Kub's Den

Wed. May 27, 2015 9:23 AM

By Elaine Kub
DTN Contributing Analyst

The past two trading sessions, along with countless others in recent memory, have been marked by a frustrating pattern. Overnight, grains will start a brave little rally based on fundamental production worries like rained-out planting or flooded, sprouting wheat. At 7 a.m., they'll be gaining a few cents to counteract the brutish losses of previous days, and then -- wham! Something will happen to douse the bullish optimism and drive prices back down.

That something has been a skyrocketing U.S. dollar index. The dollar index itself is just a number with no units, derived from a mathematical calculation to describe the value, at any point in time, of a complex idea -- that the paper printed by the government of the largest economy on Earth represents that economy's overall worth, can be traded efficiently for goods and services, and will always be honored by that government.

The grain futures contracts used to track the value of corn, soybeans, and wheat are denominated in U.S. dollars, so any time the dollar itself becomes stronger, i.e. a 1 dollar bill becomes worth relatively more in the global economy, then it takes fewer of those strong dollars to buy a bushel basket of corn or soybeans or wheat.

A year ago, the dollar was still roughly as weak as it was in 2012. The U.S. dollar index was valued at 80.35 in late May 2014. If the nominal price tag for a bushel of corn was the same then as it is now, then an ocean vessel loaded with 58,000 metric tons of corn would have carried the rough equivalent of $6.69 million worth of cargo. The U.S. dollar index has strengthened 21% since then and is now at 97.35. To a foreign buyer in this theoretical scenario where corn prices have been perfectly flat from one year to the next and the only thing that changed was the strengthening of the dollar, that ocean vessel's cargo would now cost the equivalent of $8.10 million. It's clear why a stronger dollar dampens foreign buyers' enthusiasm for our grain.

It can seem that any attempt to analyze or understand or -- dare we say it? -- predict the movements of grain prices needs to involve analyzing and understanding and predicting what will happen to the U.S. dollar. On the most extreme days, we have less need for agronomic expertise about the yield effects from late planting and more need of geopolitical expertise about global investor activity. So what does make the dollar move one way or another on any given day?

First of all, the U.S. dollar index isn't actually the same thing as the value of a dollar bill. How can it be, as it has no units? A dollar bill today is worth 0.91 euro in Berlin, or 0.65 pound in London, or C$1.24 in Toronto, or 28 gumballs at your local American candy store, or 16 pounds of corn at your local ethanol plant. The price at any given place at any given time is determined by supply and demand, of course, with demand dictated by traders' judgment of complex factors. Typically, investors determine the dollar's value from the following three main elements.

1. Interest Rates

U.S. dollars and U.S. Treasury notes are both kind of debt instruments issued by the U.S. government, and are therefore closely related. The United States is the safest bet around these days, especially with the euro plummeting in recent days, so that's one reason we see strong demand for Treasuries and the dollar strengthening. There can be a direct relationship between interest rates and the value of the currency. Even without investment money getting spooked out of Europe and into the U.S., the outlook for the dollar would still be bullish based on the near-inevitability of interest rate increases from the Fed sometime this year.

2. Economic health

An investor's outlook for a currency can involve a more subjective analysis of the country's stability and prosperity, taking into account its debt levels (U.S. debt is currently over $18 trillion), its trade surplus or deficit (a $51.4 billion deficit in the most recent report, 5.2% worse than the same period in 2014), its unemployment (5.4%, a seven-year low), its GDP (in Q1 2015, the U.S. GDP did grow but slowly at only 0.2%), and any number of other metrics. Stock market indices can be a proxy for this analysis, showing the investment environment's overall optimism, or lack thereof. For the U.S. in mid-2015, these economic health factors generally point to continued improvement, and are therefore bullish to the dollar.

3. Foreign reserves

Looking at official foreign exchange reserves is a direct measure of demand for any given currency. Foreign governments can choose to hold their wealth in any instrument or currency, and although they diversify into euros and yen and francs and Australian dollars and whatever else, the U.S. dollar is still the vastly preferred global wealth-storage device. At the end of 2014, $3.8 trillion in U.S. dollars were held by the rest of the world, 32% of total foreign exchange holdings.

Valuing the dollar is more complex than even these three factors describe. On any given day as financial instruments are bought and sold, there is also intangible trader sentiment to consider, not to mention unreadable computer codes triggering buy and sell orders during each fraction of each second.

Also keep in mind that as complex as the overall dollar market's motivations are, the U.S. dollar index itself is calculated from the values of six other countries' currencies, each moving with their own independent complexities on any given day. More than half of the dollar index's mathematical weighting comes from the euro, followed by the Japanese yen, the Great British pound sterling, the Canadian dollar, the Swedish krona, and the Swiss franc. So last Friday, for example, when Greek and German negotiations about a default broke down and made headlines during the European afternoon, sudden negativity for the euro directly and immediately resulted in a higher U.S. dollar index during the American morning.

When grain prices start doing something crazy that seems to defy the expectations of their own fundamental factors, these are the outside sources where we can look for direction in the instants before a grain market's momentum changes.


Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

(CZ/SK)

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