We were interviewed by Jim Puplava of the Financial Sense news team last month. We noted that 37% of all the corn produced in the U.S. this year will be used for ethanol production under the biofuel mandates adopted pursuant to the Energy Independence and Security Act of 2007. The U.S. is the world’s largest corn producer and largest corn exporting country, so the increased biofuel demand has added pricing pressure to the grain sector.
Note the sharp rise in the percentage of the U.S. corn crop used in ethanol production in the chart at right – as recently as 2006 only 20% of the corn crop was used for ethanol production! Over the next few years the percentage of corn utilized for ethanol production is expect to increase further due to regulatory mandates requiring the production of more biofuels (charts courtesy of the Financial Times).
The EPA last month approved a mixture of up to 15% ethanol in gasoline for retail distribution, up from a maximum of 10%, potentially adding further demands on the grain market. Demand for corn and other grains for export has lead to a boom in barge traffic on the Mississippi River and shipping firms report they are operating at maximum capacity.
Grain Prices - The Financial Times published a column last month by Hussein Allidina, head of commodities research at Morgan Stanley, which makes the case for a continued strong economic showing for agricultural commodities:
. . . While speculative long positions are at near-record highs, inventories have tightened meaningfully and to near-record lows in some cases. Even greater challenges lie ahead. Prices will need to move higher if a
sustainable equilibrium is to be achieved as only higher prices will encourage farmers to devote much-needed extra land to these crops and this burden rests largely on emerging markets like Brazil.
We have long argued that global corn and bean balances were tight, especially given the tendency of weather to surprise and that without higher prices production would fall short of demand, tightening balances to untenable levels.
In the US, poor corn yields have prompted the US Department of Agriculture to cut its corn yield estimate from an expected record high of 164.7 bushels an acre to 155.8 bu/acre – and further downward revisions may still be likely. Even if the current yield estimate is realised, stocks in the US – which is responsible for nearly 60 per cent of the world’s corn exports – are poised to fall to an untenable 6.7 per cent of annual demand. . .
In the near term, we see corn prices rising to at least a bushel (from current levels of about .60) and possibly up to a bushel as demand needs to be rationed and farmers need the incentive to plant corn, instead of soyabeans, cotton and wheat.
At current prices, the livestock and ethanol industries are broadly profitable, encouraging additional demand – on our numbers, discretionary ethanol demand of 660m gallons per year is consuming nearly 240m bushels of corn in excess of what is mandated.
If prices stay at current levels, inventories will tighten even further, resulting in the need for even greater acreage next spring and by extension even higher prices to vie for acreage. Demand must be rationed as the supply response in the short-run is trivial.
We see prices remaining elevated for the next several years . . .
Note the level of corn inventory as a percentage of consumption has fallen substantially, to around 6.7% of annual demand (see chart at right). This inventory level is the lowest we have seen in 14 years – a situation that could create price spikes should supplies disappoint. Trends in grain production have led some importers to begin to over-order to hoard scarce supplies, and some exporters have restricted grain shipments out of the country—adding further volatility to the markets.
Grain prices continued to rally last month after the announcement by Russia that it will lengthen its ban on cereal exports to preserve domestic supply. Russia, the world’s third-largest wheat producer last year, extended the ban until July 1. The country had said in August it would halt exports until the end of this year.
The National Oceanic and Atmospheric Administration (NOAA) has indicated that history indicates that once droughts like that seen in Russia have been initiated the associated below-normal conditions in soil moisture, vegetation cover, and snow cover spur feedbacks that both prolong the drought and in many cases increase its severity and/or regional extent.
Several consultants claim Russia faces an “acute” grain shortage next year after record heat triggered crop losses this summer. Even a government-imposed ban on grain exports will not alleviate the shortage according to the Moscow-based researcher SovEcon. And rising food prices may push the inflation rate to 8 percent by year-end, Russian central bank chief Sergey Ignatiev warned.
Bloomberg last month reported that Thailand’s main rice harvest may drop as much as 20 percent after the worst floods in four years. The main crop, harvested from October to April, typically accounts for 75 percent of annual output. Economist and trader Dennis Gartman claims “the world’s rice crop has been very materially reduced due to weather problems.”
Typhoons have also hit rice fields in the Philippines and bad weather has impacted the rice crop in China, prompting the Financial Times last week to note in a sub-headline “concerns a poor harvest plus high wheat and corn prices could trigger a food crisis”. The article concludes that the grain panic of 2007-2008 probably will not repeat itself but we will see higher prices due to global demand growth and supply issues.
