RECORD CORN PRICES HAVE LESSONS FOR OTHER MARKETS

The chances are that (weather permitting) the North American corn (maize) crop will be excellent.  But it won't make a difference to the price trend which is hitting new highs.  Some say that we'll see $9 corn.


If so, we need to pay attention to the lessons this will have for us in a number of linked industries.  The key takeaway: commodities are not stand-alone markets.  What happens in corn in the USA also affects the ability of Chinese middle class consumers to buy pork at reasonable prices.

Global production will rise 5.6 percent to 866.2 million metric tons in 2011-2012, still too little to meet demand of 871.7 million tons. Demand is being driven by China where both drought and floods have seriously damaged production. As it economic growth has spiralled China has also massively increase its consumption of meat products and corn provides a staple feed for pigs and poultry.

We might also see wheat being substituted for corn in animal feed. Wheat is at its cheapest relative to corn in 15 years.  US futures have hit a 6 month low on news that the harvest is reasonably good. But that doesn't mean its cheap - in fact in real terms (i.e., take out inflation) its at its highest real value since its peak in 2007-08. The markets are looking at what they say is "way too much grain" but we think that situation can change.  A great deal depends on the EU harvest (and rain suggests that might be good) and the position of Russia which may re-start wheat exports that were suspended following the fires of last year. 

If cheaper wheat can't absorb some of the extra cost of feeding animals (corn can account for as much as 40% of the cost of poultry feed), livestock owners could react by increasing the rate at which they slaughter. This has yet to occur and the situation is a little more complicated than one might expect: cattle slaughters in the Mid-West of the USA are lower than for this time last year.  Fewer cattle moved from grazing into feedlots during May from the same period last year. The smaller number of "feeders" reflects fewer calves being born during the last year as cattle producers tighten their herds before the fattening phase in the face of the doubling of corn prices. China is in a different situation having already reduced its pig herd.  Huge middle class demand and rapidly rising pork prices will drive an expansion of production and so hit feed prices. Chicken production is also booming despite outbreaks of disease.

Corn prices are also being bid up by the ethanol industry. The U.S. will convert a record 5.05 billion bushels into ethanol in the next year, compared with 707 million in 2002. The high price of crude petroleum oil and continued uncertainty in the Middle East will see bio-fuels still in the money. The US Senate has voted to repeal the ethanol subsidy but this has not become law yet and the mandate for renewable energy remains in place and will continue to climb.  

While there appears not to be a world market for alternative fuels, high renewable prices overall suggest continued bullishness in other oilseeds that can be turned into fuel. That doesn't include soyabeans (which have a relatively low oil content) and which gets driven by the animal feed market for meal - overall soyabeans look a little weak, plantings are lagging as farmers focus on getting the new corn crop planted. But higher oil bearing crops, rapeseed/ canola and of course in the tropics palm oil will see benefits in the bio-fuel complex. 

What lessons are to be learned?  Our perspective is to look at the longer term and disregard short-term ups and downs.  The key lesson is that as never before this is a highly connected world where floods in the Yangtze River Basin can drive crop plantings in the Mid-West.  

Asia, and China in particular will play a more important role in all our markets; when China sneezes, we all catch cold, or in this case food prices everywhere will jump.  This helps make sense of food security strategies being employed elsewhere e.g., as Gulf Arab states secure their own physical supplies and as China looks to invest in Africa.  We remain convinced that the food commodity markets will become more finely balanced and more subject to sudden reversal.

For more information or to ask questions, please write to foodworks@quartermainesworld.com. We enjoy your comments and will respond to every question.

FAO JUNE 2011 FOOD OUTLOOK - ASIA IN THE DRIVING SEAT

Whatever we think of the United Nations, and the Food and Agriculture Organisation in particular (don't let's get started on bureaucratic fumbling), FAO does collect and present the official world-wide government-eye view of what's happening to our markets, and the analysis is professional and comprehensive. So it's worth paying it some attention. 

The just published Food Outlook: Global Market Analysis Report for June 2011 bears out our concerns about world food supplies.

FAO's aggregate price index in May stood at 232, near the highest ever recorded.  The main theme is that with supply-side constraints in major producing countries, especially in the west (wheat and corn stocks are down in the USA and the EU is facing lower output of oilseeds and dairy products), it is Asia that holds the key to both demand (China has its own agricultural difficulties) and supply - rice, sugar and palm oil are major commodities being sustained from this region.  But the production upside is limited, so the question is, where next to invest? We think there are still niches to be found e.g., in Laos and Cambodia and Burma (Myanmar) stands out as a future massive supplier of staple food commodities. Equally, we have to look farther afield.

