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How low can U. S. grains go?

“We are seeing a lot of wealth destruction and demand destruction. I don’t think that is going to heal itself overnight.”

– U. S. Grains Analyst Jim Bower

The sell-off in grains as part of a broader flight of investment money from commodities could continue through year’s end due to the expanding credit crisis, with any global recession taking a bite out of demand.

U. S. grain prices have likely not bottomed, despite their recent slide, with the U. S. harvest getting into gear, uncertainty over demand for corn from the ethanol sector and a rising dollar that could hurt export competitiveness.

But of particular concern to traders in the grain market is the path investment money from investors like index funds will follow.

“There are estimates that by the end of the year about 30 per cent of the index funds’ positions are going to get liquidated,” said grains analyst Charlie Sernatinger of Fortis Clearing Americas in Chicago.

“That is the big question mark in the market. In order to get some stabilization in prices, you are going to need some clarification that index funds are not going to get out of their big long positions,” he added.

Index funds, along with other investment vehicles, raised their presence in the grain and other commodities markets in recent years as they shifted their focus away from the equities market in search of better returns.

Investment funds, which typically use debt to build large positions in these markets, are now actively deleveraging by getting out of commodities markets to reduce financial risk amid signs that the credit crisis is spreading globally.

There have been few signs that a $700 billion plan (all figures US$) to buy up toxic mortgage securities at the heart of the credit crunch has boosted confidence in the economy, and fears of a global recession are growing.

Chicago Board of Trade corn futures on Oct. 7 were hovering above $4 a bushel, down 14 per cent since Sept. 30 and about 45 per cent lower than the record high of $7.65 set in June.

Soybeans dipped below $10 the week of Sept. 29, and are off a record peak of $16.07-1/4 set in June. Wheat prices were just above $6, down 10 per cent since the end of September and well off their record high of $13.34-1/2 set in February.

Analysts said the exit of managed money was not the sole reason for the pressure on U. S. grain prices.

The corn and soybean harvest in the U. S., the world’s top grower and exporter of both crops, will go into high gear in coming weeks and supplies will soon be making their way across the globe, from Europe to Asia to Africa.

Prices for corn in the U. S. cash markets have dropped below $4 a bushel at a few locations in the Midwest grain belt, and are on the verge of falling below that level at most others.

Focus shifts to supply

Another pressure factor comes from the Southern Hemisphere, where farmers are gearing up to plant their crops with the arrival of spring.

“We have shifted to focus on supply – I don’t think we’ve seen the bottom yet” in CBOT futures, said grains analyst Jim Bower of Bower Trading in Lafayette, Ind.

“From an economic standpoint, we are seeing a lot of wealth destruction and demand destruction. I don’t think that is going to heal itself overnight,” he said.

“We’ve got some liquidation to do. I think the market needs to rebuild its demand base. The funds are still heavily long, and that is worrisome,” he added.

Long, or bought, positions held by index funds in CBOT wheat futures and options stood at 46 per cent of open interest, according to data from industry regulator, the Commodity Futures Trading Commission (CFTC).

Long positions held by these funds, which invest for the long haul, totalled 20 per cent of the open interest in corn, and they held 26 per cent of the longs in soybeans.

Analysts said the amount of corn used to make ethanol could fall due to softer demand for motor fuels and tepid profit margins, as production capacity jumped 60 per cent since 2007.

Joe Victor, analyst with Allendale Inc., said grain prices could find a bottom by the end of October or early November based on current demand for products such as corn and soybeans.

But any recovery could be prolonged if the financial turmoil remains unresolved, he said.

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