Risk watchdog had been bullish towards the agricultural complex for some time, but last week’s barrage of data from the US Department of Agriculture (USDA) has proved a bit of a game changer. Specifically, while still optimistic on the outlook for soft commodities such as coffee, cocoa and sugar, me and my colleagues here at BMI have turned far more cautious grains.

Our bullish outlook had been largely based on expectations of a massive global corn deficit in 2009/10. It appears that the entire market (ourselves included) were awaiting a downward revision to USDA estimates for US corn production on January 12. Instead, the USDA upped its supply estimates and now forecasts a record US corn harvest in 2009/10. This has sent grain markets into tailspin and forced a rethink of our medium-term view on grains. Here are our key thoughts:

•    In raising grain (and particularly corn) production forecasts for 2009/10, the USDA has undermined a central pillar in the bullish outlook for grains.

•    A glance at the longer-term charts reveals that grain prices remain elevated by historical norms.

•    On the back of a weaker fundamental outlook, combined with a deterioration in the technical chart patterns, Risk Watchdog now expects grain prices to enter a period of volatile sideways trade within a wide range.

•    While not outright bearish, my colleagues and I would opt for a cautious approach, particularly given the uncertainty that will pervade these markets in the short term following such a violent knock.

•    Of the grains, rice prices appear the most robust. The US is not a major producer of rice and therefore, recent USDA revisions have not altered the fundamental outlook for prices.

However, Risk Watchdog will be keeping a close eye on some factors that could bolster grain prices in the coming months. In particular, my colleagues here at BMI see potential for the Chinese 2009/10 corn harvest to disappoint official estimates. Meanwhile, the US Environmental Protection Agency (EPA) is due to rule on a potential revision to the US ethanol blending cap for gasoline in mid-2010. Should the EPA raise the blending cap from 10% to 15%, as has been proposed, this could provide a much-need boon for corn prices.