December 8, 2008

Understanding the paradox of fishmeal: Scarce supplies, lower prices and higher demand
While this protein meal's market fundamentals remain strong, monetary deflation and a tight relationship with soymeal makes for interesting price behaviour.
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by Eric J. BROOKS
After rallying to $1,230/tonne in the first three quarters of this year, fishmeal's price, like that of most other commodities and financials, crashed in less than four months. At the time of publication, fishmeal was languishing around $940/tonne. Indeed, fishmeal looks set to finish 2008 even lower than it did at the bottom of the 2007's dramatic price crash.
Global deflation hides fishmeal's underlying strength
Nevertheless, this is a fishmeal market completely unlike that of 2007. This time, its price is not being deflated by an oversupply of fishmeal or intrinsically bearish market fundamentals. Indeed, fishmeal's 23 percent price decline pales in comparison to recent 40 to 70 percent drops in the prices of feed inputs such as corn, soy, fertiliser or transport fuel. Hence, fishmeal's underlying strength is evident in the way it has maintained so much more of its market value than other feed grains, commodities or financial instruments.
Furthermore, in keeping with a long-run secular decline in worldwide fishmeal stocks, 2008's catch declined from 2007 levels, which are substantially lower than the peak production which was enjoyed in the 1990s.
Finally, it should be noted that 2007's fishmeal price crash occurred in the face of strong overall feed price inflation. On the other hand, late 2008's falling prices happened against a backdrop of global deflation, strong fishmeal demand and regional supply shortfalls.
China returns to the market
In the global market itself, after a year of domestic oversupply, fishmeal's biggest customer, China, returned to the table. While growth in China's 2008 aquaculture production was somewhat stagnant, hog inventories increased in the first half of 2008 and this kept its demand for fishmeal trending upwards. This increased buying interest on the part of China more than offset stagnant European fishmeal consumption, thereby lifting the entire market.
Moreover, in 2007, China's burgeoning fishmeal stocks gave it the luxury of avoiding expensive imports. By early 2008 however, China had already consumed most of the previous year's oversupply. Its aggressive re-entry into the world fishmeal market pushed prices strongly upward throughout the first and second quarter.
Even during September, after commodity price deflation had taken hold, Chinese demand gave fishmeal healthy market fundamentals. That month, it imported 170,000 tonnes of fishmeal. This is 50 percent more than China's September 2007 import volume. Total Chinese fishmeal imports from January to September 2008 amounted to $1.19 billion and 1.16 million tonnes. This import volume is 42.8 percent higher than the corresponding figure for the first nine months of 2007.
Most Chinese imports from Peru, which saw its exports climb by 36 percent over 2007 levels. At the same time, despite the higher demand, Chile, the number two producer, saw its exports fall by 10 percent due to the disappointingly small size of its 2008 anchovy catch.

In mid November when the new Peruvian anchovy fishing season commenced, it was reported that this season's catch consisted mostly of adult fish. With Peru accounting for the lion's share of global fishmeal production, this dearth of younger anchovy fish carries ominous implications for the size of next year's anchovy catch. Consequently, even though aquaculture remains the world's fastest growing protein line, 2009 could see a serious decline in global anchovy supplies.
How can prices fall in such a tight market?
Now, the only conundrum in this otherwise rational outline of fishmeal's market dynamics is explaining how prices fell in the face of apparent scarcity and rising worldwide aquaculture output. The answer lies in the contradiction between fishmeal's strong microeconomic fundamentals and weak macroeconomic position.
First, the deflationary momentum of frozen credit markets reflects monetary shortages rather than fishmeal's supply-demand balance.
Nonetheless, one must always keep in mind that as a protein meal, fishmeal is substitutable with soymeal. Traditionally, the fishmeal/soymeal price ratio varies between 2 and 3, mostly averaging around 2.5. When this price ratio exceeds three, more soymeal is used in place of fishmeal, putting downward pressure on its price. At the time of publication, this ratio had risen to 3.83, thereby putting considerable downward pressure on fishmeal prices.
Resists soymeal's downward price momentum
All this makes for an interesting situation. Fishmeal was, is, and will remain, a scarce feed input. Its price increases have long outraced inflation and analysts expect its real price to more than double over the next ten years.
While soy is not nearly as scarce as fishmeal, monetary deflation has also made it fall by more than its market fundamentals would justify. Nevertheless, fishmeal has proven its relative scarcity by falling in price far less than soymeal. In theory, the resulting rise in the fishmeal/soymeal price ratio should put downward pressure on fishmeal prices. 
Yet, the idea of downward price pressure on a feed input that is short supply and growing scarcer does not make sense. And, most interesting of all, the above chart shows how the fishmeal/soymeal price ratio climbed sharply -right in the teeth of growing deflationary forces. Such a courageous price performance in the deflationary second half of 2008 implies that fishmeal's scarcity enables it to resist the gravity of falling soymeal prices.
Will fishmeal & soymeal prices decouple?
There are only two possible outcomes to this scenario. One scenario would be for soymeal to rise more quickly than fishmeal, thereby lowering their price ratio back into the 2.0 - 3.0 range. On the other hand, if the 2.0 - 3.0 price ratio is restored by fishmeal's price falling further, there would be reduced incentive to produce an input vital to aquaculture, yet in very short supply. In the long run, this could lead to a rapid, volatile rebound in fishmeal's price. With such an outcome, rather than dragging down fishmeal's price, soymeal's own price would then be pulled up.
Which ever outcome eventually manifests itself, one implication is crystal clear: Fishmeal's price, relative to that of other feeds, has no intention of coming down in price for an extended period of time. Instead, both soymeal and the forces of global deflation will be forced to accommodate an emerging global shortage of this vital protein meal. With fishmeal becoming ever scarcer in relation to soymeal, I anticipate that their price relationship will eventually either break down or radically redefine itself.
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