April 13, 2012
A concise analysis for very bullish soy futures
A high ratio of Chinese soy import volumes to world inventories carries inflationary implications. We explore the relationship between inventories, top importers and why soy futures will outrace corn.
An eFeedLink Exclusive
by Eric J. BROOKS
For the past six months, soy's price rise has been stealing the show from corn, which previously has been most inflationary and volatile feed grain since 2009. Although soy is currently taking a breather from the grain market limelight, we expect this to change within a quarter or two. Not only have soy supplies become tighter, this critical oil seeds fundamentals are on track to becoming even tighter.
From a 2010/11 world harvest of 264 million tonnes, the USDA initially factored in 2011/12 global soy production of 259 million tonnes, a modest reduction. A nasty South American drought forced it to chop this estimate to 245 million tonnes by March and even further to 240 million tonnes in April.
Brazil's expected harvest was chopped 10.2%, from the 73.5 million tonnes estimated in late 2011 to 66 million tonnes. Argentina's crop estimate was cut by an even heftier 15.1%, from the expected 53 million tonnes to a mere 45 million tonnes. The Buenos Aires Grain Exchange usually revises its numbers ahead of the USDA and is forecasting a 44 million tonne harvest.
Chinese imports to equal world inventories
Assuming these estimates are not cut further by the time of publication, Brazil grew 12.6% less soy this year than in the previous growing season; Argentina 8% less. South America's disappointing performance has resulted in a 9%, 24 million tonne fall in soy production, which is the biggest annual drop record. It has changed price, inventory and export dynamics accordingly.
By running down their inventories, South America's large drop in soy output will only result in 2.8 million fewer tonnes of exports from Brazil and Argentina. The problem is that this extra two to three million in lost Latin American exports must come from the United States, where ending inventories are projected at 6.8 million tonnes. And if anything, this figure grossly overestimates US inventories, as they were a pegged at a mere 4.8 million tonnes in October 2011. This was before South America's drought transferred the export burden to North America, and before China's import demand rose in early 2012.
All this is strongly running down global stocks. Ending world soy inventories stood at 69 million tonnes at the end of the last growing season. They are now projected fall by nearly 20% to 55.52 million, the lowest year-end inventory close out since 2008/09's 43.9 million tonnes. Interestingly, our analysis indicates that while soy inventories will close out 2011/12 significantly higher than they did during 2008/09's soy price inflation, the implications are just as bullish. Here is why:
We do not measure the impact of inventories by their absolute level but by their quantity relative to demand. While the stocks-to-use ratio captures this element, it does so imperfectly. In the case of feed inputs like fishmeal or soy, China's huge market weight needs to be measured to the underlying supply base.
Hence, we prefer to measure soy's inflationary potential by comparing world soy inventories to China's import requirement, as the latter absorbs nearly 60% of world exports. And here we see the return of an earlier, mostly unnoticed story.
History repeating itself?
In 2001/02, USDA figures show that China's soy imports were equal to 32.3% of world ending inventories. By 2007/08, China's yearly soy import requirement was equal to 71.2% of ending inventories. This ratio peaked in 2008/09, when Chinese imports equaled 93.5% of world soy inventories -and CBOT soy futures set an all-time price record.
Because of late 2008's financial crisis, soy's price fell by 50% from its record high but subsequently underwent strong rally of more than 50% in 2009/10, when Chinese imports totaled 83.9% of world inventories.
2010/11 saw corn take off but soy prices stayed relatively flat. This occurred at a time when despite record Chinese import volumes, its soy imports equaled 75.7% of world inventories. Indeed, from our observation of this relationship, we can conclude that whenever Chinese imports account for 83% to 89% of soy inventories, a solid price floor or mild rally results. However, when the ratio of Chinese imports to world soy inventories rises above 90%, a strong, potentially explosive rally may result.
With this in mind, current USDA statistics show that by the end of this marketing year, China's soy imports of 55.0 million nearly equal 99.1% of world soy inventories of 55.52 million tonnes. This is significantly more than 93.5% they amounted to during 2008'oil seed price explosion. With China's early 2012 soy import purchases getting off to a stronger than expected start, it does appear as if demand is set to overwhelm the tight supply situation.
Corn/soy price ratio moves acres away from oil seed
Going forward however, there are more inflationary factors in the pipeline. After pausing for three quarters, corn as our previous grain article mentioned, is building up bullish fundamentals of its own. Consequently, with corn holding steady and soy sinking on institutional profit taking, the second quarter opened with the CBOT soy/corn price ratio falling below the critical 2.5 level -where farmers usually switch planted acres from corn to soy.
According to Don Roose, president of US Commodities said, 2.5 is the tipping point between farmers planting more corn, less soy or vice versa. With the ratio slipping below just in time for the spring planting season, this implies that farmers may opt to plant fewer soy acres than the USDA has forecasted. With the USDA already forecasting US soy output to be unchanged from last year, a reduction in planted acres could mean a smaller crop. That would mean that in wake of a failed South American harvest, the world would have to rely on an unchanged or slightly smaller US soy crop for the next three quarters. With China's demand already overwhelming world soy inventories, appears that CBOT soy's price will have more upward potential than corn.
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