One of the more frequent complaints heard in regard to futures markets in recent years has been that fundamental supply-demand forces have been subsumed by speculation. Indeed, it is this belief that bolstered importantly the pressure leading Congress to enact the controversial Dodd-Frank legislation. This act has as one of its principal goals the imposition of regulations aimed at limiting speculative influences. Yet, anyone taking a close look at the recent performance of futures markets, particularly those reflecting the situation in wheat and corn, should quickly realize that it was supply-demand that ultimately, and more often than not currently, drove history-making fluctuations in prices for these two grains.

How markets so far have acted in the 2011-12 crop season could be interpreted as a superb lesson in how speculation proved a positive in helping to ease the pressures that might have stemmed from fast-changing supply and demand conditions. Without the willingness of speculators as well as commodity index investors to take positions that often relate to individual strategies overlaying the forces that might be propelling markets either up or down, the price moves might have been much sharper than occurred. This is the basic role assigned to speculation in economic theory. If there’s ever been a crop season proving the tremendous value of participation by speculators and investors in futures, as well as underscoring the dangers of seeking to put a useless cap on such activity, it is 2011-12.

Any history that centers on markets this season, even at this mid-point, will most certainly look into the fluctuations that affected the two major grains. For one of the few times in history, corn prices went to a premium over wheat, driven by concerns about the adequacy of the corn supply to satisfy feed and industrial demand. Mandates requiring ethanol in fuel blends, even with little change from the prior year, once again were a dominant influence. In the case of wheat, a relatively better balanced supply-demand situation led for a time to less strength than in corn, including the unprecedented discounts. In wheat’s case, the exception, driven by fundamentals, was the strength in spring wheat due to global scarcity of higher protein.

The turn from early strength to pronounced weakness in both wheat and corn provides a perfect example of how fundamentals dominate. As corn prices soared and poultry and livestock operators suffered, feeding demand started to fall. The devastating impact on companies raising broilers and turkeys, where product prices failed to keep pace, played out in sharp cutbacks. This has been less a factor in cattle and hog feeding, where advancing meat prices were offsets. Still to be determined is the full effect of diminished consumer demand in reaction to high unemployment and economic setbacks.
Watching this situation evolve in wheat has been particularly revealing for the manner in which prices have been influenced by the pickup in demand for this food grain for feeding. Wheat at prices under corn almost guaranteed large increases in feeding. In turn, the drawdown of wheat for this purpose propelled larger stocks of corn than had been expected by the trade, prompting price weakness.

While the factors at work this season are largely of U.S. origin, it is especially important to appreciate how these same forces unfolded globally. One of the most significant reactions to corn’s early season climb was reduced foreign demand that in some ways proved a bearish force nearly equal to the feed use decrease. Worthy of attention was the way this caused America to lose its dominance of corn exporting, with U.S. corn clearances this season expected to be less than the combined outgo of all the other exporting countries for the first time in history. As significant as this development may be, this year’s proof of how fundamental supply-demand factors are what moves grain prices should be a highly important outcome from the memorable 2011-12 crop year.