There are a lot of ways to analyze the fundamental situation of grain markets. You can look at production figures, export numbers, inventories, farmer deliveries as well as elevators supplies. Recently, I’ve heard a lot about stocks-to-use ratio as a fundamental gauge of supply and demand. So naturally, I ask myself: “What kind of historical connection is there between grain prices and stocks-to-use ratios?”
First of all, what is a stocks-to-use ratio? The stocks-to-use ratio combines a lot of the fundamental supply-and-demand data points in to one easy-to-use number.
According to one website (futures.tradingcharts.com) “… the stocks-to-use ratio is a convenient measure of supply-and-demand interrelationships of commodities. The stocks-to-use ratio indicates the level of carry-over stock for any given commodity as a percentage of the total demand or use. The mathematical formula for this relationship is as follows:
Beginning stocks represent the previous year’s ending or carry-over inventories. Total production represents the total grain produced in a given year. Total usage is the sum of all the end uses in which the stock of grain has been consumed. This would include human consumption, export programs, seed, waste, dockage and feed consumption. By adding carry-over stocks to the total production you will obtain the total supply.
From the total supply, subtract the total use and the resultant figure will be the year-ending carry-over stock. The carry-over stock divided by the total usage can be expressed as a ratio which when compared with previous years gives the market analyst an indication of the relative supply/demand balance for a particular commodity.
This ratio can then be used to indicate whether current and projected stock levels are critical or plentiful. The ratio can also be used to indicate how many days of supply are available to the world marketplace under current usage patterns.
By comparing the current year’s stocks-to-use ratio with years when carry-over stocks were below normal as well as years when carry-over stocks were above normal, you will be able to develop an estimate as to the direction of the price trend as well as the probable extent of price change whether higher or lower.
Some benchmark ratios can be established for various crops by reviewing historical stocks-to-use data. It is useful to calculate stocks-to-use ratios for different crops and compare these projections with historical averages.”
So, historically speaking, what kind of relationship is there between stocks-to-use ratios and prices over time? Does a low stocks-to-use ratio necessarily mean higher grain prices? Does a high one mean low prices?
Long-term corn, soybean and hard red winter wheat prices versus their stock-to-use data tell some interesting stories. Over time, as stocks-to-use ratio levels drop, prices tend to increase, although not necessarily in a strong linear fashion. Also, the mathematical connection, or correlation, between the two data points vary quite a bit depending on the commodity.
In the past 20 years, the numbers show quite a strong connection for corn with a correlation of nearly 80 per cent. Soybeans have a connection of around 40 per cent; certainly there is some relationship here but not high enough to put a lot of faith in. Lastly, wheat has a low connection of only about 25 per cent.
The accompanying charts illustrate these numbers. If stocks are low and there is not as much grain around, the laws of supply and demand should kick in, resulting in higher prices, which makes sense. However, with so many factors affecting supply and demand, and therefore prices, stock-to-use numbers alone aren’t robust enough to provide any reliable predictive power. In some years, the ratio is quite low but so too are prices. Likewise, we’ve had high stock years with fairly good prices.
Bottom line, stocks are a supply snapshot at one point in time that is continuously changing. The use part of the equation is a demand-driven item which is even more nebulous, harder to quantify and certainly subject to a lot of change as well. The stocks-to-use ratio is, if nothing else, at least another guide to help understand the markets and where prices might go, what production decisions to make and which marketing strategies to use. When comparing the stocks-to-use ratio with price, like most things in the markets, it’s the extremes we have to be aware of and pay attention to.
David Derwin is a commodity portfolio manager and futures/investment adviser with PI Financial Corp., a member of the Canadian Investor Protection Fund. The risk of loss in trading commodity interests can be substantial. Past performance is not necessarily indicative of future results. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. This is intended for distribution in those jurisdictions where PI Financial Corp. is registered as an adviser or a dealer in securities and/or futures and options. Estimates and projections contained herein are our own and are based on assumptions which we believe to be reasonable. Information presented herein, while obtained from sources we believe to be reliable, is not guaranteed either as to accuracy or completeness, nor in providing it does PI Financial Corp. assume any responsibility or liability.