March 20, 2012
Big soy price move coming up or just a market inflection point?
A lot of money is being invested in soy and Latin America's drought has cut supplies. Short-term price volatility appears to be inevitable but long-term fundamentals are strong.
An eFeedLink Exclusive Commentary
by Eric J. BROOKS
Gold's price fizzled, it forgot to rain in South America and then China got hungry for beans. -Now, suddenly, everyone is buying into soy. On the feed crop back burner for most of the last three years, interest in soy -and in making money off it- is back in a big way. As we shall, whether it ends in profits or tears, we appear poised to see some oil seed market drama.
Granted, soy has made quite a case for itself already. Currently around US$13.55/bushel, it is up over 22% from its lows at the start of this year. Moreover, quite a few investors think that soy's rally has some distance to go, and this is creating some measure of controversy.
Institutions, speculators invest heavily in soy
US government data indicates that in the first quarter of 2012, both institutional and speculative investment money strongly shifted out of energy and precious metals and flowed into farm commodities.
This has created long positions in feed crop futures and options, particularly soy, where a Latin American drought has created supply concerns. With the US putting in a disappointing early 2012 corn export performance and Latin America's soy supply some 15 million tonnes below previous expectations, we are seeing a shift in price momentum from grains to oil seeds.
Moreover, this liquidity flow into feed crops, particularly beans, may have sufficient momentum to carry into the second quarter. According to Standard Chartered Bank analyst Kuon-Ken Lee, "Agricultural commodities were the main driver of bullish sentiment" in the week ending March 20th.
Similarly, Paul Deane, an analyst with ANZ Bank noted that during the first quarter, even as institutional investors liquidating their positions in oil and gold, there was a corresponding rise in soy and sugar investments, with both commodities now increasing their net long positions by more than 25,000 contracts in the last two weeks.
According to the most recent CBOT data, institutional investors now (as of late March) hold a record net long position of approximately 171,601 contracts in CBOT soy futures and options. CBOT statistics for "managed money" investors (a.k.a. speculators), shows them holding a record net long position of 201,214 soy contracts.
USDA report, upcoming volatility based on probability, not on concrete facts
Overinvestment in long positions usually means that either the market expects a grain to go straight up -or that the commodity is grossly overbought, there are few buyers left and that it is due to fall strongly. All of this leaves soy very exposed to today's USDA report on US planted acreage. In the last USDA report, soy acreage was put up from 2011 74 million acres to 75 million.
However, the last four months have seen a strong soy rally amid flat corn prices. This has taken the soy/corn price ratio from a value of 2.5 in late 2011 to 2.0 at the end of March. Needless to say, with returns on rising and those on corn remaining flat, it would not be surprising if a few million US farm acres are shifted from corn, wheat or other oil seeds to soy.
That would strongly disappoint bullish expectations at a time when most investors expected soy to rise even higher Naturally, this could result in a late March to early April sell-off of those long soy positions, and a rather sensational, early second quarter price drop. Indeed, the implied price volatility may have already occurred by the time you read this article.
Hence, over the short-term, unless the USDA pulls off one of its surprises, soy's price could be headed for some instability, and probably in a downward direction.
But having said that, the following must be pointed out: At this time, confirmed world soy supplies are rather low, China's strong first quarter import demand was real. Even if planted acres increase and depress soy's short-term price, the price behavior has underlying assumptions based on probability, not fact: The link between more soy planted acres and a bigger crop assumes good growing weather -and this before the US feed crop planting even gets underway.
From all this, we can conclude that over the short-term, soy's price will probably become more volatile, highly uncertain in direction and based more on assumption than fact.
Chinese political considerations on soy's side
However, beyond the next month or two, a strong case for higher soy export demand has been made. At a recent Global Grains Asia 2012 conference in Singapore, Abah Ofon, Standard Chartered Bank's director of agricultural research points out that alongside Latin America's well-known drought, soy harvests were down in every major producer, the US included.
This leaves soy inventories at low levels for at least the next six months. In such a low inventory situation, an uptick in demand could easily send prices higher. Somewhat of a contrarian in outlook, Ofon is expecting unexpectedly high soy demand from China.
