Conditions in the agriculture sector have the makings of a longer-term foundation, notably if the Brazilian real is finished declining. The grains, comprising the bulk of the Bloomberg Agriculture Subindex, need another exceptional Corn Belt growing season to avoid adding a lot to 2018’s minor gains. U.S. soybean supply is the main overhang amid U.S.-China trade tension, but the extreme U.S. price discount will help to rebalance global trade, boosting exports. Some dollar reversion should go a long way.

The beaten-up and previously record-short soft commodities appear to have met Brazil’s currency at the bottom. The passage of elections and a revisit of multidecade support levels emphasize upside potential vs. further downside risks. There are plenty of ingredients for a longer-term bottom in 2018, in our view.

If the real has bottomed, ags should follow
The agriculture sector appears to be on the cusp of marking bottom on the back of Brazil’s currency. Up about 10% in October, agricultural commodities should benefit if the real-dollar (BRLUSD) cross is moving beyond election jitters and bottoming similar to 2002 and 2009. In February, the Bloomberg Agriculture Spot Index began to trade above its 48-month average for the first time in five years. That rally failed as the real plunged.

October’s agricultural high is the 48-month mean, as BRLUSD appears to be forming a double bottom. It’s been 16 years since the last significant shift to sustaining above this mean as the real strengthened. Since 2002, the annual correlation of the Bloomberg Agriculture Index to the BRLUSD cross is 0.68. By comparison, the correlation is 0.76 to the price of corn.

Grains appear to be waiting on greenback
Gains in grain prices should follow strong U.S. exports. The dollar value of U.S. corn, soybean and wheat exports is among the highest correlations to the Bloomberg Grains Spot Subindex. Despite the recent dip in this measure due to trade tension, the export trend remains positive, notably since bottoming in February 2016. Since then, the dollar value of U.S. exports has increased by about a third, while the trade-weighted broad dollar has gained 3%. Ratcheting up 7% in 2018 through Oct. 29, the strong greenback is a primary drag on grain prices.

Relatively low U.S. prices support exports as global trade rebalances from this year’s distortions. Since 1999, the BI dollar measure of U.S. corn, soybeans and wheat exports (.EXUSGRN$ G Index) is 0.92 correlated with grain prices, measured annually.

Grains potential bottom harkens back to 2002
In the fourth year of narrowing price ranges, the grain market appears to be bottoming. Indicating an extreme, the average of the one-year futures curves of Bloomberg Grains constituents is near a two-decade low. Despite exceptional Corn Belt growing conditions, trade tension and the sharp decline in the Brazil real, the spot grain index is up about 3% in 2018. Divergent strength is the indication.

Wheat gains have been offset by soybean losses, with corn in the middle this year. Soybeans are at the epicenter of the U.S.-China trade dispute. Driven by politics, massive U.S. stockpiles limit upside. Unchanged from four years ago, and within the narrowest similar-period range in five decades, corn is ripe to be a leader. Upside potential outweighs downside risks, in our view.

Corn potential at the top of grains radar
Corn is ripe to exit its extremely tight range, with upside potential outweighing downside risks. Initial support and resistance near $3.25 and $4.05 a bushel in the front future represent the narrowest 48-month Bollinger Bands since 1964. Typically, when corn is this tightly bound, price appreciation wins out, particularly when it’s trading below the USDA estimated U.S. cost of production.

The halfway mark of the range since 2006 is about $5.70 — initial target resistance. The low near $3 is good support. This year marked the first test of the upper band since 2012. Some normalization in exceptional Corn Belt production should extend the top band higher. More-normal global wheat production this year could be a precursor.

Unsustainable disparity supports soybean futures
Soybean exports from Brazil have become too expensive, supporting U.S.-traded futures. The 28% premium for soybeans at Paranagua, one of the primary Brazilian ports, is the highest in the database since 2006. U.S.-China trade tension creates an unsustainable overhang of supply in the U.S. vs. empty bins in the Southern Hemisphere. Prices have adjusted accordingly, but relatively low-cost U.S. soybeans support exports to the rest of the world, including to China at such a discount.

The average Paranagua premium since 2006 to the front soybean future is 4%. The .BRLSOY$ G Index converts the Paranagua price to U.S. dollar-per-bushel equivalents to match the most widely traded future. The annual correlation is 0.86.

Softs may be forming a longer-term bottom
After significant milestones in October, a foundation could form for a longer-term low in the Bloomberg Softs Spot Subindex. Sugar, coffee and cotton prices bottomed from significant support levels, on the back of record managed-money net shorts as the Brazilian real recovered from a multidecade low vs. the dollar. It’s the kind of situation that is often looked back upon as the indication of a selling extreme.

Ending the month back at its 12-month average, the softs index has plenty of mean-reversion room, particularly if the real-dollar cross has bottomed. It would take about a 34% rally to revisit the 2016 peak. Since 2007, the softs index is 0.72 correlated to the BRLUSD rate, and about the same to coffee prices.