What has happened to the dollar's relationship with crop prices?

A farm commodity investor who began trading around the time of the Lehman Brothers collapse last autumn may have been lulled into thinking the two were inextricably linked.

Into believing that dollar moves, making US crops cheaper or more expensive to foreign buyers, were the only game in town.

Relationship cools

Crop prices' march downhill last autumn matched blow-for-blow the dollar's ascent. (See graphs below.)

And when the dollar, in early December, performed an about-turn, the two markets maintained their inverse link.

Simple.  At least it was until late spring, when the link began to break down, first between the dollar and grains and, in early June, with soybeans.

There were more than export dynamics in play after all.

Foreign exchange gains

It is clear that the strength of the dollar will have a big impact on the price of commodities denominated in the currency, especially for a crop such as soybeans of which America exports more than 40% of production.

Take a European consumer. Exchange rates would have saved this buyer E1 on $9-a-bushel soybeans over the last six months or so.

To turn the equation around, soybeans could have risen to $10.35 and cost the same in euro terms.

Rising crop hopes

But it is also hard to argue that currency movements are the only show in town.

Dollar rises have not always brought crop price nadirs. For instance, agricultural commodities were lower in 1986 than the year before, when the dollar reached a recent its peak for the last 30 years.

It looks like, this time, crop fundamentals have played a bigger part.

The decoupling of dollar and commodities has co-incided with growing hopes for US crop production.

Since May, the US Department of Agriculture has added 17m tonnes – the equivalent of another Argentina - to its estimate for America's corn harvest, undermining hopes of market squeezes.

Hedge fund thinking

Revisions may have had a particularly big impact this year because they undermined not just the conventional crop investor, but a sophisticated hedge fund strategy.

When hopes of a Chinese-led economic revival set in, a popular hedge fund trade of shorting the dollar and taking long positions on commodities worked well. Growing economic hopes lured investors out of the safe haven of the dollar, while boosting the prospects of higher commodity use.

However, bumper global crops may have made other commodities, with tighter supplies, look far better bets.

Interest wanes

It may be no coincidence that the open positions in crops registered to speculators, such as hedge funds, are lower now than in early June. They are down more than 10% the cases of Chicago soybeans and corn.

So it looks like one way to get crop prices moving again would be to lure hedge funds back.

Unfortunately for farmers, that may require more than the further dollar declines many analysts say are on the cards.

Dollar versus basket of major currencies (inverted) Jul 08-Sept 09. Source: Reuters

Chicago soybean price, near-term contract, Jul 08-Sept 09. Source: Reuters