The market for the 3 major cereals is very finely balanced

Let’s take a very careful look at what’s going on with the fundamental market indicators in the cereal grains market.  

Prices dipped in the last couple of weeks and then recovered somewhat, the G20 gave birth to half-hearted ideas with the French sounding their usual ineffectual trumpet. The Russian lifted an export ban on wheat,  US corn was thought to be in greater supply as the USDA reported perhaps prematurely on area.  The Thai election, bringing in a radical pro-poor government, heralded price subsidies that could price Thai rice out of the market, and in the last few days, China has been buying corn.

That prices are historically high there is no doubt.  We will not labour this point; the market dips and the media rush about saying that the food crisis is over. It isn’t.  Looked at over the last 10 years, prices are not at their peak, but they aren’t far off it.

We should be looking at long–term, aggregate supplies of cereals in this market – perhaps not if you are a daily trader, but certainly if your interest is investment in agriculture or agribusiness where you would expect a 3 to 5 years payback period (perhaps a lot longer if the investment was in a more challenging country than Australia or North America.

Our aggregate supply-demand-stock balance shows that while supply and demand have crept up with demand inching slightly ahead of supply, stocks have dropped off sharply.  Overall we think that major cereal grain stocks will be 20% of demand in the coming year; this is sharply lower than 26% for 2010/11 and lower again than the previous year.  Only in 2007/08 when prices skyrocketed was the proportion lower still (18%).  The market is very finely balanced with only about 5 million tones between supply and demand.  This is a better projection than the negative 34 million tons last year that has drawn down stocks so sharply, but still with little room for production difficulties.

Corn has performed well over the period driven by the demand for bio-fuel and livestock feed – as the world’s economy has begun to recover, so have people consumed more high value meat and dairy products.  Assuming the recovery continues, this demand isn’t going away.  Wheat, of course had a bad year in 2010/11 and although production has recovered it still isn’t back to where it could be.  As for rice, despite efforts to raise yields, it has shown the slowest rate of growth of the three majors. 

Where does this leave us?  Economic recovery presupposes more demand for carbohydrate, for humans, animals and to turn into fuel.  Wheat has some capacity to expand supply and is a good investment.  There seems no reason to believe that corn will get substantially weaker.

Rice presents a problem, however.  The larger producers, China and India basically cover their own supply, so the internationally traded market is very thin – about 7% of production.  The main exporters are the Mekong region countries (Thailand, Vietnam and Cambodia) and they have been having a bumper crop.  However expansion of the Viet crop is limited by land area and Thailand’s new government may introduce policies that simply mean Thailand is priced out of the export trade.  So rice is a critical variable in carbohydrates to watch going forwards.

PRICES CRASH - BUT LET'S GET THIS IN CONTEXT

A couple of weeks ago the markets were agog that we would see $9/bushel corn.  Now it's all disaster as some frankly weird data from the USDA suggest that corn stocks are higher than expected and so is the acreage. 

Corn December futures dropped to $6.58 while wheat dropped below corn to $6.33 - the first time wheat has been below corn since 1984.

In its inimitable way the popular media are now forecasting cheaper food prices. Wow! The G20 only had to meet and prices came down!  Those of us talking about a serious world food crisis? Well it look like we have egg on our faces, or at least a lot of  corn.

But wait a minute, folks, before you get carried away by the bears.  You'll notice from the futures price chart that we're only back at around May, and the $9 hype was exactly that.  Corn has never reached $9 and probably wasn't going to given that we'd already seen that wheat was substituting for corn, the crude oil price was coming back into the $100/barrel range and that Russian was already planning to re-export wheat.  Nothing here the real smart ones didn't know about.

The other point to make is that corn and wheat over $6/bushel is still a good price for farmers and a tough one for consumers.  The decade 2000-10 average price for corn is $2.78; at a previous peak in  2008 it reached $5.48 in June of that year.  So corn is historically expensive even with the sell-off.

Wheat is in a slightly different situation.  The 2008 peak was $8 and since then the price has slumped somewhat.  But even so the decade average is $4.74 so current wheat prices are not particularly cheap either. A glance at the chart shows that the actual case (unless you are a short-term trader) is that both commodities have trended upwards in the last few months based on some basic fundamentals.

What's interesting is that USDA has reported not on the overall world supply demand situation for either crop, but only on corn stocks and acreages.  USDA may well have over-estimated the area at 92 million acres (4 million more than last year and the highest on record since 1944) by not including areas flooded since the survey was completed; next month will see an up-date so be prepared for that.

USDA also said that stocks were 3.67 billion bushels, actually 15% down on this time last year, but 11% higher than the trade itself was saying.  So the price correction comes purely from the statistical inaccuracy of the analysts rather than the basic underlying data.

Of course the USA dominates the world corn market, so these detailed numbers are critical and are the basis for trading.  But for those interested in a wider perspective, both for planning projects and looking at investments, here's what the supply-demand balances say:

For corn, the old crop supply has increased but so has demand both in North America and China.  World corn trade has remained somewhat flat because the largest importers (in Asia) have done better with their own production.  Even Africa has had some productivity successes. But the old crop stock:demand ratio is at it lowest for some time, so we think the market has over-reacted to the USDA report.  Equally by far the largest volume of corn is in China and it remains to be seen whether floods there have damaged physical stocks.  Overall on the world scene while stocks will probably build in the next 12 months there is no room for complacency. even re-built stocks will still not reach the levels of a couple of years ago, and a great deal will depend on the demand for ethanol and hence ultimately the crude price.

Turning to wheat, the key feature is the re-emergence of Russia as an exporter, but that fact is already built into the price. Nevertheless, the supply side look better though for this year it remains behind demand.  Stocks are being pulled down with the price competitiveness against corn and longer-run a normal price premium will be re-established. Wheat is finely enough balanced that a lower than expected harvest will firm prices.

Our bottom line is that we should treat the current dip with some scepticism and look overall at the world grain supply situation. It is by no means dire, but neither is there so much grain around that everyone can relax and pat themselves on the back for solving the food crisis.  

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.