Where to invest now? Agriculture or stocks?

The markets are in a turmoil, Wall Street is a roller-coaster, gold hits over $1,700/oz as Asians flee to a known safe haven, Europe (according to one Irish politician) is "run by a bunch of mad people in Brussels" and the Swiss are concerned because their currency is another safe place to be, so making their watches unaffordable. Where do we go next?


Even agricultural commodities, historically more stable and rising for the last few years, have shown uncertainty and a drop off in investment values from the peak at the start of the year (Chart 1, a comparison of the S&P 500 with RJA-Agri, is discussed later in this piece).

Disclaimer: we economists are story-tellers, and we can tailor a story to suit your needs just like the augurs of old, looking at signs and portents and building the story to make folk feel happier.  Of course the real answer is,  nobody knows and we don't even know what we don't know.

But disclaimers and caveats aside here we go anyway following a tried and trusted method which is looking at the individual parts of the puzzle and seeing if we recognize a pattern - not so different from the ancient Chinese seers who shake the sticks or divine the I Ching from the patterns on a turtle shell.  We'll also ask, what can change things as we see them? Looking for the counter-argument or the absence of information is always helpful dealing with uncertainty.

First the fundamentals:  stocks of food commodities are tight, so tight that it will not take much to push prices up yet again. The weather in key North American production areas for corn and wheat has been record hot and the USDA has just adjusted its area estimates down. Rice crops are good, but for the international market a lot will depend on policy in Thailand (see our previous post on August 1st and this piece in Agrimoney).  So the supply side of the equation does seem to imply upward price pressure.

What can turn the pressure down?  Black Sea Grain reports that grain crops in the Ukraine will be larger and this is confirmed by USDA estimates.  This goes some way to compensating for any short-term decline in the USA. In the longer term, the supply side will react (our markets are at least free to do so) in a conventional way: more resources will be drawn into production and prices will react accordingly. Let's look at this in more detail.

There is huge interest in investment in agricultural land.  Every day emails come in to our FoodWorks office  bearing news of this scheme or that scheme, from wheat farms for sale in Australia to more exotic jatropha (bio-fuel) projects in Indonesia.  An excellent Bloomberg article describes the returns people have been expecting on agricultural land (16% annually!) to get an idea of how resources get pulled into production.

Two things: investors have to understand that unimproved land without the water supply, fertilizer, seeds, farm access roads, labour and machinery needed to grow crops is also unproductive land. Equally energy costs are pushing up inputs (fertilizer prices that have soared with the price of crude oil) and the wise investor should see if the gross margin he makes on the crop can really be achieved - it's NOT the farm-gate price that motivates the farmer, any more than it is the price at the check-out that bothers your grocer, it's the difference between production costs and the sales price that counts and that is not as clearly seen as the pure price level . We'll be looking at farm gross margins and profitability in a later post.

If investment does go into productive land, and we hope it will do via improved technology and market infrastructure, the supply may just turn around and go up, crashing prices.  Managing farm returns to make a long-term sustainable profit within the agricultural cycle is actually something that requires years of experience and we wonder if the hedge funds or their agents have it? We're not being patronising - after 30+ years in this business, we've probably LOST more money than we've made in risk-based agriculture (by which is meant agriculture in emerging countries).  So we understand just how difficult this industry can be.

The other side of the market equation is demand.  In this case we can point to consumption increases from China and India and other emerging economies where a middle class requires more sophisticated products and a wider mix of foods. In these countries the high rate of economic growth implies a rapid growth of the middle class and a consequent rise in demand (indeed this is implicit in GDP growth) for processed foods. As people get richer they substitute basic staples (cereals and starches) for dairy, meat and fish. As we shall see, the issue is not simply the absolute number of people on the planet needing to be fed, but the increase in the number of people who can pay, and pay well, for their food.

For fish the market situation is clear: world fish stocks are declining and farmed fishery (aquaculture) is struggling to keep up with demand (check out our page on Fishery for more detail). With regard to staples, livestock consume large amounts of animal feed to produce our desired dairy and meat products and the conversion rate from cereal grain to meat is pretty poor.  So there is considerable upward pressure on demand (and price) for the raw materials of animal feed as the rich world requires more milk, meat, cheese and eggs.

