December 27, 2011
All eyes on Argentina and the weather gods: Will China's corn trading gamble succeed or backfire?
China's decision to not import corn late in the year is based on the assumption of a bountiful Argentine harvest. With South America's weather turning increasingly dry, this trading tactic could fated to backfire.
An eFeedLink Exclusive Commentary
by Eric J. BROOKS

China & the west behave differently
After a spectacular bull run and new US$7.95/bushel price in the first two quarters of 2011 and a secondary late third quarter peak, corn ended 2011 at nearly the same price it began the year. The mid-year peak was followed by a liquidity induced downturn that eventually terminated a secondary price peak and made the market bearish towards the year's end.
This however, is not the case in China, where despite post-harvest deflation, prices remain at least 10% above their opening January 2011 levels -and the price spread between CBOT and Dalian corn has again widened to more than 45%. Since August, CBOT corn has fallen 20% but China's corn prices have only fallen by 10%. Going forward, along with the Chinese market's distinctive behavior and even more curious trading tactics, we see another, previously mentioned factor coming to the fore: Latin America's unstable weather.
La Niña wild card at centre of China trading gamble
In eFeedLink's September 17, 2011 weekly grain column, we wrote that, "La Niña is poised to remove 3 to 4 million tonnes of Argentine exports from the world market." More than three months later, world grain markets are worried by dry Argentine weather and this is giving CBOT corn price support. Beaten down to slightly over US$5.80/bushel by a combination of feed wheat substitution, disappointing US export volumes and recurrent financial crises, the prospect of losing some Argentine exports to drought pushed CBOT corn up 6.6%, to US$6.20/bushel at the time of publication.
The rise is a built-in, rising risk premium that reflects assumptions on the part of certain buyers, especially China. After making a large 1.5 million tonne purchase early in the fourth quarter, the country has been completely absent from the world corn markets.
This is partly due to a record, 191 million tonne harvest that exceeded even official government expectations. The bountiful crop reduced the country's corn prices fell by an average of roughly 10% since August, before rebounding slightly to about RMB2,280/tonne (US$9.15/bushel) near year's end. December 19 saw China announce it would begin restocking corn to ensure prices remained at a level of at least RMB2,200/tonne (US$8.83/bushel).
While high in comparison to western corn prices, the resulting feed deflation allowed fourth quarter hog and poultry production costs to fall just in time for the high meat demand period of Chinese New Year in late January. While all this made it unnecessary for China to import more corn over the short-term, the country's corn buyers have taken a large gamble on the outcome of future corn supplies.
Regional China corn price disparities tell the tale…
The details of this gamble can be seen within the details of China's regional corn market. According to eFeedLink, while China's domestic corn prices fell by 5.27% in November, "This deflation was highly concentrated in the country's northeast and especially in the south, where corn costs plunged by 8.24%." Both of these regions but particularly the south, were coping with a simultaneous influx of both domestic harvest and imported pork, making for an exceptionally large price drop.
However, except for China's south, all the other surveyed regions of the country reported price falls far below the 5.24% overall average. Except for the country's northeast (which also received import shipments), November corn prices in most other parts of China fell by less than 2%. The wide variation in price behavior is proportionate to the presence of imports. This proves that while the current corn harvest is deflationary, most of China appears starved for additional corn imports. Hence, the decision to not import corn has more to do with trading strategy and less to do with China's actual needs at this time.
Furthermore, our analysis reveals a deeper assumption (and gamble) behind the decision to not import corn at this time: After a couple of previous bad harvests, China's state corn reserves are only about one-third the level the country's government  wants them to be. Despite the deflationary impact of imports purchased earlier at above US$6/tonne, representatives of Chinese grain trading houses stated that they only would find it worth their while to purchase corn if CBOT futures hit US$5/tonne.
Chinese traders take a gamble on Argentina
As a means of meeting market needs, such statements on the part of China's shrewd corn traders make absolutely no sense at all: The country purchased foreign corn to meet its domestic needs at CBOT prices well north of US$6/bushel on several occasions, which is much significantly higher than what CBOT futures were going for during much of November and December.
Not only was CBOT corn priced higher on many of those occasions, the accompanying graphs demonstrate that China's domestic corn prices were lower when it made its first quarter 2011 corn purchases than they were even after its large Autumn harvest. Mark Kinoff, president of Ceres Hedge was quoted by TD Waterhouse's research division as saying, "They have been on the light side (of grain purchases) even with a $2 to $4 break in corn and soybean prices. I would have expected China to scoop it up with both hands."
Along with the huge difference in price behavior between China's import saturated south and less accessible interior regions, all this implies the following: China could use more corn imports, but can postpone their arrival until the second or third quarter of 2012.  The traders are obviously talking through their hat: They know China could do with more imported corn but believe its price will fall in early February 2012, when Argentina's harvest will be ready.
Weather gods could tank China's Q1 corn buying strategy
PFG Best analyst Tim Hannagan was quoted by Bloomberg stating that, China "may get the best chance for corn at value" if it imports in February. In the Chinese corn trader's mind, a bountiful Argentine harvest would depress prices. Any corn China purchases in the middle of the first quarter would  arrive in the mid-second quarter -just in time to replenish inventories that should have been topped up with imports in late 2011 (but were not). Of course, if Argentina's weather does not co-operate, they could find themselves short of corn just in time for its price to hit the roof.
In the third quarter of 2011, our weekly grain column sounded the warning bell on La Nina's likely impact on Argentina's corn crop. On one hand, even a nasty drought would not drag Argentina's crop to the catastrophic 12 million tonne level seen in the 2008/09 marketing year -the country's large increase in corn planted acreage will see to it that such a worst-case scenario does not happen.
Nevertheless, with the dry spell already in its third month and the only rain falling in temperatures of 33C to 40C, some analysts are conservatively penciling in a one to two million reduction in the expected crop size. With corn inventories nearly as tight now as they were a year ago, forcing importers to buy scarce US corn at a time of year when Argentina is expected to supply the market would certainly jack up prices in a most unexpected way.
Of course, nobody can predict with certainty the weather what to do; therefore, I would not state with certainty that Argentina's crop will disappoint the market. However, the La Nina's cold ocean current is far more entrenched off South America than it was when we first mentioned it over three months ago.
Should that cold ocean current of South America -and Argentina's dry weather- persist, early 2012 may see something that the market has not witnessed in living memory: China's traders, who have a near-perfect record of calling market bottoms, may find themselves buying corn for far more money than they ever expected -with American corn exporters laughing all the way to the bank.

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