Arrow pointed upward for grain prices

by Chris Lyddon
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The world is in for several years of a structural bull market in grains, according to Dan Basse, president of AgResource Company, a consultancy based in Chicago, Illinois, U.S. Speaking at the Global Grain 2011 Conference in Geneva, Switzerland Nov. 16-18, he warned that any loss in the 2011 crop could cause a price explosion.

Every year, Basse presents the conference with a “headline.”

“Last year we talked about the extreme volatility, and I know a lot of you in this room thought I punted,” Basse said. “That’s what our research was showing. And until the problems in Russia and Kazakhstan, that was kind of the markets we had. In 2008, we focused on the economic uncertainty that left us all with flat, declining markets until April.”

2007 was about the challenges ahead, 2006 was the year of grains, while 2005 had been the year with the arrival of the “just burn it” mentality. “We are calling (2010) right now the year of food security and can we afford to burn it?” he said. “What does that mean? It means I’m really pretty bullish about the agricultural industry as we see it today.” It likely means several years of a structural bull market. “In fact, as we go through our data, I can’t figure out how this ends nicely,” he said. He reminded the audience of the cyclic nature of agricultural markets. “We overproduce and prices go down,” he said. “We rally and we get our farmers to produce more, but I can’t find a land situation or a situation this year or next year in which I can end this bull cycle very easily.”

One reason for the bull market forecast is economic growth.

“We’re really quite optimistic the world economy is growing again and ag demand is accelerating,” he said. “Southeast Asia and Latin America are the areas of growth. The U.S. is trying to reflate its economy.”

He noted that one of the major concerns in the market is over China’s evident desire to control food inflation.
“The price of vegetables since the first of November within China, Beijing, Shanghai is up 64 percent,” he said. “This can’t continue within China. Their big concern is what’s going on, and so when the Chinese talk about controlling food prices, we’re really not sure how they’re going to do it.”

At the time he was speaking, talk of Chinese controls had triggered a sell-off in grains, especially corn (maize).

“They’re talking about it to jawbone the market down,” he said. “We have all these speculators who are long in things like corn and soybeans, and to a lesser degree they are modestly net long of wheat. You end up getting this big collapse in price, and that’s where we are today.

“Now do I think that changes our environment, our landscape and where we think markets will go in 2011? No. But is it going to give us a lot more volatility? Yes.”

Basse highlighted China’s growth. “Have any of you read the new five-year economic program that has come out in China? You need to,” he said. “One of the tenets of that program is that the Chinese plan to build 88 new cities of 4 million people or more.”

That means that within 10 years China will have created enough new demand for food to equate to the E.U.-27.

“Keeping up with the demand is going to be a struggle for all of us,” he said. “If you’re a major producer and exporter and you have adverse weather, we are going see grain prices probably reach record highs.”

He said the 2011-12 bull market will be much more structural than what occurred in 2008 when the money just kept flowing and crude oil rallied.

“My work suggests this will be around for some time. Now what does this mean for us? Will China be forced to import corn and wheat?” he said.

Basse said that China, if it really wants to cool food inflation, will have to engage itself in greater imports.

“In fact, if you are all history buffs, the Chinese tried to control inflation by food controls back in 2007,” he said. “At that point, we in the grain industry really didn’t care. It didn’t affect us at all.”

However, he did expect increased demand to force people to take another look at biofuels.

“I think this food-versus-fuel debate will become heated sometime in the upcoming year,” he said. “I think it’s coming back.”

Basse said “risk management” has become the new buzzword in grain trading.

“Whether that’s management of price, management of counterparty, or management of financial assets, I think the risk side of this thing is going to be rather dramatic, and so we have a structural bull market — at least I envision it that way — with there being no room for any additional supply dislocation due to adverse weather.

“This is a multi-year bull market that only can be solved by two or three years of very favorable growing weather. If the United States had a drought or South America or Europe, prices could go very high and very quickly the world could find itself in a food security issue. If, indeed, we have another grain problem somewhere – boom, it just kind of all explodes. We do not have the stocks to fall back on.”

Despite high grain prices, the meat sector is actually doing well as demand rises around the world. “When I look at world beef, pork and poultry production — again, these animals consume what we produce — you can see this year we’re going to be up by 5.6 million tonnes,” he said. “It’s been a very linear increase since 1970. World meat stocks will fall to its lowest level since 1981.”

A lot of meat producers will still be profitable despite what they’re paying for grain-to-feed livestock. “We’re absolutely bullish, not only on the grain sector but also on the meat sector,” he said. “It’s one of those unusual timeframes in our history where meat and grains and everything are rising at about the same time.”

Concern for the Russian livestock industry was one of the motivations behind the export ban.

“Russian domestic (grain) demand is holding steady,” he said. “The one thing the Russians are really trying to do is build out their livestock herd. The numbers are back to the same level where they were in 1992. Unless you want to see those livestock herds liquidated, the one thing you would do is ban trade and make sure you have enough domestic grain demand for those animals. All of us in this business need to plan on our friends in the Black Sea — the Russians — probably being out for maybe another year.”

He forecast a Russian crop next year of around 52.3 million tonnes. “It’s still early. We’ve got a long time to go,” he said. “We do see a recovery from this year’s 41 million tonnes.”

The problem is with wheat stocks low, the Russians will probably export no more than 3 million to 3.5 million tonnes in 2011-12.

“The other thing that happened this year that trapped everyone is that U.S. corn yield just wasn’t there,” said Basse. “All of us were fooled, because in U.S. corn we follow these things called ‘good to excellent ratings,’ ” he said. “The industry loves them. I hate them because they don’t correlate very well with yield.”

“As my farmer friends will tell you, this is probably the best looking, poorest yielding crop they had ever got,” he said. “It was just that way. Temperatures across the Midwest were the highest or second highest going back to the 1960s … a very warm and a very wet year.”

Technical advances could not prevent the problem.

“Monsanto has a gene for what, let’s see? I think they have weeds. I think they have bugs. They are coming up with drought, but they don’t have a gene for too hot a temperature or too much rain, and those were the things that got us this year,” he said. “So we have a smaller U.S. corn crop.

“This was still the third-largest U.S. corn crop on record. It wasn’t that bad a crop. The world has so much pressure on it to produce grain that we can’t afford any shortfalls.”

He expressed concern about the weather.

“We all know we have a rather strong La Nina going in the equatorial Pacific,” he said. “Our big worry is Argentina. The soil moisture profile of Argentina is really quite dry. If I’m you in the grain trade, I’m paying a lot of attention to Argentina.”

Global petroleum consumption this year is rising and will reach a new alltime high, but in the United States demand for gasoline is declining.

The U.S. Environmental Protection Agency recently approved blends of up to 15% ethanol in gasoline for cars produced since 2007.

“So we have this outlook for ethanol that’s jumped dramatically. As of (Nov. 12), we had a breakeven of 82 cents a gallon. If I am an ethanol producer in the United States, I’m still making lots of money. We estimate that corn would have to rise to $6.40 a bushel before these guys would start losing.”

He also pointed out that global vegetable oil demand is still soaring.

“Here in the E.U., you’re going to reach a new high in terms of industry use of palm, canola, coconut and olive,” he said. “The big driver is Latin America, ladies and gentlemen. They’ve mandated new soybean oil for biodiesel, and it’s taking a tremendous amount of supply.”