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November 25, 2011
 
Plunging US feed demand, surging Black sea exports - and tight corn supplies
 
Despite an improving supply outlook, corn's price is kept down by finance more than by fundamentals. How China's hunger and Argentina's harvest could spark another rally.
  
An eFeedLink Exclusive Commentary
   
by Eric J. BROOKS
  
  

        
After a year of fitful rallies and breathtaking retreats, corn has stayed in the US$5.85/bushel to US$6.85/bushel price range for most of the last three months, retreating toward the lower end of this range over the last few weeks.
 
In fact, despite the USDA slashing corn yields and its expected harvest to 146.7 bushels/acre and 312.7 million tonnes respectively, its report did little to boost market morale. That is because after a year of tight inventories and high prices, America's demand for feed corn is tumbling.
 
A three-way coincidence of high feed costs, falling per capita red meat consumption and drought in cattle producing areas forced many American farmers to cull their herds. This occurred despite otherwise strong prices for red meat and good export growth.
 
Similarly, amid slumping US poultry sales and bloated chicken meat inventories, broiler replenishment is running 6% to 8% below last year's level. Except for swine, all major US livestock lines have seen a retrenchment in inventory numbers and with it, feed demand.
 
As a result, the USDA's latest report cut expected 2011 America's feed demand for corn to 116.8 million tonnes, significantly below 2010's 121.7 million tonnes or 2009's 130.1 million tonnes. In all, despite a slightly higher population and booming beef and pork exports, America's farms are using 10.3% less feed corn than just two years ago.
 

Black Sea undercuts US exports

 These feed demand cutbacks follow bearish news on the export front, where 2009's 50.3 million tonnes of corn exports fell to 46.6 million tonnes in 2010 and an estimated 40.6 million tonnes this year. With a financial crisis making the US dollar rise, Black Sea and Argentine exporters are successfully undercutting American corn and winning a lot of orders.
 
For example, following Ukraine's removal of a 12% corn export tax, Japan recently purchased 800,000 tonnes of corn from it. Costing approximately US$0.51/bushel or 8.1% less than US corn, it was Japan's largest non-US purchase in over a decade. It usually buys over 95% of its corn from the United States but as of mid-November, this proportion had slipped to 83%, and is poised to fall further.

With the US share of the 2011's world corn exports slipping below 50%, the USDA's export estimate may yet be cut to below 40.6 million tonnes. US grain exports drive feed crop prices more than those of competing exporters. With the latter undercutting US corn, this had a dampening impact on prices, which remain historically high, though 25% off their recent peak.
 
In a mid November interview with Bloomberg News, Takaki Shigemoto, commodity analyst at Tokyo-based JSC Corporation said that, "Japan joined other Asian buyers in finding cheaper alternatives to US corn in feed, as the American supply became too expensive." He added that by relying on non-traditional corn suppliers, this, "shift in demand will drag Chicago futures toward US$6.00/bushel" -which is precisely what happened.
 

GM corn in Ukraine, Brazil & corn/sugar price spreads

Intensifying competition from the Black Sea might also become a new, long-term reality for US exporters: In the marketing year ending July 1, 2012, Ukraine expects to export 12 million of its record 20 million tonne corn harvest -a huge 140% increase over the 5 million tonnes it exported the previous two years. For now, this 7 million tonne surge in Ukrainian exports is merely replacing corn lost to US ethanol production. With the US harvest coming 24 million tonnes below this spring's early year expectations, Ukraine's export surge cannot account for the last three months of lower corn prices.
 
However, this could change in a few years: GM corn seed suppliers such as Monsanto have been working aggressively with Ukrainian corn farming conglomerates such as Mriya Agro Holdings Pte. This introduction of GM corn to Ukraine's fields raises the prospect of fast growth in Ukrainian corn yields and exports over the next decade.
 
Amid falling feed demand, falling exports and intensified competition from Black Sea grain, the only bullish indicator was US ethanol production, which stood 2.2% higher than a year ago. Indeed, with ethanol now accounting for 39.6% (versus feed's 36.5% share), this biofuel has brought petro-refining's inelastic price behavior into the corn market. This both keeps corn prices high and makes them break dramatically when they finally fall.
 
Even here, we see latent softness in the fact that at this time, US ethanol production increases are being sustained by ethanol exports to Brazil. As soon as the cost of sugar falls and its price spread with corn narrows, Brazil will re-start its own ethanol production and cease buying it from the United States. Depending on where the price of sugar goes, this could free up more US corn for export.
 

Argentina harvest wild card -assume China eats the extra corn

If GM corn from the Black Sea is a long-term consideration and ethanol is a more short-term impact, the medium-term wild card is Argentina's harvest. With prices high, crop planted area is expanding by 20% over last year's acreage. However, this bullish supply prospect is running into a possible La Niña drought. Indeed, to get around early arid conditions, some Argentine farmers have already delayed their corn planting to December, and late planted crops usually having lower yields to begin with.
 