But that can go the other way just as rapidly.  As the world struggles with what seems to be an impending economic implosion (read new recession), inevitably consumers will restrict their demand for these expensive products or (where they can) revert to traditional diets. Here's news that Tyson Foods, the largest meat company in the US, has just reported third quarter profits down by 21%: Tysons warn of "sluggish demand for chicken, pork and beef as consumers face higher gasoline prices. The company has focused on streamlining operations as a weak economy dampens consumer demand and as feed costs continue to soar, forcing Tyson to also raise its prices." (quote from Market Watch)

Result: more corn and other feed ingredients left in inventory and a downward pressure on prices. Of course it isn't that simple. Newly urbanised populations in emerging markets have less opportunity to escape the mega-city cash economy and young people (the majority of the expanding population world-wide require energy foods based on carbohydrates and sugar, but the principle of saving on the food budget is there.

We've made the point before: the world's food markets are currently finely balanced and which way this goes is not at all certain. 

Let's consider a couple of other frequently discussed elements: Demand for bio-fuel is consistently cited as a reason for high food prices.  We think it's more complicated than that.  Sugar cane and palm oil are both major sources of bio-fuel.  Neither is grown on land that is primarily suited for food crops.  Oil palm plantations in particular are grown on former forest areas in tropical countries. In the case of Malaysia, many of these plantations have been in place for probably 60 years; in Indonesia there is much new planting and to the extent that it depletes rainforest that is environmentally of concern, but does not immediately impact food crops, although here is an impact (so far unquantified) via climate change.

Climate change may indeed affect e.g., Sub-Saharan Africa, reducing food supplies, but this sector of demand is not what drives the current high market prices. As our recent post on Somalia indicates, population growth is occurring in those countries which are (a) very low incomes - so they cannot afford to buy on the international market - to use economist's jargon, this segment represents "notional" demand based e.g., on FAO or WFP benchmarks for what people should eat rather than what they can afford and do eat (or not in the case of Somalia) - "effective" demand, and (b) in many cases the poorer countries are largely agricultural and grow their own foodstuffs; China, India and Indonesia are by-and-large self-sufficient in rice.

So the driver for commercialised agricultural produce is NOT the 3 billion people at or below the poverty line (it is estimated that 3.4 billion persons live on less than $2.5/day), but as we have said the new middle class in countries like China and India that might just withdraw their demand for commercialised agribusiness products if another recession hits. One more point to remember: currency changes impact the food markets; a weaker US dollar makes US-produced food attractive to international buyers (especially given the rapid drop against the Chinese RMB) but it makes input costs (especially energy) higher reducing farm margins.

To return to bio-fuels argument for a moment.  In the USA, the expansion of the corn area has been driven by the ethanol subsidy. But to the extent that corn is grown with wheat and soyabeans as a rotation crop, we suggest that by adding to farmers' overall revenues it has actually enabled food production e.g., through the acquisition of new machinery. In general we believe that a search for renewable energy is the right (only) way to go and that the impact on the food security situation needs considering and analysing unemotionally and in depth. Overall, so long a bio-fuel competes with crude oil we think this will support agricultural investment.

So much for the fundamentals of supply and demand.  The truly shocking fact is that with the world's population hitting 7 billion, only a relatively small proportion can actually afford marketed food, i.e., the agriculture and food-based industries reflected e.g., in the exchange traded funds.  But this proportion is growing rapidly at a rate exceeding population growth and, recessions aside, can be expected to continue to grow - The World Bank estimates that the global middle class is likely to grow from 430 million in 2000 to 1.15 billion in 2030!

In this case, investing in industries that feed those with money to buy food seems like a safe enough bet. Of course what happens to the rest of the world, the majority who are poor, is critically important but a subject for another day. Let's now turn investment and the actuality of how the markets have behaved.

Take a look at the chart at the head of this article (Chart 1).  It compares the Rogers International Commodity Index for Agriculture (22 ag commodities) with the S&P 500 index of stocks (the black line is the RJA, the red line the S&P 500) since 2008 (as the peak ag prices started to decline).  Without getting too technical (and we are not technical specialists) it is clear that agricultural investments have done better than stocks.  The peaks are higher and the valleys less deep, the recovery more intense.