Ofon stated that while some analysts pointed to China's thin soy crushing margins as evidence of import saturation, they are missing the point: In China, decisions to import a feed crop are made on the basis of political, not economic considerations.
Towards this end, Ofon correctly points out that under normal economic assumptions, China's high corn price and thin soy crush margins would have China strongly stepping up corn imports while buying with less soy.
Instead, even with domestic corn's cost stuck at US$10/bushel, China appears unwilling to import more than 5 million tonnes this year -but it surprised many market watchers with strong, early year demand for soy, which eclipsed expectations.
What surprised market observers about China's early year soy import spree (14 million tonnes by the end of March), was that it appeared entirely unnecessary: There was hardly any money to be made crushing additional soy, and domestic bean inventories appeared to be plentiful. -China even opted to import more expensive US soy when it could have just waited for South America's creaky transport network brought the harvest to port.
Ofon rationalizes this counter-intuitive state of affairs by pointing out that China's high soy import reliance and reluctance to import more corn are based on political considerations, not market forces. Because it does not want to become a net corn importer, its domestic corn costs will stay high. To offset expensive corn's impact on feed prices, China keeps soy's price artificially low by importing more soy than a free market would expect it to.
That is why Ofon stated that, "While crush margins are low, that is not the game changer": With political imperatives upending logical free-market outcomes, crush margins lose their capacity to predict soy import volumes. He concluded that, "China already has a structural problem in its corn stocks; it needs to use soy to keep meat prices under control."
For this reason, while many analysts expect China's soy import growth to slow down, Ofon expects it to continue rising strongly, by 10.6% from last year's 56.5 million tonnes to 62 million tonnes this year. In 2013, he expects China's soy imports to rise by another 8.1% to 67 million tonnes. Of course, if China's import demand expands by this much and the rest of the world also consumes more soy, it would take an impressive US bumper crop to keep soy from rising further.
Moreover, if the lion's share of this year's Chinese soy imports occurs before the fourth quarter, that higher import demand would need to be met from a disappointing South American harvest and razor-thin US inventories.
Cost push component to soy rally?
With Brazil now providing more of the world's soy than the United States, Ofon pointed out that prices need to rise just to compensate Latin America's higher production costs. Brazil's real has of late lost value against the US dollar and this matter. The gas and petrochemicals used to manufacture fertiliser and pesticides are priced in US dollars.
According to Standard Chartered Bank, this makes the unit cost of farm pesticides and fertiliser three to five times higher in Brazil than in the United States. With Brazil's currency falling against the dollar, the cost differential has widened of late. In fact, the only soy growing input that is more expensive in the United States is seeds, but even this is offset by GM seeds' higher crop yields.
To this can be added Brazil's transport cost, as it takes 50% to 100% more money to ship soy to a shipping port in Brazil than it does in the United States. When oil prices went up late last year and early this, this transport cost differential between Brazilian and US soy also widened. Ofon estimated that these changes have boosted Brazil's soy production costs by 26.7%, from US$7.50/bushel to US$9.50/bushel.All this carries several strong implications. First, up to this now, soy's rally was driven by a South American supply shortfall, but soon this will change. China's soy import demand has surprised the market for nearly five years straight. If Ofon's analysis is correct, we can expect more of the same to occur in the months to come.
This implies that any short-term volatility reflects a market inflection point. The ongoing rally is changing gears. The bad Latin American harvest is fading away as an issue but low US inventories, America's soy growing season and Chinese demand will dominate market talk over the coming months.
Second, whether China's demand materializes or not, given the tight state of US soy supplies and disappointing southern hemisphere harvest, the next six months will see the world running down Latin American soy inventories. That is inflationary by implication. The occasional market heart attack notwithstanding, soy should rise to the US$15.00/range during mid year before retreating. In fact, given that soy has risen to US$14.50/bushel the past few years without so much supply and demand pressure bearing down on it, this may be a conservative forecast.
Third, with Brazil's soy production costs so high, a price of at least US$12.50/bushel is required to assure South American farmers of decent returns. All this implies that if soy's price swoons in early April, it could be a buying opportunity.
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