July 17, 2013
Bears close in on the feed crop markets: Will a dragon come to the rescue?
Record harvests, tightening liquidity put downward pressure on prices that only China stands to counteract.
by Eric J. BROOKS
An eFeedLink Exclusive Commentary
After three years of mostly bullish market conditions, a number of coincident market and macroeconomic factors are bringing us into a period of softening corn and soy prices.
Despite some of the wettest planting conditions recorded, the USDA reported that America's farmers planted a near-record 97.4 million acres of corn. This defied the expectations of market observers, who expected 2 million acres of this sum to be abandoned. Instead, 7 to 8 million tonnes of corn than was expected will be produced, and closing inventories to be augmented accordingly.
And while that excess precipitation made this year's corn planting exceptionally slow, it also restored much of the drought parched soil's fertility, creating scope for higher than expected corn yields. When the heat finally became excessive, it did so just before corn's pollination period, accelerating its growth, and lessened in mid July, right when corn needed lower temperatures for its sensitive pollination stage.The drought's impact had been lessened by the unexpectedly large size of Brazil's 2011-12 corn harvest, which came to the markets rescue in late 2012 and early 2013. Although this year's 72 million tonne crop was 5 million short of last year's 77 million tonne record, India, Argentina's and Ukraine's larger crop more than made up for the difference, keeping the market well supplied from Central Asian and Latin America until the US crop can come in.
At a USDA estimated 354.3 million tonnes, this year's American corn harvest will be 29.4% larger than last year's drought slashed harvest of 273.8 million tonnes, and 6.6% larger than 2009-10's peak crop of 332.5 million tonnes. But in truth, given the large planted area, benign to positive growing weather and timely, limited summer heat, the 354.4 million crop might come in closer to 370 million tonnes this year.
Having lingered in the 5% to 8% range for most of the last three years, this could push America's corn stocks-to-use ratio back into the far more normal level of 15.4%. Should the crop come in 10 million tonnes above expectations the stocks-to-use ratio could jump to 18.5%, which is near the lower end of its post-World War II average, when corn was plentiful.
A similar situation is also underway with soy. Here, record US planted area of 77.4 million acres comes on the heels of China's spring time H7N9 avian flu epidemic, which cut 2012-13 soy import demand by 4 million tonnes or 6.4%, to 59 million tonnes, from the 63 million tonnes initially expected.
With such a large planted area, America's soy crop of 92.3 million tonnes will be 12.4% higher than 2012-13's harvest and even 9.6% larger than 2011-12's crop, when there was no crop yield slashing drought underway.
Moreover, because of transport bottlenecks, South America's record soy crop shipments were delayed into the early summer months. By that time, it became apparent that the prospect of record planted area, good yields and a record harvest would be further burdened by the prospect of South American supplies coming in out of their usual shipping season.
Clearly, both feed grains and oil seed fundamentals have tipped strongly on the side of supply. Barring a rare, freakish occurrence of unusually bad US growing weather, all this implies softer corn and soy prices well into next year, with US$5/bushel for CBOT corn and US$13/bushel for soy being near their upper limits.
On one hand, with the corn stocks-to-use ratio going from 14.5% in 2012-13 to a USDA projected 16.2% in 2013-14 (and possibly higher if the US crop comes in on the large side), inventories have started their recovery but have not completed it:
But more than market fundamentals are turning against corn and soy: So is the world economy and more important, the liquidity cycle. In the years of high demand growth and disappointing harvests, feed's implicitly inflationary bias was exacerbated by global monetary trends, with more money being printed up in the last five years than ever existed prior to 2008.
Now, just as the harvests start growing strongly, demand growth is falling off and so is the world money supply. America's Federal Reserve Board has made it clear that it intends to halt its five year monetary expansion. This contractionary measure makes it harder for all commodity prices to increase, with not just feed crops but even gold, metals and oil prices feeling its deflationary downdraft.
Moreover, the Fed's monetary tightening is also having two other strong macroeconomic impacts. First, by restricting the supply of US dollars, it has made that currency's value rise by 5% in three months. A strong US dollar always exerts direct downward pressure on feed crop prices over the immediate short-term, most especially when it coincides with rising inventories.
But the Fed's tightening of liquidity also has an additional medium term bias: Since 2008, economic activity in emerging markets where meat demand is growing most strongly has been fuelled by a massive, unprecedented inflow of US dollars numbering in the trillions. Now, with the Fed's tightening, that monetary flow has gone into reverse. Those same US dollars that fuelled developing countries' demand grow for meat are leaving those emerging markets for the safe haven of America, causing their economic activity, meat consumption and appetite for feed crops to temporarily stop growing.
The impact of the Fed's tightening can already be seen in that most economically important of all feed crop importers, China. Beijing reported that June exports fell by 3.1% from the same month a year earlier while imports fell 0.7%, with its growth rate coming in at 7.5% instead of the usual 9%+. All this implies that even as world corn inventories recover on the back of America's projected record corn and soy harvests, demand for feed crops will taper off both in China itself and also in the overall global economy.
With institutional investor trades now making up well over 90% of the market, this coincidence of bullish feed crop supply news and bearish liquidity trends appears to have spooked them into a bearish stance. According to CFTC data, managed money accounts cut their long exposure to major American agricultural commodity futures and options by nearly 54,000 contracts in the first ten days of July.
The shift left speculator's and institutional investor's net long-position slightly over 120,000 contracts. That is approximately 50,000 contracts above an April's number, which represented the lowest on records going back to 2006, and well below net long levels many times this number, which peaked in February.
With recovering US supplies, faltering demand and tightening liquidity all exerting deflationary force on feed crops, is anything (other than possibility of freakishly bad weather) on the side of inflation?
At this time, the game appears to be in China's court. On one hand, with its own economic growth rate falling off right after the H7N9 avian flu cut demand for soy, the country's feed consumption may turn out to be unusually weak over the coming two quarters.
On the other hand, by setting a floor price for domestic corn at over US$9.20/bushel, any sustained fall in corn's price below US$5/bushel will surely tempt China to import more corn. Always short of corn, China's inventories fell by 5 to 10 million tonnes or 8% to 16% last year, depending on which government or analyst estimates you believe
Moreover, since the middle of last year, feed wheat has become far less available and more expensive than corn, making its substitution increasingly problematic for China's feed mills.
This year, despite a record harvest, the USDA expects a 211 million tonne crop to fall short corn consumption of 224 million tonnes, with imports of 7 million tonnes expected to bridge the supply gap.
With China's currency continuing to stay at high levels against the US dollar, the propensity to import more US corn will remain strong. A scenario could develop where every time corn's price sinks to US$5/bushel or lower, it will import corn, implicitly setting a market floor in that price range.
In addition, after growing by 5% annually for years and this year staying flat at around 59 to 60 million tonnes, China's soy imports are expected to jump by an impressive 13.5% or 8 million tonnes in 2013-14.
Both of these made-in-China factors should start to take effect only late in the third quarter, by which time, a large US harvest and chilly macroeconomic winds may have taken hold. At best, they could serve stabilize prices into the late fourth quarter or early 2014, when the Latin American harvest's state will begin to drive the market. At this point, barring any unforeseen market upsets, with the exception of China's domestic corn sector, the momentum in feed crop markets has turned in a deflationary direction.
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