It is however true that since January the RJA has been going down or sideways but  it is also true that as the current decline has set in, agricultural investment has held up better than stocks (see Chart 2). So not only is there less long run volatility in agricultural investment, but the data shows the returns are indeed also better.

Another interesting point from the data  is the volume of contracts trade in the market. Look at the red and green bar chart. Note the greatly increased volume of trades since January, creeping up since the previous September. Volume is an indicator of where people are putting their money and the build up of interest in agriculture is significant.

What's do we conclude? From our perspective agriculture is a long-term safer bet than stocks because despite it's dependence on biology and the environment and the obvious fact that it has large cycles, the fundamentals are more understandable than stocks and the market is overall less inclined to panic. We also think that investment in emerging markets is the way to go; first such markets often offer lower production costs and second, we think this is a way that the problem of the lower income demand for food can be satisfied. But we hasten to add: agriculture has VERY nasty ways of catching one out and the supply-demand equation is a lot more complicated than many expect.  So be careful and be prepared for the unexpected!

"Amazing Thailand" - new rice policy will damage the market and Thai rice farmers

While the weather still keeps us on our toes in North America, let's take the opportunity to look at the rice industry.  Above all we need to understand the serious downside impact the ridiculous policy proposals of the incoming populist Pheu Thai government]will have on international supplies.

Rice represents 23 percent of the world's supply of major cereals and is the preferred staple food of much of Africa and most of Asia - in other words the regions of the world where the population is growing the fastest (a recurring theme in this Bulletin).  Although many Asian do consume wheat or corn products, in almost all these countries the word "rice" is synonymous with eating - the Thai will say, "gin khao mai?"  - "eaten rice?"when she asks if you've eaten a meal and it is an equally common greeting.  The Japanese word for cooked rice "Gohan" is synonymous with "meal".

Seventy-eight percent of the world's supply of rice is produced in China, the Indian sub-continent, the Mekong Sub-Region and Indonesia, while demand is similarly concentrated - 67 percent is consumed in China, the Indian SC and Indonesia.  Partly because of the deep-seated cultural importance of the crop Asian countries want to be self-sufficient and largely they are. Indonesia has been an exception switching from being an exporter to an importer depending on the harvested volume. The operations of the Indonesian government's procurement agency BULOG are important to watch.

This means that the international trade in rice is very "thin", i.e., the volume is a small proportion of the overall amount of rice in the market.   Exports represent just 7 percent of the total supply, and about half of that comes from just two countries, Thailand and Vietnam (Cambodia and Laos also contribute, but much of their rice is actually taken through the two main Mekong countries).

The small volume of internationally trade rice (relative to the overall supply) means that prices can swing rather dramatically depending on the volume available for export and the fact that there are few sources with a surplus to buy. For example, when BULOG enters the market on the buy side, rice process can jump by $100/ton.  Similarly a reduction of supply will raise prices dramatically.

So what happens in Thailand and Vietnam is critically important to those who DO import rice - many African countries and Europe. Countries like Ghana, Senegal and Tanzania (which actually do grow their own rice) have relied on cheap Thai and Vietnamese to meet growing demand.

Let's review the situation in Vietnam first: there are two main rice growing areas, in the north the Red River Delta (surrounding Hanoi) and in the south, the Mekong (Viet. Cuu Long) Delta are both intensively cultivated.  From being just self-sufficient in the early 1990s, Vietnam has raised production to the extent that it now exports the world's second largest volume of rice (6.4 million tons) and competes equally on quality with Thai white rice.

The issues for Vietnam are (a) paddy land is being lost to industrialisation, (b) industrial pollution is damaging yields that have hitherto been driving the production increase, and (c) the water in the Red River and the Mekong is being limited by dams built upstream by other riparian countries.  Vietnamese experts say they expect that rice exports will peak at around 7 million tons and may well come down.