Weather may be the main underlying factor in higher world prices, but FAO also points to the wave of unrest in the Arab World, oil prices and even the Japanese tsunami as de-stabilizing the markets.  None of this is really news, of course, so the interesting analysis will be to look at the detail and see where the next unexpected turn of events will take us.

Inventories in the cereal markets are low, at least for corn (maize) and wheat; rice is something of an exception with bumper harvests. A recent road trip we took around the Thai North-east (Esarn) saw a wonderful new crop on the way and Thailand should hit record exports this year. But overall the grain stock situation is tight, although, says FAO, less so in importing countries. This is fortunate because high crude oil prices will hit freight rates adding to import bills.

The oilseeds and oils market is driven by two major items, the ratio of corn to soyabean prices in the Mid-West and the demand for palm oil.  Prices have pushed up since 2009 mainly because of strong demand for palm oil from China and tightening supplies of soyabeans which have given up land in the USA to corn produced for ethanol. In general, higher crude oil prices will favour that substitution and add to prices.  The current soy:corn price ratio favours corn and with poor weather in the EU for the rapeseed/ canola crop the tight supply situation is likely to continue.

The market segment to watch here is bio-fuel. FAO says that fully half the anticipated rise in consumption of vegetable oil is due to this market, with overall 12% of total demand being for bio-fuel.  FAO notes that the driver here is not just the crude: bio-fuel price ratio, but the mandatory inclusion of bio-fuels in gasoline - watch for news items that airlines are starting to use more bio-fuel.

High prices for cooking oil (along with high flour prices) strike directly at the relatively poor in developing countries.  First entrants into the commercial world usually set up food stalls,  retailing simple, high-carbohydrate foods. If they cannot afford their basic ingredients not only do their nascent businesses fail, but there is an immediate impact on urban working people who eat their food.  One result could be an increase in unrest everywhere and government attempts to control prices of basic foodstuffs.  Expect greater civil unrest in more African countries and (if it were possible) in Pakistan.

Higher income groups will also be affected by the  rising cost of livestock products (meat and dairy) which are at record levels. These commodities will be equally hit by feed costs and costs of cool storage and transport. Higher energy costs will also add to packaging. The good news is that there are ample stocks of feed meal (derived as a by-product of the oil extraction  from oilseeds) but massive demand for livestock products e.g., in China will keep prices firm. China has been hit by reductions in pork meat supply and imports are likely to be at record levels. Similarly poultry meat production increase could be as much as halved with outbreaks of avian flu in Asia. Milk, cheese and butter prices also stand at record highs as a result of a slow supply response and apparently unfavourable policies in key regions such as the EU. Hit by higher food prices and limits on her credit card, the middle class consumer will reduce other purchase so leading to a slowing world economic recovery.

Switching consumption to fish doesn't offer much relief to the housekeeper. As Robert Lindley wrote here recently (see archived post 2nd June), capture fisheries are in decline and this tight supply  has pushed demand for farmed fish which in turn are affected by high feed prices.  The FAO Fish Price Index shows that prices are higher than ever before - May this year 18% higher than the same period in 2010.

Of the major staple foods, only sugar has shown weakness in price as a result of large supply in key countries - again favourable growing conditions in Thailand and India pushed up stocks. These gains offset reduction in supply in the developed countries. Demand is expected to increase only in line with population as the world economic recovery lags, but the volume of trade could be smaller because the main producing countries need to hang on to their own production to ensure demand is met.

What to make of all this?  One recurring theme in the FAO Report is the importance of the Asian markets, both in terms of demand, with China absorbing increasingly large volumes of all the key commodities and where its own production difficulties suggest this import demand will only increase, and for supply with countries like Thailand, Indonesia and India supporting vegetable oil, sugar and rice production.

The question is to what extent is Asia reaching the limits of its productive capacity? Rice is cultivated with great intensity in these countries so without yield increases and with land lost to industrial use Asia's traditional suppliers are unlikely to be able to bear the brunt of any production shortfall in the western countries.

One answer may be for Asian countries to diversify into higher-value crops that return more per unit of land area and indeed this is a strategy the Thai government is considering (encouraging farmers not to plant a third rice crop). Also Africa today appears mainly on the demand side of the equation - rice exports to Africa are at record levels. But Africa and perhaps Central Asia provide the only areas where large production increases can be projected in the long term.

FoodWorks is located in the heart of Agricultural Asia with outreach to Africa, the Middle East and Central Asia via its network of Project Partners.  Contact us for more information about our expert services for investment and project implementation and management.