This uncertainty about Argentina's weather has led to wildly varying Argentine crop estimates, ranging from the same as last year's 22.5 million to 30 million tonnes. Needless to say, when the estimated change in year-on-year exports ranges from zero and 7.5 million extra tonnes, the variation makes a huge difference to the world market. Interestingly if we take a conservative, midpoint harvest estimate of 26 million tonnes, the entire extra 3.5 million tonnes of exports could be eaten up by one country -China.
 
It is no secret that China wishes to avoid buying US corn, if possible. With China's own government projecting 5 million tonnes of imports over the coming year, Argentina is the one non-American supplier capable of supplying the bulk of this extra demand. Negotiations are ongoing and it is believed that within the next few months, an agreement on a sanitary corn import protocols will be reached with China. Argentine traders already assume that 2 to 3 million tonnes of its corn will be exported to China .

 
But it really is not bearish at all

In sum, we must weigh the comparative impacts of America's disappointing corn harvest and Argentina's supply uncertainties against new Black Sea supplies and rising Asian demand. While the fundamentals are not as tight as a few months ago, the demand side is still strong relative to supplies.
 
Even with all these cuts in America's corn demand, US consumption and exports still exceeds this year's harvest by 7.6 million tonnes, leaving its stocks-to-use ratio at 6.7%, not much improved from its pre-harvest 5.3%. With the US supplying just under half of world corn exports, even under worst case scenarios, thin domestic inventories will continue to carry implications.
 
Essentially, higher Argentine exports are already spoken for by China. The seven million surge in Ukraine corn shipments, while impressive, cannot counterbalance that compared to 2009, the United States and Brazil are exporting 10 million tonnes and three million tonnes less corn respectively. With falling US harvest still insufficient to balance consumption and exports and higher Asian demand matching additional exports from other countries, the market is just almost as tight today as it was several months ago.
 

A new rally may start early next year

The only genuinely deflationary factor outlook comes from the macroeconomic sphere, where the ongoing EU debt drama is changing the behavior of non-traditional grain market investors. Alarmed by repeated incidents of near financial paralysis, many of them cashed in their positions and decided to sit out the market, bringing prices down a notch from their third quarter highs. Matthew Pierce, chief trader with Grainanalyst.com states that, "Money feels like it is moving to a 'risk off' stance into the end of the year."
 
Many other observers concur about the EU crisis's impact on feed crops. According to Tom Cleveland, an analyst with Forex Traders, "The European debt crisis has put a temporary damper on all trading markets, including corn. The impact can be duly noted above by the gradual decline in daily trading volumes. Investment advisors the world over have been telling their clients to move into cash and cash equivalents, at least until the current wave of volatility settles down a bit."
 
To this EU-induced chill can be added the return of the late-year market cycle: December has traditionally been the weakest month for feed crop futures. Due to a succession of disappointing grain crops, recent years has seen corn defy December's traditionally deflationary bias and continue rising.
 
Normally, a coincidence of world liquidity drying up, a rising US dollar, falling American feed demand and sagging US exports would be enough to make post-harvest corn prices fall. This year, with supplies in short supply for a second consecutive season, prices are likely to remain flat or even rise slightly.
 
Many believe that once December's post-harvest season surplus is cleared, corn should resume its rally. For example, Standard Chartered Bank analyst Abah Ofon believes that while the rally will be less inflationary than early 2011's run up,  CBOT corn could average US$7.75/bushel in the first quarter of 2012, implying a price north of US$8/bushel by the second quarter of next year.
 
In a similar vein, Société Générale commented that even though it believes supplies are more plentiful than the latest USDA report implies, it expects corn to, "break out of the recent range-bound pattern to the upside." Michael Haigh, an analyst with Société Générale points out that this year's corn stocks-to-use ratio is, "well below the 10-year average of 13.4% and the five-year average of 12%."
 
We could add that for most of the years 1945 to 2000 when corn cost a fraction of its current price, the market operated with  US stocks-to-use ratios well north of 20%. According to Haigh, "If prices do not encourage needed acreage and/or the weather next summer disappoints, inventories could remain tight, sending prices even higher than currently forecast, especially in the longer term."
 
In sum, a combination of EU-induced bearish sentiment, a higher US dollar and undercutting of American exports by cheaper supplies is keeping the market around US$6/bushel. Nevertheless, the underlying supply situation in the US remains tight and extra corn brought to market by Argentina and Ukraine may be just enough to match additional demand from China and Southeast Asia.
 
A sudden EU financial catastrophe notwithstanding, corn's current price softness represents a buying opportunity. Sudakshina Unnikrishnan, an analyst with Barclays Capital stated that, "While China is expecting a record corn harvest, consumption trends are dynamic and domestic reserves will need to be replenished."
 
With Dalian corn futures near US$8.73/bushel, 45% above CBOT corn's US$6/bushel territory, a 45% price spread will start to feel irresistible to China's importers. Look for a large Chinese corn purchase in the weeks to come: Given China's record of shrewd buying on market bottoms, that would imply that corn has bottomed out and can only go up.
  


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