And now for "Amazing Thailand" (those familiar with Thai tourist advertising will get the allusion).  Thailand has dominated the international rice trade both in terms of volume of exports (up to 10 million tons at the peak) and quality.  Thai "fragrant" or "jasmine" (Th. khao hom dork mali) is a premium product that sells for over $1,200/ton in e.g., Hong Kong.  The issue for this variety is that it grows only on  dry land in the North-east so overall production is limited. But Thai white rice is grown extensively throughout the central areas of the country  supported by an extensive and relatively well-managed irrigation system. Weather, soil, water, experienced and hard-working farmers, available seed, technical expertise and a sophisticated export trade.

What could possibly go wrong?

The answer is (as is often the case in developing countries - Thailand is "emerging"  - but one wonders what it will emerge as?) GOVERNMENT.

Of course all governments interfere in agriculture and the Thai government is no exception.  However the proposal of the incoming (elected by a huge majority) Pheu Thai government to establish a monopolistic farm-gate price for white rice of 15,000 Baht (about $517) per ton and more for fragrant/jasmine rice amounts to sheer unadulterated lunacy.

The current price paid to farmers by hundreds of millers is roughly half that amount; production costs amount to (at a guess) $400/acre, with a yield of, say 2.5 tons/acre and a farm sale price of the current $241/ton, the farmer gets a gross margin of roughly $200/acre.  About 60 percent of farmers have holdings of  less than 10 acres. But even at this level, with three crops a year under irrigation the farmer's gross income is around $6,000/year.  Although not large by western standards this is considerably more than the minimum wage.

So the average Thai rice farmer is not poor (by world standards). But of course he would like to be richer and the rural population voted almost exclusively for the Pheu Thai party and for a government-subsidised farm gate price about double what he or she gets now. Nice if you can get it, but unfortunately one of the basic rules of economics (not a subject well understood in Thailand, at least not in official circles) is "there is no free lunch".

At the subsidised price for paddy rice, millers and exporters estimate (see article in The Nation newspaper) that the F.O.B price would have to rise to over $800/ton - when Vietnam is exporting comfortably at $545.

The Thai government (we should say, the Royal Thai Government - RTG - to be correct) proposes to use its food security warehouses to buy all the paddy. It will become (that lovely word) a monopsonist - the sole buyer of farmer's paddy.  This will be milled on consignment and then packaged and sold ONLY from the government warehouses, it is said on "government-to-government" arrangements.  Official stocks are forecast to rise to well over 6 million tons for the current 3 million.

They could be even higher, because rice will flood into Thailand from, you guessed it, Vietnam, Laos and Cambodia. Hey folks, it's called arbitrage - absent effective border controls (and I can assure you they ARE absent) a commodity will simply follow the money.

So now we have the very real prospect because of this daft politician's promise, made for no other reason than to get elected, that not only will Thai rice - hitherto available competitively for export at a reasonable price relative to other cereals - back up in government warehouses, but export availability will be reduced in Vietnam and other neighboring countries.

One wonders what the WTO will make of this flagrant abuse of anything resembling free trade, and one is SURE that the prospect of "government-to-government" deals without the benefit of the current competition between dealers, will lead to rampant corruption.

In the end who will be the loser?  Unfortunately the very person the policy is intended to benefit, the Thai rice farmer, who will have priced himself out of the market. And the consumer, now without a supply of reasonably-priced rice. With rice removed from the thinly traded export market, prices will sky-rocket.

What could change the situation?  An outbreak of common-sense in Thailand is never a likely prospect. But India is set to lift a ban on rice exports and this may relieve pressure on the international price.  So then the RTG will be the proud owner of millions of tones of rice that it has bought for considerably more than the world price; you can keep  rice, but not forever:)

As we who live in Thailand  say, "TIT" - This is Thailand, and as the Thais say, "mai pen rai" - Never mind!

Somalia: Tip of the Iceberg?

For years famine has haunted the Horn of Africa.  Remember “Live Aid” in 1985?  Celebrities like Bob Geldorf and the egregious Bono have made careers out of pushing famine relief so very unfortunately it has almost become a cliché.  The South Park cartoon series actually has a hilarious episode deriding Bono; we get inured to the awful pictures on the BBC and CNN.

Get used to the fact that famine is not unusual, it will increasingly become the norm, and that Somalia (and Ethiopia and Northern Kenya) represent the tip of an enormous iceberg.

