November 8, 2008
Feed & the global financial market crash: Grain prices diverge from reality
Prepare for higher prices and shortages. Financial panics are making grain prices ignore underlying market fundamentals. Key inputs are following credit conditions rather than actual supply and demand. Such confusing market signals could lead to large supply shortfalls within one or two growing seasons.
An eFeedLink Exclusive Commentary
by Eric J. BROOKS
Prices fail to communicate market conditions
Grain's roller-coaster price swings have always been a part of financial market lore. Now however, it is financial markets that are swinging wildly and dragging along feed grains for the ride. This is a serious and worrying situation because prices play a vital role in regulating market supplies. High prices tell farmers to raise feed grain production and help to eliminate supply shortages. Low prices tell them to curtail output in order to reduce surpluses.
At this time however, feed prices are sending out incorrect market signals and creating disincentives that do not reflect actual supply and demand.
Finance crashes corn
For example, from its lofty heights near $8/bushel just four months ago, CBOT corn plunged over 50 percent, falling as low as $3.55/bushel by late October before stabilizing around $3.83/bushel at the time of publication. What is troubling however, is the consensus that these price swings are due to financial market upheavals, not corn's underlying supply and demand fundamentals.
At this time, there is no evidence that a global recession has curbed feed demand. Yet America, the world's largest corn exporter, is not alone in having a smaller corn harvest this year. Argentina is hoping to reap 19 million tonnes against last year's 20 million tonnes. Similarly, Brazil cut its estimate of its upcoming corn crop to 54.75 million tonnes from 55.5 million the previous month.
These three countries account for about 90 percent of global exports and prices are down even though they have less to sell this year. Since this report, heavy rains has slowed down the planting of both Brazilian corn and soy, creating scope for a further crimping of global supplies in the spring of 2009.
Hence, overall feed grain supplies are almost as tight as earlier in the year, and perhaps trending tighter. Nor are there any reports of actual physical demand for meat falling off in any major market.
Letters of credit impacting corn prices?
Aside from the contagion of financial deflation itself, only one other factor has impacted inventories and demand in a way that could move prices: since late September, there have been ongoing reports of occasional ships filled with corn or soy stranded at US or South American ports when their importer's letter of credit was turned down due to frozen global credit markets. Should such incidents increase in number, they will certainly dent feed grain purchases, but not in a way that truly reflects the dynamics of a normally functioning market.
In CBOT trading pits, the consensus is that without the financial panic, there are no factors at work that could have dragged corn below $5/bushel, much less the $3.70+/bushel range it traded in as of late. Before oil prices fell, it was estimated that corn production costs had risen to approximately $4.50-$5.00/bushel. Even with energy and fertilizer price declines, corn farmers would be lucky to merely break even at today's prices.
According to Vic Lespinasse, a CBOT floor trader with GrainAnalyst.com, "if these markets keep breaking, corn, as well as the other grains, will be pulled lower also, so any recovery in corn is tentative until the financial markets regain a semblance of 'normalcy'."
According to Lespinasse, should oil drop to slightly above $50/barrel or lower, this could lead to corn prices below $3/bushel amid still-high costs for seed, fuel, fertiliser and weaker cash grain market corn. He added that at below $3/bushel, it would become uneconomical for many American farmers to grow corn. In a world of tight corn supplies and high production costs, is this the type of message that the CBOT market's price signals should be sending out?
Chris Hurt, a Purdue University agricultural economist states that farmers will need to earn nearly $5/bushel next year to cover rising fertilizer costs and other expenses. Yet, Indiana corn farmers were receiving less as little as $3.56/bushel at the time of publication. While $3.50-$3.80/bushel would have been considered a good price two years ago, that was before fuel and fertiliser underwent several years of triple digit hyperinflation.
Hence, rather than reducing abundant grain surpluses, low corn prices may lead to serious underplanting among key exporters such as America, Brazil and Argentina.
The story is similar in soya beans, as they fell approximately 43 percent from over 15.90/bushel in early July to $9.16/bushel today. CBOT Traders report continuing strong demand from China. Yet, two days before publication, Brazil revised its soy production estimate to 58.85 million tonnes from 60.7 million last month.
