July 13, 2015
Enjoy higher feed crop prices, while you can
Bad weather, tight US fundamentals give corn and soy a lift but abundant global supplies, deteriorating liquidity point to a fourth quarter market correction.
By Eric J. BROOKS
An eFeedLink Exclusive Commentary
At the start of the growing season, it appeared that only unusually bad growing weather could push corn over US$4/bushel or soy above US$10/bushel. Although such weather has now materialized, our analysis shows that only having a material impact on US supply/demand balances.
From their respective early spring bottoms near US$3.55/bushel and US$9.70/bushel, CBOT corn has risen 25% and soy 8% in response to a string of disappointing news regarding US inventories. Having worked through its bear market cycle ahead of soy, corn rose more strongly–though current price levels are still roughly 25% below its 2011-13 average of near US$6.00/bushel.
Corn scarce in US, abundant in rest of world
That is because entering the current growing season, corn's 2014-15 closing inventories had been steadily revised downwards, from over 50 million tonnes expected late last year to the current marketing year's 40.6 million. It was then assumed that this year's harvest would at least equal America's domestic corn consumption and exports.
Instead, a rapid start to planting gave way to near record wetness and flooding throughout the Midwest; and it only got worse as time went on. According to Andersons Incorporated, from mid-June to early July, six times more rain than normal fell on Midwestern states such as Illinois, Indiana, Missouri, Mississippi and Ohio. As these regions grow both corn and soy, both crops were impacted. Corn, because of its longer planting season, received more price support than soy.
With two years of falling corn prices having already reduced its acreage, excessive late spring rains further reduced corn planted area. The mid-year USDA report reflected this loss of acreage to the Midwest's very wet conditions. While no repeat of last year's record 361.1 million crop was expected, July's 2015-16 estimate reduction from 346.2 million to 343.7 million tonnes –and the possibility of more harvest estimate reductions in months to come– was more than the market expected.
With acreage down sharply amid unchanging feed demand, exports and biofuel output, expectations for closing corn inventories fell by 9.7% in July, from 45 million tonnes to 40.5 million. What is more interesting is that mid-year is usually a time when normal crop growth brings about a flattening out and weakening of prices.
Abundant Chinese supplies
Over the longer term, since last December, closing US corn inventory expectations were slashed by nearly 20%, from 50 million tonnes to just over 40 million. This in turn sunk the US corn closing stocks-to-use ratio from an expected 2014-15 close of 14.6% last December to an actual close of 13% --and an expected close at a relatively thin 11.6% in 2015-16. This implies regional shortages in America's corn supply chain during the early autumn.
In response to corn's rising scarcity within America, CBOT futures adjusted upwards accordingly, up 25% from the US$3.55/bushel level in the early second quarter to US$4.45/bushel by mid-July. Depending on how the weather turns out, they could stay at this level or even rise another 10% during the late growing season and early harvest period. Thereafter, many factors favour a hammering down of corn's price to below US$4.00/bushel.
For while corn's fundamentals are getting slightly tighter, this rebalancing of supply and demand has occurred only in the United States. While July's USDA report cut US closing inventories for 2015-16 by 10%, world corn inventories were only adjusted downwards 2.7%.
In physical terms, while closing 2015-16 US corn stocks were cut by 4.4 million tonnes, corn inventories in the rest of the world fell by less than a million tonnes. Because the rest of the world consumes 2.3 times more corn than America does, in the eyes of the global corn market, it is an immaterial inventory drop. To put it another way: China, which accounts for 91.9 million tonnes or 63% of the 145 million tonnes of non-US world inventories, is projected to have a record crop –and the USDA projects this year's 229 million tonne Chinese harvest to exceed domestic consumption by 9 million tonnes.
Weak long-term soy fundamentals
Interestingly, despite its relatively bearish long-term fundamentals, soy has more short-term upward potential than corn. There are two reasons for this. First, while the market immediately factored rain damage into corn's price, with Midwestern farm field flooding going on longer than expected, the full impact on soy yields will only be known later. At this time however, ground level evidence suggests that the USDA was wrong to keep the US soy harvest constant at approximately 105 million tonnes.
