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Long-Term Drivers of Grain Prices
The long-term investors need to look at the macro forces that will be driving prices over a three to five year period. It is very difficult to estimate weather conditions and short-term use, but the intelligent investor indentifies the long-term trends.
The three trends that we believe are the most important, and will drive grain prices over the long-term are: exports to emerging markets, the declining U.S. dollar, and the evolving link between energy and agricultural markets (biofuels).
Exports
Rapid population and economic growth, primarily in India and China, will increase food demand and U.S. exports. China is one of the largest importers of grain, as the country has roughly 20% of the world’s population although only 7% of global arable land.
China was a major exporter of grain, but increasing incomes and the development of a middle class have changed consumers’ diets, moving away from carbohydrates and towards proteins. The continued transfer to proteins will significantly increase the demand for grains as one pound of meat requires roughly 10 to 15 pounds of grain.
The increasing global demand for grains needed to feed the growing world population. and its changing dietary habits. will continue to increase U.S. agricultural exports. Looking forward, the USDA baseline projections show a continuing upward trend with total U.S. agricultural exports reaching $119 billion in 2019, from $82 billion in 2007.
U.S. Dollar
The U.S. dollar has been on a significant rally since mid-2008, due to a flight to quality and demand for U.S. treasuries. The long-term outlook for the U.S. dollar is a different story. Large U.S. deficits and the Federal Reserve running printing presses 24/7 will leave the dollar with only one direction to go: down.
A lower dollar is positive for the grain market, as it makes the price of U.S. corn cheaper to foreign buyers. Holding all else equal, a lower price will expect to result in larger imports. There would be a movement down the demand curve to a new, larger equilibrium of quantity supplied and quantity demanded.
The relationship between the U.S. dollar and grain prices does not have a high correlation over the short-term due to other factors. Over the long-term though, as demand for grain imports grow from emerging markets, a cheaper U.S. dollar will make U.S. grain exports more attractive than other markets.
Energy and Agriculture
Agriculture and energy markets have become inextricably intertwined since 2005, as biofuel production and demand surged. Use of corn stocks for these alternative fuels became so prevalent that a biofuel premium had been built into global pricing.
According to the USDA, ethanol production in the U.S. has increased from less than 3 billion gallons in 2003 to over 6 billion gallons in 2007, and is estimated to exceed 12 billion gallons in 2020. The Renewable Fuel Standard from the 2007 Energy Act calls for total renewable fuel to reach 36 billion gallons by 2022. The USDA estimates that more than 33% of the U.S. corn production will have be used to produce ethanol by 2010.
The EPA is also reviewing a proposal to approve the use of 15% ethanol blend gasoline from 10% to help achieve the Renewable Fuel Standards requirements. The increase to E15 will have substantial impact on the agriculture industry as the demand for grains used for ethanol production will increase for the higher ethanol production.
Conclusion
Although there are many factors that will drive grain prices over the long-term, we believe that investors who follow these three trends will be well rewarded.
Grain markets are starting to wake up to the limited amount of supplies available and the difficulty the world will have feeding itself in the future. As the three factors discussed above continue to limit the amount of grains available, the world will be closely watching the grain markets.
Read more about farmland and agriculture at Farmland Forecast.
Disclosure: No positions
Higher Yields on Brazil’s Horizon
To help feed the world’s growing population, Brazil has its eyes set on much higher grain yields. Through genetically engineered seeds, double cropping, market changes, and exchange rates, Brazil could emerge as one of the top exporters of corn and other grains.
Brazil’s current corn crop production is about 1/10th the size of the U.S. Of the corn produced, 80% is kept for domestic use and the other 20% is exported. After the approval of genetically engineered seed last year in Brazil, farmers will be able to produce much higher yields and broaden Brazil’s export market.
Genetically engineered corn seeds made up about 30% of Brazil’s corn crop this past year while next year, 50% of the crop could be GE corn. Genetically modified corn should boost yields by an average of 15-20% while lowering chemical costs, making way for more fertilizer. Higher fertilizer use could boost yields even higher.
Brazil will also produce more corn is as more are planted. Brazil’s second crop planting area is expanding to increase production. About one third of the normal crop area could be double cropped. This year, the areas that are double cropped are 50% greater than last year.
The Asian rust disease, Ug99, made this all possible. Because of Asian rust, Brazilian farmers plant shorter cycle soybeans which allow for another corn season to fit into their rainy season from September to May. Double cropping is a risky operation though. The risk increases for drought, frost, and poor grain prices; which could make or break an entire crop.
Brazil will also gain market share of corn exports as Argentina is producing significantly less corn due to droughts. According to Steve Cachia, analyst for Cerealpar, “Argentine farmers are seen shifting away from corn even more next season as capital is scarce. Brazil could gain even more space on the international market as many importers no longer trust Argentine supply.” Brazil’s export market is expanding to Asia as well, which has eased the pressure from European producers.