With financial markets and import financing problems impacting corn prices more than supply, demand or the weather, are there any market signals implying a rebound in feed grain prices? Indeed there are. CBOT December 2009 corn is selling for nearly 21 percent more than corn slated for December 2008 delivery. In today's deflationary environment, this represents a formidable price premium and the expectation that corn is underpriced. A similar, widening price premium also exists between December 2008 and December 2009.
Credit freeze plunges fertilizer market, creates huge intra-regional price differences
Despite the fact that feed grain prices do not reflect market realities, the deflation has been good in one way: fuel costs and fertilizer prices, though much higher than two years ago, are now much lower than they were a few months ago. Yet, the situation is deceptive and not expected to last.
For example, fertilizer markets are now exhibiting bizarre behaviour. After rising hundreds of percent a year for nearly two years, fertilizer prices have crashed anywhere from 45 percent and 70 percent â€“in a mere 3 weeks.
Most strange and indicative is the fact that we are seeing large price gaps opening up for the same fertilizer in different parts of the world. For example, Russian and middle eastern urea usually trade within $10/tonne of each other. As the price fell from over $800/tonne to below $350/tonne, a price difference of nearly $100/tonne opened up between them.
Similarly, after both touched $880/tonne, in just three weeks, middle eastern ammonia fell to $590/tonne while Russian ammonia crashed to $360/tonne. In normal times, such huge price divergences do not occur. Instead, they again reflect the financial crisis, which hit Russian credit markets more violently than it did the wealthier middle eastern producers. Market newsletter reports that with much of today's fertilizer having been made earlier in the year, "world fertilizer markets are suffering from the twin problems of high-cost inventories and a lack of credit." The latter is causing prices to fall more dramatically in regions were the global financial crisis has paralyzed credit markets.
In normal times, properly functioning credit markets would create arbitrage opportunities whenever price gaps between Russian and middle eastern fertilizer became too wide. That way, the market would close any price gaps and resume focusing on fundamental supply/demand issues. At this time however, grain and fertilizer prices only reflect credit market paralysis, and nothing more.
Grain farmers should take advantage of temporary input price distortions
These errant, artificially low prices are tending towards underproduction followed by a large price rebound when financial markets regain their balance. Hence, a wise grain farmer will do his best to take advantage of this situation while it lasts.
Assuming that eventually credit markets recover, food is a necessity, not a luxury and underlying fertilizer demand cannot change that much. Fertiliser market analysts argue whether prices will set new records or stabilize but everyone agrees that with today's production costs higher than even early 2007's fertilizer prices, a price level that feed grain farmers would find comfortable is simply not sustainable.
Instead, the market appears ready to correct itself in an upward direction as soon as global financial markets again enable fertilizer shipments to flow smoothly between importers and exporters. Alan Kluis, a market analyst with agricultureonline.com expects, "seed prices to increase by 25 percent to 30 percent, fuel costs to jump by 30 percent to 40 percent, and fertilizer prices to run 60 percent to 100 percent higher."
Staying one step ahead of the market
What is being said by such bold predictions is that it is not just feed grain prices that are out of line with market fundamentals: Thanks to the financial crash, seeds, fertilizers and even fuel prices do not reflect their tight supply/demand fundamentals any more than feed grains do.
While the current economic crisis looks like it take years to unwind, the artificially low prices it has created for feed grains and their inputs cannot persist for nearly as long. With low prices depressing their production in an already tight global market, feed grains and their input costs are destined to rise above the underlying overall price level sooner or later.
Deflation or not, low prices will encourage underproduction of both feed grains and their inputs. Should this occur, even a credit market recovery will not be able to materialize grains that were not grown or fertilizer that was not produced in time to avoid shortages and price spikes. Yet, that is the situation that today's artificially low grain and grain input prices are leading to.
For a feed grain grower, all this means buying up as much fuel, seed and fertilizer as possible at today's low prices. Similarly, livestock farmers should take advantage of today's low feed grain prices and fill their inventories to the brim with today's low cost feed. That way, when prices recover, your higher revenues will not be swamped by input costs that rise just as rapidly or even faster than feed grain prices.
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