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Jordan Rizzuto is a proprietary trader covering the U.S. equities and global commodities markets. Jordan was previously Vice President of Storm Exchange, where he managed the company's analysis of weather’s impact on macro- and micro-economic trends, primarily for the agricultural commodity... More
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  • China and the Dollar Push Grain Prices Higher 0 comments
    Jun 1, 2009 11:45 AM | about stocks: MOO, DBA, JJG, CF, TRA, AGU, POT, MOS, MON, SYT, ADM, ANDE

     

    The following excerpt is taken from our monthly Agriculture Outlook Report, issued to subscribers on the last Friday of every month.
     
    China
    China’s demand has been a key driver of U.S. soybeans prices this year; first quarter imports alone were up an incredible 31% from the same period in 2008. Through the government’s grain reserve agency, Sinograin, the Chinese have implemented a strategic stockpiling campaign, whereby the government has been purchasing domestic soybeans since December 2008 at prices above prevailing market rates in an effort to support farmers’ income. Sinograin has since committed to purchasing 40 million tonnes of corn and 7.25 million tonnes of soybeans for strategic reserves.
     
    To put these volumes in perspective, those 40 million tonnes of corn represent roughly 25% of China’s total annual production.   While recent reports suggest that current storage is reaching full capacity, the government has now announced that it plans to construct additional storage facilities this year with capacity of another 15 million tonnes of grain. 
     
    The government’s stockpiling program has created the current market dynamic where local Chinese prices are being maintained at higher levels than international prices. This condition has played a major role in the higher soybeans imports noted earlier, and a similar dynamic is developing for China’s domestic corn and wheat markets. This month China publicly confirmed that their purchasing campaign will indeed now spread to corn and wheat this year. The National Development and Reform Commission has just announced that the 2009 wheat purchase program will begin by the end of May, and will serve the same purpose to support local prices should they fall below pre-defined thresholds. 
     
    As remarkable as these purchase volumes have been, the government’s announcement of further storage construction erases any doubt that China’s grain demand will continue in the near term. For the longer term outlook however, we must remain cognizant that many factors which have supported higher soybeans prices have been “one-time” in nature and may abate next year. The Argentinean farmers’ strike, historic droughts in both Argentina and Brazil, and the strength of the Brazilian Real in late 2008/early 2009 were all major factors this year that may not be part of the equation for the 2009/2010 marketing season.  
     
    The U.S. Dollar Weakens, China Diversifies, Institutional Investment Reappears
    The discussion of China’s purchasing behavior this year leads us to another crucial factor influencing grain price trends, namely the dollar’s recent fall in relative value. The dollar is now off nearly 10% from its highs, which (not surprisingly) coincided with the interim lows established in the broader equity markets in early March. During that same period an equal-weighted basket of corn, soybeans and wheat has catapulted nearly 29%. There are several fundamentals to consider here beyond the natural inverse correlation between the dollar and dollar-denominated commodities. 
     
    As noted above, China has clearly emerged as the marginal buyer in the international grain markets (much as it has for most major commodity classes). Chinese officials have also voiced their concerns over the longer-term impact of current U.S. monetary and fiscal policies, as the value of their massive U.S. debt holdings will be depressed by the specter of inflationary programs and the inevitable higher interest rates to follow at the long end of the Treasury curve. Through their stockpiling of physical assets, the Chinese are accomplishing two strategic goals: 1. stability of natural resource availability to support the largest national population in the world, and 2. diversification of their existing asset base. This behavior is analogous to an institutional investment manager who seeks to improve risk-adjusted returns by allocating a portion of the portfolio to commodities. China is clearly making a move to diversify away from a concentrated position that is levered to a strong U.S. dollar, and balancing their asset base by increasing exposure to physical assets that benefit from a weaker dollar. 
    Source: Bloomberg
     
    Institutional traders have also responded to the dollar’s move, as evidenced in the CFTC’s weekly Commitments of Traders (COT) report. Since the dollar’s highs in March the large speculators have dramatically increased their net long positions in corn and soybeans, while also reversing their net short position to a net long in wheat contracts:
    Source: CFTC Commitments of Traders Report 
     
    While corn and soybeans have enjoyed strong fundamental support from a supply/demand perspective, we noted last month that wheat entered May facing abundant global supplies. The strong dollar had depressed export demand, as the more expensive U.S. wheat offers were frequently snubbed in favor cheaper Russian supplies through the early months of 2009. Although global stocks remain ample to meet current demand, the weaker dollar has certainly made wheat more competitive in the export market as we enter the summer. 
     
    The large speculators have indeed turned convincingly bullish, yet we are still quite far from the speculative heights we witnessed during last summer. At current levels the large speculators’ net long positions in corn and soybeans contracts are still only 45% and 77% of their previous maximums respectively.   Institutional money flow can still be a powerful force to drive prices higher as we enter the summer. 
     
    Bottom Line Near-Term Price Outlook:
     
    We expect the grains to maintain their bullish momentum on Chinese stockpiling, tightening U.S. stocks-to-use ratios, and potential yield reductions due to poor planting weather and reduced fertilizer applications. &nb... most apparent risks to the current price trend include a rebound in the U.S. dollar, another downturn in the broader equity market which would renew risk aversion, or a surprise increase in planted acres in the USDA’s June acreage report. 
     
    Disclosure: No positions
     
    Themes: Materials, Agriculture, Economy, ETFs, Commodities Stocks: MOO, DBA, JJG, CF, TRA, AGU, POT, MOS, MON, SYT, ADM, ANDE
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