until 2009, long after the bubble burst and policy makers at the Fed and elsewhere were busily trying to cover up their mistakes.

What followed was seven years near the zero target rate and multiple rounds of bailouts and quantitative easy. This changed in 2016 as the Fed tried to engineer a return to normalcy and a soft landing. It did not work and under the cloak of the covid-19 crisis, the Fed went into double panic mode with a return to zero rates and quantitative easing combined with the Federal government’s unprecedented fiscal stimulus.

At the far left of the graph, you can see the Fed has once again embarked on a normalcy/tightening phase that has only just begun. The Fed has yet to raise its target rate above 1 percent. Balanced sheet reductions will be small until after the November election. Their response is particularly anemic so far given that CPI inflation is above 8 percent.

The thirty-year fixed-rate mortgage is a primary driver of housing bubbles. The 6 percent rate that caused the previous housing bubble seems high compared to recent years, but 6 percent is lower than at any time since we went off the gold standard in 1971.

The truly remarkable rates occurred only in the last few years when a combination of the Fed driving its policy rate to zero, massive quantitative easing, including massive purchases of mortgage-backed securities (MBS) and a tame CPI inflation led to the lowest rates ever, often less than 3 percent!

The Fed’s verbal war on CPI inflation by its top policy makers threatening large and sustained rate hikes and enormous balance sheet reductions, combined with out-of-control CPI inflation has moved market mortgage rates up sharply, now above 5 percent. The shift in recent years to fixed rate mortgages and away from variable rate mortgages should insulate current holders but could also crush potential home buyers and eventually hurt mortgage investors, banks, the Federal Deposit Insurance Corporation (FDIC) and even the Fed itself, which is the largest investor in mortgages.

If CPI does not soon collapse, the Fed will have to move rates much higher and that would trigger a downturn in housing statistics including prices and new permits—the new housing bubble would go bust. Recently on Bloomberg, a top Fed official was asked if its policy could reduce home prices and make it more affordable for first time buyers. The official quickly coughed and said the Fed would never reduce home prices, only the rate of increase. I’m glad that isn’t my job!

In the twenty years prior to completing my paper the total amount of real estate loans at commercial banks increased from $1 trillion to $3 trillion, a massive $2 trillion increase. That same number increased from $3 to $5 trillion, another $2 trillion increase over the last fifteen years despite a soft or negative overall market from 2009 to 2015.

The personal saving rate was above 10 percent on the gold standard and few people were on the public dole. Since going off gold in 1971 the saving rate has been declining and registered near zero when I completed my chapter in 2006. It has since risen to a higher level but remained below the gold standard percent-of-income level, until the covid-19 crisis hit, and the Fed went into its inflationary panic response in March 2020. The Federal government also ran massive deficits combined with multiple rounds of “stimulus” vote buying sprees. With vast amounts of free money and historic economic uncertainty, the personal saving rate spiked to over 25 percent and has since returned to the prior rate between five and 10 percent.

The money supply as measured by the MZM statistics increased by 50 percent during the first housing bubble and has increased another 50 percent since then, increasing in the last few years from roughly $6 trillion to $9 trillion. Obviously, the Fed is trying to do the impossible, which is to engineer and print the economy to prosperity, or whatever goal they are pursuing.

During the previous housing bubble, the amount of Real Private Residential Fixed Investment increased substantially, nearly doubling in the fifteen years leading up to the bubble’s end. During the second housing bubble, it has nearly doubled again. During the previous housing bubble, I marked the beginning of that bubble by noting that housing investment even increased during the prior recession. Investment also spiked again in the recent short recession during 2020 which might suggest that the current bubble has yet to reach its final stages.

Another good measure of housing is the number of single unit housings starts, measured here with New Privately Owned Housing Units data. That number increased substantially in the fifteen years of the previous bubble, before dropping precipitously to a record low. Housing starts have been on a similar trajectory since the previous bubble-bust ended. Although it has so far not reached the same height of the previous bubble its absolute increase is about the same and the number of multi-unit dwelling has noticeably surpassed the previous bubble. Also, the number of employees in the construction industry has reached back to the previous record levels that occurred during the previous housing bubble.

The amount of household debt increased enormously during the previous housing bubble and continued to increase for two years after my paper was completed, before hitting the crash/recession and tapering off for several years before being reignited and reaching its new highs. Since mid-2013 household debt has increased by over 30 percent despite the covid-19 crisis bout of higher household savings.

There are a number of alternative explanations for the red-hot housing and construction sectors, but I have viewed this market as a bubble in the making for many years. My anticipation is that while it could continue for some time, ultimately, we will see that mistakes were made caused by the Fed.

Prior to the last crash in housing prices Fed officials told us there was no housing bubble, that the Fed had near-omniscience and power, and that they would intervene quickly to prevent a bubble or a bust in housing. They claim that was their own transparency, but it turns out it was really their deception of us.

Then on top of that, the Fed acquired new powers and authority, Congress enacted sweeping regulatory and reporting requirements, while everyone else became much more skeptical about house flipping, multiple home ownership, and the charms of “housing prices never go down,” and “no one ever lost money in real estate” maxims.

Now we hear that people are still desperate to buy a house despite outrageous prices. That prices are bid up higher than asking prices. That homes-for-sale inventories are non-existent in some markets and that available homes are snatched up instantly in other markets. That buyers are in a catch-22 of rising prices and rising mortgage rates. That recent buyers can flip for a profit. To me, these are all echoes from a housing bubble being blow up to its inevitable breaking point.

  • 1. Mark Thornton, “The Economics of Housing Bubbles” in America’s Housing Crisis:  A Case of Government Failure Edited by Benjamin Powell and Randall Holcombe. Independent Institute, 2009.
     
  • 2. Bubbles usually get named after the sector most impacted by the Fed’s monetary inflation and low interest rate policy, but most asset classes have reached bubble proportions in this cycle. NOT SURE IF HE ACTUALLY COINED THE PHRASE.
     

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