Trade of the Month: A Soy Play

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With all the economic jitters today, investors and traders alike have been taking the cautious approach. As a result, because greed of previous years has turned into fear, to raise cash the good has been sold off along with the bad. Recently there have been some signs of stabilization in the "outside markets" (stocks and bonds) that should open the way for the good to shine through.

I see soybeans as one of those "good" markets, a market with decent fundamentals that's currently undervalued as a result of the margin call-selling that's taken place this year across the board.

Consider the following facts:

• Tight supplies: The US Dept of Agriculture (USDA), in its most recent supply/demand report, once again lowered its "ending stocks" estimate for soybeans to an historically tight 185 million bushels. Additionally, South American supplies are projected to decrease. Argentina's equivalent to the USDA, the Argentine Association of Regional Consortiums for Agricultural Experimentation, or CREA, estimates the Argentine crop will be smaller this year by at least 9 percent, perhaps as much as 12 percent.

• Robust demand: Last week exports were a huge 30 million bushels, again led by Chinese demand. The US has already shipped over 80 percent of the USDA's projected exports for this current crop year, with more than five months remaining in the crop year. China has been importing soybeans from us at a record pace.

How would I play these facts?

First, let's separate what's termed the "old crop" from the "new crop." The "new crop" is the 2009 crop that will be planted in the coming weeks and harvested in the fall. It begins with the November contract. Private estimates point to higher new crop planted acreage. I'm not recommending buying November or later-dated soybean contracts.

The 185 million-bushel carryover estimate by the USDA refers to the "old crop," the existing carryover supply from last year's harvest. This is represented by the May and July contracts; these are the contracts I suggest we focus on.

If current demand trends continue, the US could theoretically run out of old crop soybeans before the new crop becomes available. In reality, supplies never actually run out. What occurs is shrinking supplies effectively lead to higher prices, and higher prices eventually ration demand. We're looking to play for those higher prices.

The chart below depicts the May 2009 soybean contract.

May 2009 Soybeans

Source: Commodity.com

Looking at the chart, you could conclude the major trend has been lower since last summer. The contract low price was registered last December, with a first rally into January and a break into early March, a classic "test of the lows." Recently, from approximately mid-February into mid-March, the market has been moving essentially sideways.