Corn, wheat, and soybean implied volatility and CVOLTM have been high in recent weeks relative to recent years. Implied volatility for some grains and oilseed contracts was even higher, however, during parts of the commodity boom of the early 21st century. How do the supply and demand fundamentals of 2008 compare to 2022, and what can we learn from the past to inform our expectations for the future?
Present Volatility Driven by Fundamentals
The figure below shows corn, wheat, and soybean CVOL for the past 12 months, with a clear spike in volatility following the February 2022 Russian invasion of Ukraine. Because the Black Sea region produces more than one quarter of the world’s wheat, uncertainty around supply has led to a significant spike in wheat volatility in recent weeks. Corn, which is also produced in the Black Sea region, has also experienced heightened volatility.
Corn and Wheat Domestic Supply Uncertain
The March 31, 2022 USDA Prospective Plantings report, which reports the intended acreage for principal crops in the United States, serves as the benchmark predictor for the upcoming crop year. This year’s report espoused the intentions of the nation’s farmers to move increasingly from corn to soybeans, with record high soybean acreage recorded. Many attribute that crop-shift to high fertilizer prices. Domestic wheat acreage, which had already been planted at time of survey, marked what the USDA stated will be “the fifth lowest all wheat planted area since records began in 1919.” The department also noted that low intended acreage defied the expectation that high wheat prices would incentivize planting.
Spring wheat, which is planted in regions where winters are too harsh for the overwintering process required of winter wheat, is not expected to fill the supply deficit with increased planting in 2022. Low supply increases sensitivity to weather, and cold weather in the Northern Plains and Western Canada is said to be adversely affecting intended acreage among spring wheat farmers. In addition to geopolitical tensions and weather specific to the present crop year, farmers are experiencing supply chain issues held over from the COVID-19 pandemic, such as high labor costs and low labor supply, as well as hampered logistics.
These factors have resulted in record-high nominal prices. The figure below shows nearest December Corn futures average settlement prices by week, throughout H1 from 2007 to 2022. In nominal value, December Corn futures saw an average weekly settlement price of $7.417 per bushel in the 17th week of 2022: the highest new-crop weekly average that corn futures had ever reached that time of year. In inflation-adjusted real value, however, that price was exceeded by both December 2008 and December 2011 Corn Futures, which in the 17th week of the year saw respective average weekly settlement prices of $8.134 and $8.516 in 2022 nominal value.
Volatility and the Commodity Boom of 2007-2009
Volatility for December 2008 corn exceeds December 2022 corn by 5-10% in March of the respective years, and overall at-the-money (ATM) 360-day volatility in 2022 is 25% less than during the 2007-2009 commodity boom. Comparing call skew over the two periods, the 15-delta risk reversal (which takes the difference between a 15-delta call minus a 15-delta put) trades at substantially different levels to puts in the present day vs. 2007-2009. Calls are now trading at an 8%-9% premium vs. 5%-6% during the commodity boom.
Like in the present-day, volatility in 2008 was caused by a supply-demand imbalance. But in addition to some supply-side commonalities to the present, 2007-2009 was characterized by a demand-side burst (on top of a global recession that complicated access to credit). The figure below, for example, shows global production vs. usage of soybeans. The crop years 2007/2008 and 2008/2009 exhibit usage exceeding production to the greatest degree since the beginning of record.
Though the period of 2007-2009 is generally associated with the Great Recession and the U.S. subprime mortgage crisis, the ascent and accelerating growth of emerging markets, in particular the BRIC nations of Brazil, Russia, India and China, shared economic precedence.
The BRIC nations were characterized by large and young populations, vast natural resources, rapid industrialization and urbanization, and what economists determined to be an intermediate stage of economic development. Expectations for the BRIC nations were so high that in 2006, Goldman Sachs released a report entitled BRICs and Beyond, in which it projected that in 2050, the top 10 largest economies would include China, the United States, India, Brazil, Mexico, and Russia. Under this prediction, China, India, Brazil and Russia would see real growth of up to 4,000% during the period 2006-2050. While China, India, and Brazil have largely proved worthy of the economic confidence imparted on them, in growth to date, Russia has been a notable underachiever.
Indicative of the country’s urbanization and increasing wealth, China’s soybean imports skyrocketed in the 2000’s, from annual imports totaling only hundreds of thousands of metric tons in the 1990’s to 50 million metric tons in the 2009/2010 crop year, to over 90 million metric tons in the most recent crop year.
Such an increase in consumption put pressure on soybean exporting nations, including the United States. The growth in demand, predictably, was a tailwind for soybean pricing.
As BRIC nations increasingly demanded imports to feed their growing populations during the 2007-09 period; weather, trade and economic dynamics convoluted global trade. A drought in the Southeastern United States complicated the growing season for some U.S.-grown field crops. Meanwhile, the period saw a massive acceleration in the production of corn-based ethanol, fanning the flames of the “food vs. fuel” debate by diverting a significant share of corn from both exports and domestic food and feed use. Echoing present-day issues, fertilizer prices skyrocketed in 2008, driven by increased demand and the slowness of the domestic fertilizer industry to adjust to new fundamentals.
An important difference between then and now is the availability of more sophisticated risk management tools. Times have changed since the commodity boom of the early 20th century, and so have the hedging tools available. Short-Dated New Crop Options, for example, were listed in 2012 and allow participants exposure to longer dated contracts such as December 2023 Corn or November 2023 Soybeans with shorter time horizons.
This allows participants to gain exposure with lower premiums than conventional long-dated options.
After the Booms
The drivers of the commodity boom of the early 20th century are considerably more ingrained with, for example, a notable deceleration of China’s consumption not beginning until 2015, when investors and supply chain players grappled with slowing Chinese demand.
Early 2022 volatility is largely attributable to supply disruptions stemming from the Russian invasion of Ukraine. The Russian invasion of Ukraine interrupted the factors underlying what many predicted was another commodity supercycle, increasing the sensitivity of agricultural markets to more classically endogenous forces such as weather.
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