Profit Opportunities In Oats

SHAWN HACKETT
Published 2/1/2010

From time to time, a particular commodity market simply provides a buying opportunity that would be classified as a “hanging curveball” that homerun hitters look for to hit easy profits. Such an opportunity occurred last week in the oats market. First, let’s take a look at the price chart below.

As one can clearly see from the weekly spot price chart above, the collapse in oats prices last week has approached what should be major underlying support in the $2.20 per bushel to $2.25 per bushel area that represents the uptrend line going back to February 2009 and the major support line going back to the first half of 2006. This suggests that the closing price for Oats on Monday at $2.25 should be an ideal place to begin entering new investment positions. As a secondary confirmation let’s take a look at the daily March 2010 price chart for oats.

The March 2010 daily price chart also suggests that the current closing price at $2.25 is sitting at major support near the uptrend line going back to August of 2009. An even more important and impressive feature is the deeply oversold condition of the RSI. This is the fifth most oversold condition over the last decade suggesting extreme short term investor bearish sentiment. Needless to say, such over balanced bearish sentiment is the quintessential contrarian bullish signal that tends to occur near most major lows in commodity markets.

So from my perspective the technical picture of the market is set up for an ideal entry point to maximize investment returns and minimize potential for loss. Let’s take a look at oats prices from a comparative point of view to the Corn market which tends to be a good signpost for Oats in terms of relative value.

Looking at the chart above of the relative value of cash oats to cash corn, it is fairly clear that a very well defined range has been established that when oats supplies are abundant relative to corn, Oats prices will trade at 60% of the price of corn. However, when oats supplies become scarce relative to corn, oats prices can trade in parity or slightly above the price of corn. This framework helps us get a good firm historical understanding on when oats prices are relatively cheap or when they are relatively expensive to a bench mark grain market like corn.

Currently, Oats prices are trading at about 60% of the price of corn or at the low end of the historical pricing relative relationship. This would argue that oats, relative to corn, is as cheap as it is likely going to get. This condition should be associated with an abundant supply of oats relative to corn.

However, that is not the case. This is what makes the oats market so very attractive. Let’s briefly go over the fundamentals of oats to see why the market will be approaching historical tightness in 2010 and could even get into a supply crisis in 2011 if Canadian planted acres for oats falls short of what is needed to balance supply and demand.

First, I would like to take a look at the relative net returns per acre for Oats with other crops which compete for similar Canadian farmland in appropriating planted acreage distribution. For oats, Canada is the key Oats growing country that determines prices discovery for CBOT futures. The United States imports the majority of all oats grown in Canada as other crops in the United States have garnered greater farmer interest placing the United States in a perpetual domestic oats supply/demand deficit. So the potential planted acreage battle in Canada is the key fundamental construct to get ones hands around to determine future price discover.

Looking at the chart above, if you were a Canadian farmer, would oats be on top of your list for planting additional acres in 2010? In fact, the poor relative returns for oats above suggest that farmers will likely maintain current historically low planted acreage, driven by crop rotational practices, instead of increasing planted acreage. Canadian ending stocks are expected to drop by 50% from 2009 to 2010 as a result of last year’s low planted acreage numbers and subpar yields. This has brought Canadian stocks to usage ratios to near 20-year lows.

If one assumes normal yields in 2010 for Canadian oat farmers, a 5% to 10% increase in oats planted acreage would be needed to stabilize current tight ending stocks levels. However, anything less than that would place Oats into a very dangerous and precarious supply/demand situation especially if Mother Nature becomes less than friendly in 2010.

All this says to me is that oats will need to reprice higher by early spring 2010 planting season in order to avoid a potential supply crisis. The current price of Oats at 60% of Corn is inconsistent with the historical relationship when oats supplies have gotten to such tight levels in the past. This not only suggests that higher oats prices are needed and likely in 2010 but also strongly suggests that oats should outperform corn in 2010 by a healthy margin. Even if corn prices were to average $3.50 in 2010, it is possible that oats could trade in parity with corn to achieve the upper level limit to the historical price relationship discussed earlier.

The last aspect I would like to briefly cover is that Oats demand seems to have entered a renaissance phase over the last year. Numerous reports about the extreme health producing attributes of consuming oats against the need for families to consume more economically value oriented foods as a result of the current recession has bumped up oat demand in the month of December to some of the highest levels in 12 years.

For example, in December 2008, 22% of available oat supplies were consumed whereas in December of 2009, 30% of available oat supplies were consumed. This level represents a 12-year high. Quaker Oats and AC Nielson shared some retail figures recently that confirm this record disappearance of Oats in December as it seems a possible lifestyle change in eating habits may be afoot. This greater uptick in food consumption should it continue in 2010 and has the potential to be a game changer as human food oat demand gains market share on the feed oat demand component.

I view the current 50¢ collapse in oat prices as a golden opportunity to buy a market that is mispriced in relation to the economics of competing acreage crops in Canada and is equally as mispriced in relation to the historical benchmark price relationship to corn. To me this strongly suggests that sometime in 2010 oat prices will likely see spot futures prices north of $3.00. Such levels in comparison to the current $2.25 level would be an outstanding return indeed.

The initial margin of an oats futures contract is $1,080 with a total contract value of $11,550. I would look to buy March Oats at current prices with an upside objective of $2.75. That would provide a potential profit of $2,500 per contract or close to 150% gain on the initial margin requirement. Place protective sell stop orders 15¢ below purchase price.

This seems to me to be a commodity that could feed investor returns.

Shawn Hackett, commodities broker and author of the Hackett Money Flow report newsletter (hackettadvisors.com), is a nationally recognized agricultural commodities expert with more than 15 years of money managament experience.