The Economic Crisis & Ag Markets
by Mike Krueger
The overwhelming factor in every market — not just in this country but worldwide — continues to be the slumping economic outlook. There are still no clear signs that the credit crisis has been resolved despite historic actions by nearly every government, including interest rate cuts and substantial industry bailout programs. Even the nation of China recently announced it will inject $600 billion into its economy in an effort to promote economic growth.
China, of course, is a key player in nearly every commodity market. The Chinese appetite for all things from iron ore and cement to soybeans has been largely responsible for the ignition of the “era of hot commodities.” China’s economic growth has been above 10% per year. That is an incredible growth rate, especially for an economy and a country as big as China. What’s interesting is that the world now views as bearish the possibility that China’s growth could slow from 10% or above down to 8%. Even at 8%, the growth would still be huge.
The economic crisis represents a clear threat to world demand (consumption) of all commodities. If consumption declines, ending supplies will increase — and that will take some of the pressure off the tightness in world supplies of wheat, feed grains and oilseeds. My opinion is that the world’s economic problems have not, so far, cut significantly into demand. The collapse in commodity prices, at least to this point, has been more the result of an enormous amount of cash being forced out of every market for a variety of reasons. Those reasons include: (1) Taking money out of commodity funds to meet margin or cash requirements elsewhere. (2) As markets have declined, margin calls have increased. (3) As markets of all types have declined, investors have been moving money out of what they consider “risky” investments into what they consider “safe” investments.
The result of all of this has been that speculative commodity investment funds — especially the much-publicized “index” funds — have been liquidating positions in commodity and equity markets in a very dramatic fashion. For example, the size of the index fund positions in wheat, soybeans and corn futures has dropped by more than 50% since July.
Index funds are, by definition, always long commodities. That means when they liquidate or close out positions, they are selling, not buying. So we have seen corn, soybean and wheat futures lose 40% to 50% of their value in just four months. Nearly every commodity has witnessed the same trading pattern and similar loss of valuation. In fact, if you lay the agricultural futures market charts over the crude oil price chart, they are nearly identical. It has been a non-discriminating decline.
There have been some corresponding bearish developments in U.S. and world grain and oilseed markets. The world’s wheat crop will set a new record by a very wide margin; but when all is said and done, the world will still have the third smallest wheat supplies ever. U.S. corn ending supplies will decline this marketing year despite the second biggest yield ever and a steep cut in the corn export forecast.
This brings us to the oilseeds situation. USDA had an interesting month of October. In the normal October estimates, they “found” an additional 2.2 million acres of soybeans and increased the ending supply numbers to reflect those discovered acres. The result was that soybean ending supplies jumped from a squeaky-tight 130 to 140 million bushels to a more comfortable 205 million bushels (which is still relatively tight).
USDA then decided to issue a special report on October 28 in which they admitted their acreage numbers were too high — so they cut acres and reduced production. But they also felt compelled to cut demand and leave ending supplies unchanged.
In the November report, they reduced the projected soybean yield by just 0.2 bushel per acre, but again cut the crush number (processing) to offset the production loss and leave ending supplies unchanged.
USDA is projecting that soybean exports will decline by 140 million bushels from last year; but the export pace today is actually running ahead of last year’s pace. China has purchased more U.S. soybeans at this date than during the same period last year. If the export pace remains strong, USDA will have to increase exports and lower ending supplies. There are a number of analysts, myself included, who believe the U.S. soybean yield is too high. USDA did cut the estimate of Brazil’s soybean crop in their November report.
The U.S. sunflower harvest is nearly complete, despite some serious weather delays in the Dakotas and Kansas. Yields and quality have been generally very good.
The problem is that the same malaise that is affecting commodity futures markets spills over into those commodities, like sunflower, that don’t have futures markets. As prices in general decline, buyers of all sorts buy as little as possible. They will only buy what they need tomorrow until there is some evidence the economic climate is improving — and with it, the prospect for higher prices. Until then, expect choppy markets with a bearish bias. My opinion is that patience will be a virtue in these markets. When the economic outlook improves, commodity prices will improve quickly.
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