Forecasting world agricultural production

Futures, Jul 2007 by McNew, Kevin, Basist, Alan, Basist, Marc

The Special Sensing Microwave lmager (SSMI) measures the temperature in the canopy and the level of moisture in the soil from both precipitation and irrigation. Because the signal is in the microwave spectrum, similar to our cell phones, transmission occurs through almost all types of cloud coverage, night and day. Using a 12 plus year climatologically base period, the temperature and wetness measurements can be translated into variations from normal (anomalies). Specifically, how much wetter or drier, colder or hotter, is it at the county level. This information is available in near real-time for every agricultural location globally during each week throughout the growing season. This data is run in Commodity Hedgers Inc.'s (CHI) proprietary models, and projected local and global agricultural yields forecasts are generated monthly. These monthly projected yield forecasts are complimented by weekly data, which is released in a map format, in a written weekly analysis and in a weighted area of production for each particular crop.

The SSMI data is utilized by many of the world's leading yield forecast agencies, such as the USDA. Other applications are ethanol plants, which use the SSMI data to know precise future county level production to determine their procurement needs and better manage risks (see "Microwave imaging that predicts yields," September 2006). Traders also are utilizing the data.

The comparison of forecasts begins with the USDA's August survey-based corn crop report and concludes with a comparison of the final estimate released the following January once harvesting is completed. Cash Grain Bids' analysts demonstrated that the CHI corn production forecast out-predict the USDA final estimate. Through the last 12 years, the CHI August forecast, which is released at the end of July, has outperformed the USDA August forecast at predicting the final corn estimates. This encouraged us to explore the value of trading the satellite information.

The test was simple: USDA corn forecasts in August were compared to CHI forecast at the same time from 1995 to 2006. Our trading strategy was also simple: if the CHI forecast was above (below) the USDA's forecast then we expect more (less) corn than the market expectation based on USDA information - then bought December corn futures. We held this position until after the announcement of the October crop report when both the USDA and CHI had similar forecasts. This simple trading rule generated five buy signals and seven sell signals, profiting in 10 of the 12 years (see "Trading results," left). The result was that on a single corn contract, which currently requires an initial margin of $1,350, the average profit from this trade was $1,317 per year with an average maximum drawdown of $491.

Corn acreages this growing season are at near record levels and the volatility is being driven by the demand for corn, between the food and energy industry. We generally need a better than average crop to fulfill the demands being placed by the new ethanol plants that are coming on line. Any major adversity in the corn belt will likely promote a sharp response in futures pricing.

The month of May did not provide great growing conditions. Many regions were planted late, due to extreme wetness, though it has since dried out and crops are in the ground. Another concern is the current dryness in the region south of the Great Lakes and in the lower Mississippi Valley.

While the wetness product is an excellent measurement of "surface" moisture, that does not mean that there is a lack of "deep" soil moisture. However, it does mean the upper surface is rapidly drying out under extreme heat in May (see "Surface wetness anomalies," left). This type of situation can draw down the deep soil moisture reserves in the soil and if the dryness persists, the proprietary crop models will indicate the results by the end of July.

Marc Basist is sales and marketing manager at Commodity Hedgers Inc. and can be reached at Marc@commodityhedgers.com. For more information on this new technology visit vyww.Commodityhedgers.com. Futures magazine's Web site will be broadcasting monthly data through the growing season. To better understand and manage spatial pricing discrepancies in commodity pricing visit www.Cashgrainbids.com.