Mid July farm reports from the Midwest report that in some areas, soy crops with extensive yellow leaf (overwatering) damage are at only 40% of the normal height expected by this time of year. Upon returning from a tour of soy growing areas, Michael Mock, senior risk manager for Ohio-based Anderson's Incorporated opined that, ""I don't think I've seen a worse-looking crop in such a broad area." Despite such somber ground-level reports, the USDA (which surveys crop land more slowly than private analysts) reduced its 2014-15 soy harvest estimate by an immaterial 0.8%, from 105.7 million tonnes to 104.8 million.
While the USDA's soy harvest estimate looks increasingly doubtful, high crushing rates boosted America's 2014-15 domestic consumption and exports by 5%, from the 99.4 million tonnes the USDA expected last December to 104.4 million tonnes in July. With soy demand and harvest projections going in opposite directions, America's estimated September 1st 2015 soy inventory and stocks-to-use ratio has fallen dramatically: From the 11.2 million tonnes and 11.1% last December to 9.5 million tonnes and 9.3% in May to a thin 6.9 million tonnes and 6.6% at the current time.
While the USDA expects soy inventories to rebound to 12.9 million tonnes in 2015-16, this is based on the increasingly unlikely scenario of a 105 million tonne crop. It looks far more likely to come in closer to 100 million tonnes. –That in turn would mean that closing 2015-16 inventories will not rise from this year's low, approximate 7 million tonne level.
But while America's domestic soy stocks are clearly scarcer than those of corn, outside of the United States, soy supplies are more bloated. On one hand, instead of closing at 91 million tonnes as was projected at the start of this year, 2014-15 world soy inventories are now expected to be 82 million tonnes.
On the other hand, while world corn inventories have levelled out and fallen marginally, even after soy's downward inventory revision, it leaves 2014-15 world soy stocks up a whopping 30% or 19 million tonnes higher than in the previous marketing year.
Nor is there any supply-side tightening on the horizon: Based on current USDA Latin American harvest estimates, 2015-16 world soy inventories will rise to 91 million tonnes –in fact, it would take a catastrophically small (and unforecasted) US harvest just to keep overall world inventories from rising further.
When we analyse the numbers, we see that from 2011-12 through the end of 2014-15, America's corn stocks-to-use ratio rose from 7.4% to 13.0% -- but for the rest of the world excluding America, it rose from 16.0% to 19.7%. Going into 2014-15 however, the world corn stocks-to-use ratio drops slightly, from 19.7% to 19.2%, while America's falls more sharply, from 13.0% to 11.6%.
On the other hand, from 2011-12 through to the end of 2014-15, America's soy stocks-to-use ratio increased from 4.5% to 6.6%. Should another 5 million tonnes of soy be lost to bad weather, it will top out just below 7% in 2015-16. However, the soy stocks-to-use ratio outside the United States climbed from 19.7% to 27.8%, and is projected to exceed 28% in 2015-16.
Clearly, while both corn and soy are scarcer in America than in the rest of the world, soya bean inventories are especially overflowing. This is why soy's price has risen less than that of corn. It is also why while soy may outperform corn in the late year growing year and early harvest, thereafter, it will be subject to far stronger deflationary pressure.
Going forward, once America's corn and soy harvests come in, end of marketing year supply shortfalls will give way to new crop supplies, ending the price support that corn and soy are currently enjoying. Beyond that point, with a strong El Nino promising abundant South American precipitation through the year's end, it is difficult to imagine a supply forecast that provides much price support to either corn or soy.
WARNING: Liquidity crunch ahead
The above forecast is made even more conservative by demand side trends. China and Southeast Asia, which function as feed and livestock's growth drivers, are undergoing a sharp economic slowdown. This decelerating world meat demand is coinciding with a drying up of market liquidity.
China's 30% stockmarket crash occurred within a week of Greece's US$300 billion debt default. Because monetary shocks take a few months to reach commodity markets, these two crises could profoundly impact commodity trading from the fourth quarter onwards.
Should dwindling liquidity coincide with rising inventories and a post-harvest resolving of US feed supply chain issues, it could induce a nasty, 2008-type plunge in corn and soy prices later in the year. Moreover, even if market liquidity were to sharply recover from its ongoing downturn, just based on pure fundamentals, the current feed crop rally looks like a small upswing within a larger bear market cycle.
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