October 14, 2018
USDA report makes beans jump... or was that a billion dollar knee-jerk?
News reports are crowing over how soybean prices jumped upwards in response to the USDA's latest WASDE report. The short-term price fluctuation is a mere symptom of market turbulence, as bean fundamentals continue to deteriorate.
By Eric J. Brooks
An eFeedLink Hot Topic
The market reacted positively to the latest USDA WASDE report's soybean estimates, firming up its price -when it had no business doing so! Beans have long been in a deflated state and rather than reversing its dreary fundamentals, markets reacted in an oddly positively to a slower than expected deterioration in supply/demand balances.
With US soy yield estimates being revised sharply upwards, analysts feared that US closing soybean inventories would become ultra-bloated. From 8.2 million tonnes in 2016-17, they closed at 11.9 million tonnes in the 2017-18 marketing year that ended in late August. It was feared they would jump as high as 28 million tonnes by the end of the 2018-19 year. Needless to say; it's hard to make a case for inflation when inventories triple in just two years.
Rather than reducing its inventory projection, the USDA's earlier 23 million tonne estimate was only raised marginally, to 24 million tonnes. This is due to the fact that low soy prices and unusually high domestic red meat production have improved crushing returns. The resulting higher crush rate eating up 3 to 4 million more tonnes of soy that had been anticipated.
All this means that world soy stocks will not rise from 96.2 million tonnes and a stocks-to-use ratio of 28.6% to a feared 114 tonnes and 33% stocks-to-use ratio. Instead, they are projected to total a still badly bloated record 110 million tonnes and distressingly high 31% stocks to use ratio -but any ratio north of 25% is in deflationary territory.
Even so, within hours, beans jumped 6 cents/bushel, their biggest leap in months. They ended their day of the WASDE report's release at US$8.58/bushel -but this short-term market activity needs to be put into perspective: All major world stock markets had fallen the previous day (due to Fed rate hikes).
Flush with cash from selling off equities, news of the WASDE report's lower US soy inventory balances caused some institutional investor fund money to be automatically placed into beans -and that's why soybeans went up even though both their supply/demand fundamentals continued to deteriorate: -A billion dollar knee-jerk reaction to changing world liquidity conditions is thus made to look like a USDA-induced jump in soybean prices. In reality, US soybeans lost their best customer -and the latter is buying fewer beans from the rest of the world too.
China imported 94 million tonnes of soybeans in 2017 instead of the 97 million tonnes expected. In the coming year, China soy imports are expected to stay at 94 million tonnes -not the 103 million tonnes that was expected before the trade war broke out.
America remains the soybean market price setter but with China importing almost all its soy from Latin America, the spread between US and Brazilian soybeans gets ever wider. The 10% to 15% discount US soy traded at during the trade war's start at one point narrowed to 5% to 10%.
Thereafter, China tapered off soybean purchases just in time for America's record harvest to come in. America grew 13 million tonnes 11% more soy was grown than was expected six months ago but exports were not revised proportionately upwards.
As the attached chart shows, that widened the spread between Brazilian (US$425/tonne) and US (US$325/tonne) beans to more than 23%. The spread is made worse by quality control problems: Heavy rains are impacting harvest beans quality in Iowa, snow in North Dakota and Hurricane Michael in the Midwest's southeastern states have caused beans from parts of these states to be sold for discounts of up $1/bushel or up to 12% below current US cash prices, which are already discounted relative to their Brazilian competition.
Unexpectedly low US soy prices are wonderful news for European and Asian oilseed buyers but are reducing US soy farming incomes by 12% to 15% from where they would be if this wide price spread did not exist. All this, however, does not change one salient fact: Soybeans cannot bottom out until world harvests stop growing and inventories enter a period of sustained decline.
At this point, only three forces could allow soybeans to bottom out: First, if America and China negotiate an end to their trade war, that could boost Chinese soybean imports by up to 20 million tonnes in less than two growing seasons -but this appears unlikely to happen.
Second, South America would need to plant fewer soybeans, but that is not happening: This year's bloating of world soybean inventories occurred even though Argentina's drought shriveled 2017-18 bean harvest was twenty million tonnes below expectations, at 37 million tonnes. With Argentina's harvest expected to "rebound" back to 57 million tonnes and Brazil's soy harvest on track for another near 120 million tonne crop, we have the following situation:
World soybean demand is growing by 17 million tonnes, from last year's 336 million tonnes to 353 million tonnes this year -but South American production will be approximately 21 million tonnes higher. To this can be added an additional 3 million tonnes of US supplies (after higher crushing demand is taken into account). A bad harvest could stabilize the situation but for the market trend to turn, that would need to be followed by a poor US harvest or an end to the trade war between the US and China.
Third, Nature could assist inventory reduction by bringing in a poor South American harvest. Last year, southern East Pacific Ocean temperatures were more than 0.5C below normal. The resulting La Nina condition created Argentina's drought and made it miss its harvest estimate by 20 million tonnes. As the above chart shows, this year's East Pacific Coast temperature anomaly exceeds 0.5C, implying that wet, El Nino conditions could cause severe rain damage to the soy crop, particularly in Argentina.
Over the long term, beans remain 24% down from their 2016 bear market peak of US$11.19/bushel and more than 50% below their 2012 all-time high. -Corn has suffered even steeper deflation since 2016 and 2012 respectively but its lower price relative to market peaks makes its future deflation risk lower than that of soy. Moreover, with world corn consumption exceeding harvests for several consecutive years, world inventories are falling -and the latest USDA report boosts corn's long-term upward potential.
All this is augmented to President Trump's recent announcement that he favors allowing US petrol's ethanol content to be raised from 10% to 15% for the entire year. That would further boost US demand for corn at a time when China is running down its own corn stockpile by boosting ethanol production.
Therefore, while Nature and Trade War politics can provide short-term returns in beans, sitting on corn might be a wiser strategy. Even if South America's weather goes to Hell, soybeans will not enjoy inflationary fundamentals any time before the early 2020s. Corn has found a bottom near US$3.50/bushel. A bad Latin harvest in Q2 2019 followed by higher US ethanol usage levels could carry corn above US$4.00/bushel within a few quarters.
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