In the last week, U.S. crude oil prices hit a three month low dropping below $88 a barrel, attributable to economic slowdowns in China, Europe, and the U.S. Further downward pressure on oil prices has been caused by reduced earnings forecasts by U.S. corporations, unmet expected profits, and the growing worries for lower growth across the global economy. Crude oil inventories rose by 5.9 million barrels to a total of 375.1 million barrels, the highest since 1982.

This drop in oil prices will have mixed results for consumers. On the bright side, the lower prices may contribute to some relief for consumers at the pump, thus leaving additional room in consumer budgets for consumption of other goods and services – an accretive trend for GDP growth. On the other hand, the price drop is a symptomatic factor for a regressing weak global economy and suggests further slow growth.

This summer’s unusually hot weather combined with little rain is shaping up to have a profound impact on corn yields for 2012. At the close of trading on Monday, corn futures settled at $7.75, up 40% since June 1, and 12% since July 1. These radical increases in price are a clear reflection of small yields for corn, and thus lower supply to meet both domestic and foreign demand. Further compounding the corn outlook is weather forecasts, which continue to predict below average rainfall for the next few weeks. As a result, we are likely to see further increases in corn prices.

What does it all mean for investors? If one is long corn via a futures contract or commodities fund, this news is likely accretive. However, for companies that rely on corn as a key input for production, this represents an added cost of production and a drag on profitability. For consumers, higher corn prices will probably equate to higher grocery bills.

This past Friday, March 30th, the United States Department of Agriculture (USDA) released the 2012 Prospective Plantings report, which included various estimates. Amongst the estimated data, the Prospective Planting report included a lower than anticipated soybean forecast. According to the report, “Soybean growers intend to plant an estimated 73.9 million acres in 2012, down 1 percent from last year and down 5 percent from 2010. Compared with last year, planted acreage intentions are down in many areas as some acreage is expected to shift to corn” (USDA).

The projections on soybeans from the USDA indicate that soybean ending stock is expected to reach dangerously low levels. After the release of the USDA prospective planting report, soybean future prices quickly skyrocketed as anticipated rationing of soybean stock will most likely result throughout the year. The price of soybeans ended up over 3% from the previous day’s close indicated from the chart above. Although it may be too late for U.S. farmers to switch acres to soybeans this season due to the fieldwork they have already completed, the higher prices have the potential to entice South American farmers to switch during their next planting season. This additional soybean production will be necessary to fulfill Chinese demand as they continue to be a dominant player in the agricultural market.

Sources:

• USDA Prospective Plantings report
• Farm Press Article: by Dr. Scott Irwin, Dept. of Agriculture and Consumer Economics, University of Illinois
• Bloomberg article – China reference

Domestic energy production has experienced a renaissance over the last few years, mainly driven by natural gas production. While oil prices hovered around $100/barrel for most of 2011 natural gas prices hit lows not seen since the 1990’s. As this chart shows, the relative price of oil to natural gas (shown in gold) was fairly stable during the 1990’s and most of the 2000’s but has soared over the last few years. In the short term some divergence is understandable, but over the long term these two energy sources are substitutes and we would expect to see energy consumers switch from oil to natural gas given the price differential.

The line in gray shows the number of natural gas drilling rigs in the U.S. and the explosion of drilling in 2006 and 2007 led to the increased production and lower prices we see today. What is also interesting is natural gas drilling activity has remained fairly stable over the last two years while oil drilling activity has reached levels not seen in the last twenty years (black line). Will the increase in oil drilling lead to more production and lower prices? If natural gas is any indication, Americans might see more oil production and lower prices at the pump in the years ahead.

For all the press coverage of rising gold and oil prices, commodity prices during the first half of 2011 showed a tremendous degree of dispersion across different sectors. Silver saw the greatest increase in value as it rose by more than 12%, but wheat fell by more than 26%, thus creating a spread between best and worst of almost 40%. Despite hitting a price of $1,600 / ounce earlier this week, gold rose by less than 6% through the first 6 months of 2011; in fact, only 6 of the 14 commodities on the chart actually increased in price. The main take away from this chart? Commodity investors must have a keen understanding of their underlying exposures, as the large dispersions of individual commodity returns can lead to vastly different results across products and strategies.