April 26, 2012
Get ready for a new soy price record
Why the price spread between corn and soy needs to widen.
An eFeedLink Exclusive Commentary
by Eric J. BROOKS
After briefly rising on talk of China importing more corn, CBOT corn futures have sagged to the lower end of the US$6.10/bushel to US$6.60/bushel range they have stayed in for most of this year. At one point, July delivery corn futures fell to US$6.01/bushel before bouncing back above US$6.10/bushel in overnight trading. Was corn's large sag outside its yearly range justified?
To be fair, while the USDA's prediction of a record corn harvest still has months of growing weather to cross, plantings have gotten off to a promising start. According to the USDA, by April 22, US farmers had sown 28% of this year's anticipated corn acreage. While rains in the western corn belt kept this below the 31% preliminary estimate, it is far ahead of the 15% of corn usually planted by that date.
According to University of Illinois agricultural economist Darrel Good, planting ahead of time could boost US corn yields by 2bushels/acre. That would translate into 4.8 million tonnes more than the record 355 to 366 million tonne crop most analysts are expecting. Should a corn harvest of approximately 370 million tonnes materialize, it would profoundly dent CBOT corn prices.
Assuming US ethanol demand for corn remains constant near 130 million tonnes, feed demand rises from 116 million tonnes to 120 million tonnes and other demand remains constant, total US corn consumption would amount to 285 million tonnes. Granted, the Latin American drought means that US corn exports could jump to 50 million tonnes in the next marketing year, from the current season's 43 million. Even so, that could see US corn inventories nearly tripling from this marketing year's 20.4 million tonnes to 56 million by the end of next August. If such a bountiful US harvest materializes, it could send corn towards its US$4.50/bushel price floor, below which growing returns can turn negative.
Of course, if the US Midwest's weather holds up and corn planting continues at its current torrid pace, the next USDA WASDE report will take such factors into its projections -and give the corn market a serious hammer blow.
And now for the bullish corn newsâ€¦
But there are a few bullish updrafts amid the deflationary fall-out. First, Argentina's crop, which was once expected near 30 million tonnes, and is currently pegged at 22 million by the USDA is now forecast at 20 million tonnes by the country's own government. Six months ago, many expected Argentine corn exports of 20 million tonnes but the USDA has written this down to 14 million tonnes. But with Argentina's own government cutting it harvest to 20 million tonnes, it is difficult to imagine Argentine corn exports of more than 13 million tonnes.
Second, after using cheaper Ukrainian corn in place of some US purchases, Japan suspended import shipments, citing serious quality problems with Ukraine's corn.
Third (and most importantly), with CBOT corn at US$6.14/bushel and Dalian futures at US$10.64/bushel, the 73% price spread puts huge, overwhelming pressure on China to import corn. According to calculations published by Morgan Stanley, importing corn gives a 5.5% (or US$0.59/bushel) advantage to corn importers that pay China's import value-added tax (VAT), and a 15.5% (US$1.65/bushel) price advantage to Chinese buyers exempted from paying VAT.
The last week of April saw corn rise on Chinese import rumours, then fall on the inability to confirm them. One thing is for sure: Free market prices do not lie; sooner or later, China will need to import corn just to get its agribusiness cost inflation.
According to USDA data, at least 600,000 tonnes of American corn was purchase by China in mid-April. However, with the buyer of other large shipments not yet accounted for, many believe that China could be purchasing up to 500,000 tonnes of old crop corn and 1.5 million tonnes for the marketing year that begins on September 1st.
All this adds up to 5 million tonnes to America's corn export ledger for old crop corn. That is why, despite corn's languishing near US$6/bushel, Goldman Sachs predicts old crop corn needs to rise to US$6.90/bushel, stating that, "We continue to expect that old-crop corn prices will likely rebound on evidence of Chinese import demand and resilient corn grind for ethanol." While Goldman is aware that a large harvest could devastate prices, it cautions that, "Summer weather remains key to this [bearish] supply response."
Beyond the third quarter, Goldman states that assuming a large harvest, prices could fall to US$5/bushel while Australia's Macquarie states it could fall towards it US$4.50/bushel floor. Even so, Macquarie warns that, "Old crop corn prices and basis need to work harder than they are currently doing to further ration demand." -and this forecast depends on a crop whose shoots have not even broken through the soil yet.
Soy to the rescue?
But while corn's fundamentals are cooling down, soy's are definitely heating up.
South America's drought was followed by harvest time frost. Argentina's soy crop, which was initially budget at 52 million tonnes and had been downgraded by the USDA to 45 million tonnes. Citing frost damage, the third week of April saw Argentina's government downgrade its forecast to 41.9 million tonnes, with many private analysts pegging it closer to 41 million.
That will drag this year's world soy harvest down by 10.6%, to 236 million tonnes from 2010/11's's 264 million tonnes. With the USDA reporting that America is on track to only sow 73.9 million acres with soy, we now have a paradoxical situation: The prospect of a record US and world corn harvests coinciding with flat American feed and ethanol demand on one hand -and a record drop in the world soy harvest made worse by a relatively small US soy crop on the other.
Moreover, with Oil World reporting that Canada's slightly larger projected rapeseed crop is being more than offset by smaller expected rapeseed harvests in Europe and Australia, there is not much scope for substituting one oil seed in place of the other.
With China continuing to buy hundreds of thousands of tonnes of US soy weekly at a time of year when it normally depends on South American supplies, the supply shortage is being exacerbated by high demand. The USDA's April projection that America will close out the marketing year with 6.8 million tonnes of soy in inventory looks increasingly unrealistic, with the true number probably closer to 5 million, if not less.
Clearly, US farmers need to plant more less corn and more soy -but they are not getting the price signal to do so. Despite the high CBOT soy price of US$14.68/bushel, it only makes for 2.4 price ratio with corn. To get US farmers to plant more soy, the ratio needs to be north of 2.5. Unfortunately, the high pace of corn planting implies that US farmers have already placed their bets with the golden grain, not soy.
When all this weighed together, the following becomes clear: The market needs to either convince US farmers to plant more soy, or barring that, convince South America's farmers to do so later this year. Only disastrous, crop losing weather in May or early June could convince US farmers to switch from corn to soy this late in the game.
Normally close to 80 million acres, the US will have to satisfy world high soy demand with 5% fewer acres than normal (73.9 million) from now to next March. That implies that soy's price will rise higher than it is today, and kick the corn:soy price ratio not just to 2.5 but solidly above 2.6, even close to 3.0.
At this point, the ratio really depends on corn's price more than soy, which should start closing above US$15/bushel and break its 2008 daily price record near US15.10/bushel. -And it needs to stay in the US$13.90/bushel to US$16/bushel range for some time to come.
Much like in 2007-08, soy will lead the new rally. To bring more acres under oilseed cultivation, the corn:soy price spread will fly north of 2.6 from midyear onwards, and pull corn's base, post-harvest price above US$5/bushel. In fact, if the US corn crop disappoints or China gets hungry for it, with soy exerting an upward pull, corn could stay above US$6/bushel, so long as soy stays above US$15/bushel. One thig is for sure: For the next few quarters, soy will take the feed crop market's centre stage.
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