In addition to the recent corn, wheat, and rice supply problem the ‘stocks to use’ ratio for coarse grains is at near-record low levels – the second lowest reading since 1973 - adding fuel to the concerns over global grain supplies (see chart at right courtesy MF Global Hartfield Report). The long term trend of the chart is concerning – and points to more volatility and higher global prices in the grain sector.
Sugar prices last month soared to 30 year highs as demand increased with the global economic recovery, and Brazil’s production has disappointed due to dry weather. In emerging economies the increase in sugar prices is driving food inflation sharply upward, raising political concerns.
Cotton prices reached their highest price since the Civil War, surging because of worries about bad weather destroying crops and delaying harvests. Even coffee has jumped, hitting a two year high, as rainfall in Colombia (the second largest producer) and Vietnam raised concerns over a squeeze on supplies (chart at left courtesy Financial Times).
Benner 19 Year Climate Cycle - Weather in the U.S. corn belt has for the most part been very favorable for crops over the last decade. Yields have been at or near all time highs, assisted by advances in plant genetics as well as by fertilizer application. Some agricultural climatologists caution that historically the crop conditions during growing season in the Central U.S have deteriorated due to drought or disease, and that such occurrences are infrequent but can have major impacts.
Dr. Elwynn Taylor of Iowa State University notes that over the last century there have been 17 general drought years in the Central United States – roughly one year in six. But he notes that an analysis of crop yield records indicates the distribution of the drought events was not random.
Samuel Benner, a farmer who was wiped out in the panic of 1873, proposed that a drought pattern for Central North America exists and is governed by a 18 to 19 year cycle. Others proposed a cycle closer to 22 years. Surprisingly, Dr. Taylor notes that tree ring analysis over the past 800 year period indicates that a drought cycle exists, and that the drought cycle is closer to 19 years than to 22 – confirming Benner’s premise. Exactly why droughts have occurred in such a cyclical manner in the Central U.S. is not clear to scientists.
What is significant about the Benner cycle is that Dr. Taylor notes “drought years [for the Central U.S.] since 1970 are usually considered to be 1974, 1983, 1988, and perhaps 1995”. So it has been some time since the last cyclical drought – which increases the chances of another drought to more than the one-in-six long term average, possibly by a factor of two. Should a drought impact crop yields in the U.S. at a time when global inventories to use ratio is so low prices are likely to rise to levels that will spark global unrest.
Agricultural Equipment - Illustrating the impact of the bullish movement in grain prices the latest Mainstreet Economy Report, authored by Dr. Ernie Goss at Creighton University, indicated the agriculture-equipment sales index continues to rocket upward—rising to 61.0 from 56.2 in September and 52.7 in August. This was the seventh month in a row of expansion.
“While businesses on Rural Mainstreet continue to struggle, farm indicators remain very strong, including farmland prices and the sale of agriculture equipment,” said Dr. Goss, the Jack A. MacAllister Chair in Regional Economics at Creighton. Farmland prices also continue to increase at an impressive clip. The latest data from the Creighton survey was released October 21st.
The Beige Book survey from the Federal Reserve last month claimed farmers are generally seeing favorable conditions during the fall harvest. The central bank's report said the harvest was ahead of schedule. "Commodity prices strengthened further, boosting optimism among producers in the Dallas District and spurring higher cropland values and capital spending on agricultural equipment in the Kansas City District," the Fed said.
Investment Opportunities & Cyclicality - The Globe & Mail last month published an article that noted agriculture stocks tend to make their biggest moves during the last five months of the year, particularly in November and December, according to Brooke Thackray, an investment analyst specializing in the sector. After the summer growing season “farmers flush with cash look for ways to reduce their taxable income and tend to make their purchases of farm equipment or fertilizers before year-end” he claims.
“From 1994 to 2009, the Standard & Poor’s GICS agriculture sub-index focused on U.S. stocks has risen 15.5 per cent on average in the last five months of the year,” Mr. Thackray said. “Out of the 16 cycles, there have been six years of returns greater than 25 per cent. The only large loss was in 2006, when it fell 27.4 per cent. But that year was the start of a strong commodity boom with the index increasing 78 per cent in the first seven months of the year.”
Dennis Gartman, fund manager and author of the Gartman Letter and expert on grains, claims that “farming communities in the Midwest are going to be resurgent, and the equipment manufacturers, the fertilizer sales organizations, the grain elevators and perhaps most of all the small local banks will benefit manifest and continually. After a decade of weakness, strength returns to the farming Midwest.” Gartman claims the recent U.S.D.A. agricultural reports are the most “astoundingly bullish crop reports we’ve seen in many, many years.”
