Markets still in 'era of volatility'

by Chris Lyddon
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The annual outlook conference of Britain’s Home Grown Cereals Authority (HGCA), a rare foray to London for an organization which is becoming increasingly rural based, was a chance for the trade to take a close look at just how volatile the grain market has become, with the reassurance that agriculture and the agricultural markets know how to respond to volatility.

Jack Watts, the HGCA’s senior analyst, pointed out that the era of volatility for grain markets is still with us. In 2007-08, it began with the market showing what it could do with the movement of £75 a tonne. In 2008-09, there was a supply response as agriculture showed what it could do given the right price. That was a movement of £64 a tonne. In 2009-10, the market dealt with a surplus and moved by £22 a tonne.

In 2010-11, the uncertainties have returned. A combination of nature and politics has given us a market in which there has already been a massive move.

“We’re not even a quarter of the way through the season and the market’s already moved £66 a tonne,” he said.

The problem with this season has been that the market approached it expecting little volatility, but then came a host of weather events that impacted wheat crops. The world lost its cheapest source of wheat with the Russian export ban, and bullish funds returned to the market.

The result had been a 50% increase in Chicago Board of Trade wheat since June. At the Marche a Terme International de France, wheat is up by 60%.

Watts highlighted the sharp swings in the USDA’s crop estimates, noting a fall of 29 million tonnes in the world wheat crop figure for 2010 between the May and September reports. “The difference in wheat is quite astounding,” he said.
He cited changes in wheat crop estimates around the world. Russia’s crop had been cut by 24 million tonnes, the E.U.’s by 10 million tonnes, and Canada’s by 2 million. However, the U.S. estimates were increased by 6 million tonnes, China by 3 million and Australia by 1 million.

“It would be wrong to suggest now that wheat stocks were tight around the world, but certainly they are less comfortable,” he said.

He pointed out that the most important stocks were in the U.S., where ending stocks are predicted at 24.6 million tonnes, compared with 8.3 million tonnes in 2007-08. He said this is making the world a much more comfortable place than it was in 2007.

Governments’ attempts to gain an advantage in the face of recession added to the uncertainty. “We’re in this phase now of very cyclical volatility between currencies as everyone is trying to devalue at the same time,” he said.

One of the most important drivers is the Russian wheat situation as well as the Russian government’s response to it. “One of the key questions is did the world become too reliant on Russian wheat?” he asked. “With a continental climate such as those in Russia and the wider FSU (Former Soviet Union) region, we cannot guarantee production.”

Without wheat from the Black Sea, the world would have to turn to the U.S.

“The U.S. will become a primary beneficiary from the demise of the Black Sea,” he said. “On paper at least, the U.S. can cope with this extra demand.”

However, the U.S. is at a freight cost disadvantage, which he put at $12 a tonne, into North Africa.

U.S. maize (corn) will outcompete E.U. feed wheat, which gives the Europeans a problem. “The E.U. will find it very difficult to export feed wheat in 2010-11 given the current price relationship with maize, so the emphasis will be on quality,” he said. “In France, we knew that yields would be down.”

Yields actually turned out better than expected in France, while quality was reasonable. Germany, however, had quality problems.

“Only about 45 percent of the German crop will be selected for milling compared with the usual 90 percent,” he said. “Germany’s had to rely on increasing exports of its feed wheat into the E.U. That’s in direct competition with U.K. exports.”

For Watts, the swings in the modern grain market are proof that it’s doing its job. “We’ve now had four seasons of extreme volatility,” he said. “It is demonstrated to the world that the global wheat markets are working. The price rises and the world produces more. The world hasn’t run out of wheat. It’s run out of cheap wheat.”

HGCA analyst David Eudall explained how problems in rapeseed crops on the continent had put the U.K. in a strong position.

“The planting incentives for farmers are now being given by the European market,” he said. “The U.K. is now part of a European whole.”

Britain had a bigger crop, while other European countries had struggled, especially Germany where a heatwave caused a 10% drop in production. Europe couldn’t solve its problem with imports of rapeseed, because Ukraine, the usual source, had been hit by flooding. Another strategy to deal with a poor rapeseed crop, substituting sunseed, was not available because of low sunseed production.

Soybeans remain the dominant oilseed, although he noted that the premium for rapeseed had widened. “You would expect most of the value in this market to be driven by the soybean market,” he said. “You’re seeing crush levels set a new record. That’s being driven by lower production of other oilseeds.”

With much of the crop not even in the ground, the market in soybeans remains hedged with uncertainty. “Spring 2011 for soybeans is a key risk,” he said. “The South American soybean crop is at high risk to potential weather events.”

In particular, La Nina could affect the planting and growing season of Brazilian and Argentine soybeans. “The La Nina weather formation will be key,” he said. “The rainfall level will be key.”

Also, in the short term, China is looking at very low soy oil stocks to go with its record demand, he said. China will have to bring its stocks into the supply equation.

“They are nearing the end of their shelf life,” he said. “The stocks need to be used.”

In the vegetable oil market, the weakness of the Malaysian ringgit against the U.S. dollar is supporting palm oil prices. La Nina, David Eudall explained, is causing heavy rainfall over East Asia with a negative impact on palm plantations and transport.

Steve Jesse, head of agricultural commodities sales at Barclays Capital, also stressed the difference between the current situation and 2007-08.

“We haven’t come off the back of two Australian crop failures,” he said. “Stock levels aren’t actually low. We do think that the basis of all your markets is very much fundamentally driven. The production losses and the subsequent export ban for wheat in Russia has changed the profile for the whole grain market in 2010 and likely for much of 2011.

“At a time when the demand fundamentals for corn and soy were also very supportive, the floors beneath all grain markets have risen significantly and look likely to hold firm well into 2011. These tight fundamentals leave the markets much more sensitive to further weatherrelated supply setbacks for at least the next 12 months, until the world’s grain producers replenish stocks.”

Jesse said that with a limited amount of additional acreage in the main growing countries, it may well take even longer for all markets to build stocks to sufficient levels to push actual prices and volatility back to levels of six months ago.

“We are not suggesting that the current situation is the same as 2008 when global wheat stocks reached critical levels after successive Australian crop failures,” he said. “Therefore, we do not anticipate the frenzied price action witnessed then. However, we do believe the market will take longer to replenish stocks to more comfortable levels in all the major grain markets which reduces the likelihood of significant price decreases beneath the support levels, while increasing the possibility of some dramatic short-term rallies.”

He contrasted financial and commodity markets. “Commodities are generally much more volatile than the financial markets,” he said. “The derivatives markets aren’t as evolved as they are in the financial markets.”

Carl Atkin of Bidwells Agribusiness suggested that economists were expecting a structural change in agricultural prices to drive enhanced returns from agricultural real estate, operational farming and the agribusiness supply chain.

“Buy land — they don’t make it anymore,” he said, quoting Mark Twain.

However, there were problems with buying farm land in many countries. “Foreign direct investment in land is a much more emotive issue than in any other sector,” he said.

He pointed out that farmland behaved differently to any other asset. “High profitability at farm level leaks up and down the value chain,” he said, noting that, for example, it would mean higher prices for fertilizers or land. “Agriculture is pretty recession proof.”

Chris Lyddon is World Grain’s European editor. He may be contacted at: