Traders can use Agricultural futures to represent commodities, such as cattle, grains, corn or soy.
The fundamental analyst will look at certain factors to help determine where the price of these commodities might move in the future.
The primary relationship and driver of price is supply. Agricultural products have a unique production cycle as most are produced during a certain time and consumed until the next production cycle. This is unlike other products, which can be produced throughout the year.
Once crops are planted, no more can be planted until the following year. This creates a situation where the supply of the product is extremely important and any changes in anticipated yields may have an extreme effect on price. This creates a supply and demand cycle where the fundamental analyst is required to forecast not only an unknown supply in the future but also future demand.
Fundamental analysts will analyze the uncertainty surrounding supply as crop and yields vary each cycle. Sometimes yields will be higher than expected and sometimes they will be lower than expected.
For most agricultural products, weather is the most important factor effecting supply and price. Weather influences the entire crop production cycle: planting, growing and harvesting.
Fundamental analysts track the weather during each phase of the growing cycle and form an opinion on how it will affect yields. The weather during planting, growing and harvest seasons can reduce expected yields, which will impact prices of the futures contract.
For example, if the weather during planting is too hot or too wet, seeds will not germinate properly. This means yields may be lower than average for the acreage of crops that have been planted, which will affect supply and, thus, the price of the futures contract.
Other factors that play a part in the pricing of agricultural futures are:
Along with weather reports, fundamental analysts will also use crop reports produced by the USDA to create their analysis of crop yields and livestock. These reports are detailed, government-produced reports that provide status updates on the supply of agricultural products.
The crop progress report offers a country-wide assessment of how crops are progressing through the growing cycle and whether yields are predicted to be lower or higher than anticipated. The report is updated weekly from April to November by the National Agricultural Statistics Service NASS. Traders interested in soy products can visit the National Oilseed Processors Association, while traders of livestock can view the National Grain & Feed Association.
The price and demand from the previous season can have an effect on the crops planted the following year.
For example, a corn farmer might switch to soy if they believe they can earn a greater profit from growing that commodity. If farmers have excess inventory, they might not want to produce as much the following year, which can limit supply the following year and increase prices, leading to increased production the following year. The cycle can repeat with suppliers always slightly off on their forecasts.
Government subsidies are common in the agricultural market. The number of subsidies will change over time and can make one crop more advantageous than another. This means there might be incentive for farmers to grow a different crop that might be more profitable for their operation.
For example, if soy is being heavily subsidized, farmers might be interested in growing the crop since it might have a lower production cost due to the subsidies. The excess supply can lower prices as more producers grow crops that are subsidized.
The fundamental analyst will look at secondary uses for a commodity in addition to the primary use when building their fundamental forecast of price. The profitability of these extended uses may have the effect of shifting supply from one use to a more profitable use.
For example, corn is eaten directly and in its processed form, but it is also used in ethanol production. If the demand for ethanol increases enough, and producers are willing to pay higher prices for corn that is being used for ethanol production than eating, this will change the fundamentals of the corn market and the drivers of price.
The agricultural futures market contains many exchangeable products within the market.
For example, soy and corn can both be used for livestock feed or human food production. If one commodity increases in price, farmers may be able to switch to the other commodity to feed their livestock for a cheaper cost.
The fundamental analyst must be aware of the ease that one commodity can be substituted for another commodity. If the commodity is easily substituted, supply issues might not have as large an impact on price since customers who cannot obtain the commodity can easily switch to another.
Fundamental traders will also analyze the differences in the ratio of prices between different stages of production for a commodity.
For example, a trader can use soybeans, soy meal and soy oil. Since the cost to refine soybeans remains constant over time, the ratio of price between each stage of refinement should remain fairly constant as well. The fundamental trader can analyze the change in this ratio to help determine if one of the soy products is relatively over or under valued.
Agricultural products are unique as only limited amounts can be produced at certain times of the year. The products are perishable and need to be stored to match seasonal supply to demand that occurs year-round. The market is challenging with many moving parts, as such the fundamental analyst will need to apply very specific models to make future price assumptions.