Let’s deconstruct what’s happening.  And for those wondering why this is relevant to the commodity markets, the issue of famine is at the very sharpest end of demand for food, so it is essential to understand this aspect of the supply-demand equation that determines prices on the international markets.

In the 18^th Century one Very Reverend Thomas Robert Malthus pointed to the problems of population growth within a space of finite resources.  Subsequent experience in the 1960s and ‘70s showed that the resource boundary can be pushed back through innovation and technical change.  The Green Revolution is a classic example in agriculture with increasing yields and understanding of how to grow crops in adverse conditions (e.g. zero till).

So everyone went back to sleep.  The EU produced literally mountains of grain and butter and the US had its PL480 program to giveaway grain.  We monetized Canadian grain to start the famous Dairy Development Board in India and a myriad other schemes to help the disadvantaged. Never mind the impact on local farmers or on incentives to actually invest in productive areas.

By the way, the industrialized countries insisted that while we could subsidize and otherwise protect our agriculture developed countries had to de-regulate, abolish subsidies and open their trade.  So the terms of trade turned unequivocally against those poorer countries where the most investment in agriculture and food production was needed. And all was right in the best of all possible worlds.

But now we re-awake to the fact that innovation in agriculture, by its nature a slow process, has been further slowed by a lack of investment (especially by governments in the poor countries), incompetent development agencies, NGOs that love the local people but fail to understand agricultural systems (which - God forbid - require agribusiness and capital and traceability and international hygiene standards), and concerns  about poor margins of profitability by the private sector investors.

The latter are slowly revising their models based on the highest prices we’ve seen ever, but for the rest the best they can do is make warning sounds, write reports and issue ineffective communiqués (e.g., G20 recently).  Needless to say the NGOs wring their hands and the bureaucrats (as they are wont to do) do nothing except siphon off the funds into salaries, study tours, "fact-finding" missions and lots of other goodies.  

Yes, Dear Reader, this is the reality of agricultural development.

So with some modification it could be that Malthus was right after all.  Ironically the highest rates of population growth are in the least wealthy countries and in those countries where the ratio of persons to domestic food supply is the highest.  These are the countries where domestic agricultural capacity has been systematically undermined and whose ONLY hope now relies on private sector investment.

Some hard numbers will make the point:  even with the current disaster, outmigration and other woes, the Somali population is growing at 1.6% (2011 estimate). This implies a doubling time of 43 years.  Ethiopia, population grows at 3.2%, doubles in just 21 years; Kenya – 2.5%, doubles in 28 years.  Africa has the highest fertility rates in the world (for some countries the norm is up to 8 children per family). Sub-Saharan Africa  - including the poorest and most dysfunctional countries - held 800 million people in 2007 and was growing at 2.3% - so by 2038 (27 years from today) we can expect a population in this region alone of 1.6 billion people.

Do any of my readers seriously believe that agriculture can catch up? The author has been working in agricultural development for the last 30 years in many of these countries.  There has been no indication whatsoever that our approach has the slightest hope of feeding even the current Sub-Saharan population, let alone double that number of people.

According to the UN’s Food and Agriculture Organisation (FAO) growth rates in agricultural production are the lowest since 1960. The growth rate for 1994 to 2001 was just 1.5%. FAO (which in this case may be regarded as an authority on the subject) says, “Growth (or decline) in total factor productivity (Auth. i.e, for agriculture) results predominantly from public investment (or lack of investment – Auth. my italic) in infrastructures (irrigation, electricity, roads) and in agricultural research and extension, and from efficient use of water and plant nutrients”.

It is true that FAO goes on to say elsewhere that it believes agriculture can keep pace with population growth, but ONLY on the assumption that demand drops! Good grief! FAO also says this will be, “provided that the necessary national and international policies to promote agriculture are put in place” (Ed. my italic).

Is there any reason to believe that they will be?

The irony is that some of our most successful development projects have been in the area of health, specifically tackling HIV/Aids.  USAID’s budget for the Health Sector was (FY 2010 obligation to programs) US$5.95 billion, for agriculture (including their nicely named but more or less ineffectual “Feed The Future” Program) the obligation was only US$1 billion.   

