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Introduction to Fundamental Analysis


The Important Stocks-to-Use Ratio

The stocks-to-use ratio is a convenient measure of the supply and demand interrelationships of commodities. The stocks-to-use ratio indicates the level of carryover stock for any given commodity as a percentage of the total demand or use. The mathematical formula for this relationship is as follows

Formula 1

This can be simplified by consolidating the upper portion of the relationship to:

Formula 2

Using the long hand formula, beginning stocks represent the previous year's ending, or "carryover," inventories. Total production represents the total supply produced in a given year. Total usage is the sum of all the end uses in which the stock has been consumed. In the case of grains, for instance, this would include human consumption, export programs, seed, waste, dockage, and feed consumption. By adding carryover stocks to the total production you will obtain the total supply. From the total supply, subtract the total use, and the resultant figure will be the new year-end carryover stock. The carryover stock divided by the total usage can be expressed as a ratio which when compared with previous years gives the market analyst an indication of the relative supply/demand balance for a particular commodity. This ratio can then be used to indicate whether current and projected stock levels are critical or plentiful. The ratio can also be used to indicate how many days of supply is available to the world marketplace under current usage patterns (e.g. a 20% stocks-to-use ratio for wheat indicates that there are 75 days supply of wheat in reserve).

By comparing the current year's stocks-to-use ratio with years when carryover stocks were below normal as well as years when carryover stocks were above normal, you will be able to develop an estimate as to the direction of the price trend as well as the probable extent of price change, whether higher or lower. Some benchmark ratios can be established for various crops by reviewing historical stocks-to-use data. Several examples: On a world basis, a stocks-to-use ratio for wheat under 20% has typically led to strong price advances. For corn, the comparable number appears to be under 12%. For soybeans, the critical level is below 10%. It's useful to calculate stocks-to-use ratios for different crops and then compare these projections with historical averages provided by entities such as the United States Department of Agriculture (USDA). By reviewing past data and estimating the current year's stocks/use ratios on a crop-by-crop basis, appropriate trading strategies can be developed.

Next chapter: Conclusion

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