The “reflation trade” may be back, increasing energy prices for growers but breathing new life into hopes for a broad-based commodities rally.
The breakdown in energy prices threatened Ideas that inflation was finally beginning to return to normal levels. But after falling more than 15% the past three weeks, crude oil futures found some footing, holding a test of $47. The nearby rallied today to a close back above its 200-day moving average, buoyed by a raft of friendly news.
First, the U.S. Energy Information Administration reported a drop in crude inventories last week, confirming the private survey out Tuesday from an industry group. Analysts had feared another build to record levels. But rising production as more rigs come back into service was offset by lower imports.
The International Energy Agency also provided support, saying global supplies could begin to fall later this year if OPEC and its allies maintain cuts.
The pièce de résistance came when the Federal Reserve released its latest statement of monetary policy Wednesday, “Inflation has increased in recent quarters,” according to the Fed, moving close to the central bank’s 2% long-run objection.
Deflating prices, including commodity values, has been one of the great fears of policy makers around the world. Growing economic activity appears to be conquering those concerns, one reason for the run to record prices on Wall Street this year. At the same time investors hoped that growth would continue, they also began buying commodities to take advantage of this “reflation.”
The break in crude, which extended deep into the grain market, threatened that scenario, causing funds to dump some of their bullish bets in both sectors.
Rising energy prices, of course, are a two-way street for growers. Higher fuel costs trim already squeezed profit margins but increase prices for biofuels. Ethanol got a lift today from news that production increased last week even as supplies shrank.
Midwest wholesale diesel popped a couple cents Wednesday on the crude rally. Supplies in the region dropped last week on lower production and demand ahead of spring planting. Stocks fell sharply nationwide as some refineries on the Gulf Coast had problems.
Basis for wholesale Midwest diesel against ULSD futures settled off New York Harbor have strengthened seasonally. Still, cash diesel looks fairly priced, or maybe even a little underpriced, according to mymodel of supply and demand.
Buying opportunities for fall diesel likely will wait until summer after spring planting demand is over. Swaps for summer are a few pennies higher than the spot market. While the reflation trade could continue to rally energy prices into the spring, volatility in options also suggests potential for prices to break sharply, likely on rising inventories and/or troubling world events. While crude oil is fairly valued between $48.20 and $50.20, according to my model of supply and demand, current volatility implies a potential price range risk between $34.75 and $65.60.
Last week I recommended using the pullback to get started on propane pricing for fall by covering 25% of needs. The market is higher this week on the return of winter. Supplies remain tighter than a year ago on strong exports but a break in crude below $40 would be a chance to complete pricing, likely this summer.
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Senior Editor Bryce Knorr first joined Farm Futures Magazine in 1987. In addition to analyzing and writing about the commodity markets, he is a former futures introducing broker and is a registered Commodity Trading Adviser. He conducts Farm Futures exclusive surveys on acreage, production and management issues and is one of the analysts regularly contracted by business wire services before major USDA crop reports. Besides the Morning Call on www.FarmFutures.com he writes weekly reviews for corn, soybeans, and wheat that include selling price targets, charts and seasonal trends. His other weekly reviews on basis, energy, fertilizer and financial markets and feature price forecasts for key crop inputs. A journalist with 38 years of experience, he received the Master Writers Award from the American Agricultural Editors Association.