The final reason lies in the exchange rate of the Brazilian Real. Currently the exchange rate is at roughly 1.75:1 with the US Dollar. If the Real weakens, exports will be hurt, but if the Real strengthens, corn exports may increase even more.
Brazil’s grain future is very bright. While their current yields are significantly lower than US yields (50 bushels per acre versus roughly 160 bushels per acre in the U.S.), Brazil’s yields will increase substantially as more genetically engineered seeds are used. Once technology is caught up in Brazil, their yields and exports will undoubtedly increase.
Read more about farmland and agriculture at Farmland Forecast.
Disclosure: No Positions
Grains Rally in the Heat of July
U.S. fields have been a different story, with excellent weather during the all important growing season. Fields that were planted late, due to excess moisture levels, have made strong improvement during July. The top three most valuable crops in the U.S. remain in above average growing conditions. Across the Midwest, corn has tasseled, soybeans have formed pods, and wheat is being harvested.
Commodity Prices
Commodity prices soared in July as reports of poor yields across Europe and Asia sent importers searching for new sellers. Corn closed in July at $3.93 per bushel, increasing by 10.8%. Soybeans closed at $10.53 per bushel, increasing 11.0% marking the first monthly increase since April of this year. Wheat spiked up 42.3% to a 12-month high in July, closing at $6.61 per bushel. Wheat yields in the Black Sea region have been hurt the most by the dry weather translating to the drastic increase in U.S. wheat prices, along with other domestic grains.
Chinese Demand
China is entering a “new era” of corn buying. The world’s most populous country may import as much as 15 million tons of corn in 2015, according to the U.S. Grains Council. China has historically been self-sufficient in corn production, but demand is starting to outpace supply as the nation continues to consume more protein.
Chinese imports of corn will grow from 1.7 million tons in 2010 to 5.8 million tons in 2011, and to 15 million tons in 2014-15 according to Hanver Li, Chairman of Shanghai JC, speaking to the U.S. Grains Council. 15 million tons of corn translates to the U.S. exporting roughly 600 million bushels of corn, which will have a substantial impact on corn stocks.
We see China’s transition to a net importer of corn very similar to China’s transition to becoming a net importer of soybeans. Before 1995, China was a net exporter of soybeans but by 2010, it is the world’s largest soybean importer and is expected to import more than 40 million tons of soybeans this year.
Farmland
Creighton University publishes a monthly farmland index, which remained above growth neutral for the sixth consecutive month, although it declined sequentially to 52.5 from June’s 54.7. We think that farmland values should increase over the second half of 2010. One hurdle in valuing farmland has been the lack of comparable sales across the Midwest, but we believe there will be an increased amount of farms starting to appear on the market in the fourth quarter. More land sales will help bridge the gap of comparable land sales for appraisers.
WASDE
U.S. corn ending stocks for 2010/11 were decreased by 200 million bushels to 1.373 billion bushels from the June estimate, but higher than the average estimate of 1.269 billion bushels. The decrease in ending stocks was due to an increase in usage from 2009/10, decreased harvest area, and a 125 million bushel decrease in production. Corn stocks-to-use ratio for 2010/11 is now estimated at 10.3%, the lowest level since 2003/04.
Estimated ending stocks of soybeans remained unchanged by the USDA this month as increased exports and crush offset the increase in U.S. production. U.S. production increased by 35 million bushels on an increase in area harvested. An increase in foreign demand was not enough to offset higher production of wheat. The USDA estimated wheat ending stocks for 2010/11 to increase by 102 million bushels due to increased area, yields, and carryin.
Renewable Energy
Due to the time sensitivity of farmers’ crop decisions for each year and the desire for farmers to maximize their income to meet the potential increase in demand, the agriculture industry is encouraging the EPA to make their decision soon on requiring U.S. gasoline to contain 15% ethanol, instead of the current 10% blend. Unfortunately, the EPA has delayed their decision on whether or not to approve ethanol blends of 15% in gasoline until the fall of 2010. The primary reason for the delay is the Department of Energy (DOE) has not completed vehicle testing.
We believe that the EPA will make the increase to E15 as it is the only realistic solution to meet the Renewable Fuel Standards and reduced the United States dependency on foreign hydro carbons. After the Deepwater Horizon disaster, renewable fuel sources, that are environmentally friendly and add jobs, will continue to become a larger part of the United States fuel supply.
The agriculture industry is very excited for E15 and believes there will be substantial impact on the demand for grains used for ethanol production. The impact will not be felt over night, but will support farmer’s income and the demand for agricultural products.
Outlook
We expect farmland values to grow at strong rates because of the crop outlook for the rest of 2010. Even if this year is not a bumper crop, elevated grain prices will support healthy farm incomes come harvest. Some farmers had feared soybeans to be below $9.00 per bushel by the end of the year, but currently soybeans are trading over $10.00 per bushel for November delivery. The increase in grain prices will trickle down and benefit the majority of the agriculture sector.
Read more about farmland and agriculture at Farmland Forecast.
Disclosure: No positions