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COMMENTARY & ANALYSIS
 
June 16, 2017

UPDATE: Are feedgrains exciting again? - Short-term wheat and drought speculation vs. long-term corn fundamentals
 
By ERIC J. BROOKS
 
An eFeedLink Hot Topic
 
 
 •  Dry American and Australian weather have created short-term excitement over wheat but corn has greater long-term strength.
 •  Both short-term and long-term money-making opportunities exist but the cycle is only starting to turn -so don't expect a jumpy 2012 style rally.

Grain markets are suddenly filled with talk of drought but will corn and wheat respond? With dry conditions afflicting both Australian wheat growing regions and America's corn belt, much depends on the latter. Will it rain in America's Midwest before early July? Or will there be a much talked about repeat of the 2012 drought?
 
It would take a coincidence for both America and Australia to have comparably strong droughts at the same time, but the possibility does exist. Given the current market uncertainty, we attempt to answer both what could happen to grain markets over the next two months, and longer term feedgrain market trends.
 
Both corn and wheat hit rock bottom in Q3 2016, when their world inventories hit new all-time highs. Since then, corn has risen 20%, from US$3.16/bushel to approximately US$3.80/bushel. Wheat rose by 16%, from US$3.91/bushel to US$4.50/bushel at the time of publication. Although there is currently more media attention on the potential for a US drought to impact the wheat crop, corn is what one should be looking out for, as it contains more upside potential.
 
There is more to this than a potential US drought or ongoing Australian drought. The latter is poised to make its wheat crop come in several million tonnes below the 24 million tonnes projected. But while a coinciding US drought could cause wheat to rally above U$5.00/bushel over the short term, the real excitement -and long-term potential- is in the corn market.
 
Supply-wise, corn has turned the corner -but wheat has not. Before this drought, global wheat inventories were projected to rise for a fifth consecutive year (and the 8th time since 2008), by 1.8%, from 256.4 million tonnes to 261.2 million tonnes.  A drought would level off wheat inventories over the short-term, they remain very bloated. As the attached graph clearly shows, wheat inventories only starting to level out; they have yet to enter a sustained downtrend.
 
More telling, corn and wheat both had stocks-to-use ratios in the 25% to 40% range before the year 2000. After 2000, corn became relatively scarcer than wheat -and remains so: Since the early 2000s, corn's global stocks-to-use ratio has fluctuated in the 15% to 22% range whereas wheat continues to vary between 25% and 35%.
 
Over the shorter term, world corn output has fallen twice since the 2012 market peak, and both times in recent years. Wheat production rose for five years straight before falling a (pre-drought projected) 1.8% for the 2017-18 marketing year.
 
Finally, America accounts for a much larger proportion of world corn output: More in fact than the combined proportions of both US and Australian world wheat production. Hence, even in a worst-case scenario, coincidental US and Australian droughts will impact the world corn supply more than it does that of wheat.
 
Over the longer term, wheat's stock-to-use ratio in fact, only fell below 25% during the 2007-08 grain market rally, when it set price records and outperformed corn. Projected to close at 35.5% during the 2017-18 marketing year, the wheat stocks-to-use ratio remains at the deflationary upper end of its historical trading range.
 
-Hence, even if both Australian and American wheat harvests succumb to drought, a resulting fall in the stocks-to-use ratio to just below 30% would trigger at best, a mild, limited bear market rally. While that constitutes a money-making opportunity, barring further crop production problems in Europe or South America, it would probably thereafter retreat.
 
This is because as the accompanying graph's trend analysis shows, wheat inventories are starting to level off but have not yet entered a downtrend phase -something that from the (limited) viewpoint of regression analysis, could commence within one to two marketing years.
 
Fortunately for corn, it is ahead of wheat in the market cycle: Corn supply fundamentals were tightening up even before America's recent dry spell: From 128 million tonnes when the world feedgrain market peaked in 2012-13, world corn inventories rose 75.5% to an all-time peak of 224.6 million tonnes at the end of the 2016-17 marketing year that ends in late August.
 

 
Going forward, world corn production is expected to fall a USDA projected 3.3%, from 1.067 billion tonnes in 2016-17 to 1.032 billion tonnes in the 2017-18 marketing year. With its corn harvest projected to fall from 384.8 million tonnes last year to 357.3 million tonnes this year, America was expected to account for approximately 27.5 million tonnes of the projected 35 million tonne drop in world corn production, with China (-4.5 million tonnes) and Brazil (-2.0 million tonnes) accounting for the rest.
 
At 1.054 billion tonnes, 2017-18 world corn consumption will exceed harvests by 32 million tonnes. Whereas wheat harvests have exceeded consumption every season since 2012-13, this is the second time in three years that the world corn harvest size has declined and demand has exceeded production.
 
That will induce the first meaningful decline in corn inventories since 2010. Even if no drought occurs in America, world corn inventories are projected to fall 13.5%, from their record 224.6 million tonne peak, back to 194.3 million tonnes.
 
This has in turn sharply reduced the USDA's projected world corn stock-to-use ratio for the first time since the early 2010s. After being stuck in an undulating 21% to 22% plateau since 2014, the world corn stock-to-use ratio is projected to fall to 18.4% by the end of the 2017-18 marketing year -and all this was set to happen even before worries about a US drought began to materialize.
 
Consequently, a short glance at this article's accompanying graphics shows a clear trend developing: Even without a drought, bloated world corn inventories and their global stocks-to-use ratio have entered a downtrend. A drought in the middle of America's corn growing season would accelerate this trend already underway -and probably kick CBOT corn above US$5.00/bushel.
 

 
All this explains the 20% rise in corn prices since H2 2016 and a possible drought upside well above US$4.00/bushel -but is insufficient to trigger the large market rallies seen in 2007-08 and 2010-12. For that to happen, the world corn stocks-to-use ratio would need to bottom out around the same 14% to 15% range it was back then.
 
--But everything changes if a nasty, 2012-style drought reduces America's corn harvest (and world corn harvests) by 50 to 60 million tonnes. Before the resulting higher prices curtail projected world corn consumption, a 50 million tonne reduction in corn inventories would bring the world corn stocks-to-use ratio down to 13.6% --as low as it was during the hyper corn rally years of 2007-08 and 2011-13.
 
On one hand, that does not mean we will have a record setting, hyperactive corn rally like we had in 2012. Five years ago, corn fundamentals were supported by rapidly expanding US ethanol production and a strong, multi-year commodity market boom. Post-crash grain market liquidity was significantly more abundant than it is today.
 
On the other hand, should a US drought materialize, it would bring forward the date at which corn jumps above US$5.00/bushel by one to two years.
 
Drought or not, the world corn market is visibly tighter than it has been in several years. Wheat is only starting to level out its growing stockpiles. You could take a chance that America's dry weather will continue; if it does, you could profit over either corn or wheat in the short term.
 
But drought or not, this is a good time to invest in corn over the long-term -and keep a close eye on the US Midwest's rainfall -or lack of it- over the next few weeks.
 


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