Health programs save lives and do so rather rapidly with the minimum of innovation (malaria nets, for example) and we welcome that.  But agricultural innovation even when we do it right takes years to succeed. And for the most part unfortunately and despite some people's best efforts (usually those working in the field and not behind a desk) we do it wrong.

So we are successful at increasing the population growth but singularly unsuccessful at feeding the very people whose lives we have saved in infancy.  Result! 

And USAID and the other donor agencies are staffed by PhDs paid with YOUR tax money and YOUR national debt.

We estimate that any single innovation in agriculture takes a minimum of five seasons to be fully adopted (and a lot longer in some places where traditional agricultural systems prevail).  So even if fully successful, that leaves just under 6 project cycles to come up with technologies and related infrastructure to feed double today’s population of Sub-Saharan Africa. 

Does anyone out there believe it can be done with present approaches?

We should mention climate change (as one has to do these days in every consulting report to the donors).  The fact is that we really have no idea of the long-term effects of climate change and even less what to do about it. But it does seem from an anecdotal perspective that many areas are becoming warmer and drier (drought is the basis of the current Somalia crisis). We do have technology that copes with changing environments (water management systems, adapted crops) but again what is needed is not more hot air from the lips of governments, but coherent action across a wide range of disciplines. Judging from the programs we’ve looked at, none of that coherence exists, so we face the prospect of decreased productivity where increases are most needed.

The fact is that famine and starvation in Africa (and maybe elsewhere) are unfortunately going to remain the norm unless we radically change our approach.  

To an extent the same logic and calculations will apply in other parts of the world; India still has the largest single group of persons below the poverty line of any country, Pakistan’s agriculture is under-performs by a huge degree and countries like Burma (we insist on not calling it Myanmar) and Bangladesh will also struggle with the problem.  Indonesia is rapidly approaching the limits to its agricultural potential.  In China population growth may be under control (though with enormous but necessary costs in human rights and in distortions of the male-female ratio) but income growth rates will equally suck in food.

Our analysis concludes as follows:  for a very significant part of the world's population – perhaps 2 billion persons – food scarcity will remain the norm (remember – this is the basis of FAO’s assumption that overall agricultural production will keep pace with population growth!).  There will be increasing incidents of famine.  Agriculture development will largely fail to tackle this problem not because of a lack of natural resources but because of a failure of policy and decision-makers to grasp what needs to be done.  Bureaucrats will not change their spots because the sociology of bureaucracy is such that it prevents radical change and effective action “outside the box”.

For other parts of the world (e.g., China, South-east Asia) income growth will push diets towards the Western obesity model.  Food demand will be for processed products high in sugar and fat, Starbucks (expensive) coffee, “organic” (i.e., high cost) fruit and veg, meat and dairy products and high-value fish (stocks are in decline).  In this segment of the market, i.e., the growing middle class transitioning from a basic diet of products grown on their own smallholding to sophisticated products which they now consume as urban dwellers, food will be available but at a high cost (not least in terms of the energy needed to process and transport it). 

Is there any hope in what we have to say on this subject? There is perhaps some.  

We believe firmly in markets and that high crop prices (and more particularly good margins) will bring in the investment, innovation and technology that is required. It will come from the private commercial sector aimed at making money (anathema to many in the development community). 

• NGOs have to stop whining about GM crops and the depredations of large-scale farming and start making positive suggestions that lead to the development of integrated systems that include smallholders and agribusiness.  
• Developing country governments have to step out of the way if they cannot facilitate this investment.  
• Donor agencies need to clue in to what’s happening rather rapidly or else hand the money back to the taxpayer and go out of business.
• Private investors should look very seriously at LONG TERM investments in agriculture and agribusiness that are sustainable and integrated with the local community and stakeholders. 

Or  else we will undoubtedly live in a world where a very significant minority lives as our ancient ancestors did, ill-fed, short and brutish lives.  I find that quite unacceptable - and probably they will too with consequences we can only wonder about.

Geoffrey Quartermaine Bastin

Bangkok, July 2011

The author's views are his own and do not reflect the opinions or policies of any of the companies or agencies or clients with which he is associated or has been associated.

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.  

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.