He Said, He Said: Analysts Go Head-To-Head

Posted on November 17, 2017

Neil: Hey Jon. I’m feeling a little underwhelmed by the markets. It seems like the bears are carrying the day. Take a look at wheat, the world looks like it just produced another huge crop. After everyone was talking about about drought in key North American spring wheat areas. And Western Canadian wheat yields recovered from downgraded expectations too.

I think the real wheat story is actually being written elsewhere. Increasingly with the Black Sea region and Russia the new ‘king’ of wheat. Their production is forecast at an all-time high, 82 MMT, and they are poised to become the largest exporter, surpassing both the U.S. and the EU for the first time. Russian wheat quality has really improved. It is working its way into Mexico, Peru, Nigeria, places that used to source wheat from North American.

Jon: If it was just wheat, that would be one thing. Production out of the Black Sea region has been creeping into other crops as well, like soybeans and corn. Seven years ago the U.S. represented over 50% of global corn exports. Now they are barely 30%, with the Ukraine and South America taking over a sizeable chunk of the difference.

It’s not just the ‘Big 3 crops’ – the Black Sea region is starting to eat into markets that the Prairies used to dominate. They’ve been more competitive with flax into the key European market, and have recently started exporting peas, lentils and durum as well. The volumes are still a fraction of what we sell, but even a few cargos around the margins adds an important element of competition from an importers perspective. There’s every reason to believe that their footprint will only increase.

This is sounding a bit gloomy – let’s look for a light in the tunnel that’s not a train. My first thought goes to demand growth, particularly in vegetable oil. What do you think?

Neil: You’re right we shouldn’t get ahead of ourselves. There are signs of growth even here in Western Canada. Globally there still is some momentum behind the “protein play”. In Canada, the most obvious example is in the growth in oilseed acres. Manitoba just finished harvesting a record soybean crop – both in terms of acres and production. Canada also keeps increasing canola acres and crush capacity. South America has their collective foot on the pedal and continues to push forward with soybean acreage expansion.

The main reason for the increase in oilseeds is because the demand is there. China seems to have an insatiable demand for soybeans. Imports are set to reach record levels, livestock remains in an expansionary mode, and China seems serious about bio-diesel/ethanol. China is definitely leading the demand, but there are other countries/regions that are increasing their consumption of oilseeds. Take a look at the Middle East and South Asia, rising populations and governments interested in promoting food security. Speaking about food security it sure seems to have lost much of the cache it had just 5 years ago. Do you think we are getting complacent?

Jon: Good question. Based on the way markets are behaving, there is a lot of complacency. Volatility is extremely low, and most key markets are trading in narrow ranges. In the case of corn and winter wheat, they are near decade lows. The global supplies are comfortable and we simply have not seen a major ‘wreck’ nearly anywhere in several years.

There seems to be little doubt that genetics, farming practices and the ability for crops to withstand moderate adversity has improved. It’s not like the last few years have been without their challenges, yet production totals come in surprisingly high.

Speculative money is bearish despite prices that are already very low. They currently hold near-record-large short positions in corn and wheat, clearly signalling that they don’t see much upside risk. Maybe this is a ‘bull market in complacency’? Weather is always unpredictable, and while crops have become more resilient, we are overdue for a more severe weather threat in one or more production regions. Demand remains strong, even if it’s currently well supplied. Perhaps there will be some shift in sentiment from outside investors about the commodity markets in general, given that energy and metals are trading at the highest level in several years. Eventually this could also draw some money flow into grain markets.

Unless we get this inevitable weather problem, do you think we remain sandwiched in this range bound, big demand/big supply situation that keeps us booooooring?

Neil: I have heard it said, several times and in various ways “lower for longer”. Farmers have done a great job in responding to the incentives from the ethanol era. The question going forward is whether or not there is a policy program that will provide a similar incentive to encourage ‘more’? People have already forgotten the power behind the ethanol mandate. The U.S. had tried all sorts of programs over the years to support farm incomes. Most of these were various storage programs, payments to reduce acreage, or even direct supports to farmers.

The genius of the ethanol mandate is that it shifted the responsibility to another group and made it mandatory to show ethanol inclusion in the U.S. gasoline supply. The luck component was the ethanol mandate kicked in just as the Chinese pushed the pedal to the metal on their soybean import demand. I would argue that in the history of agriculture, this policy has had one of the biggest roles in shaping behaviour. The wide-ranging impact, in terms of both geography and economy, were probably not contemplated when the mandate was being structured, but it left a truly re-shaped world in its wake. So here we are, in the post-mandate world searching for the next catalyst to spark demand. On the ground it seems India and China are most directly dealing with the problems of abundance, with various levels of concern about farmer incomes.

Of course, just when we get complacent about our ability to produce there will be the inevitable short crop situation.

Assuming next year is not the year, do you think we are dangerously close to repeating the mistakes of history: more trade disputes, prolonged price weakness, and stress on farm incomes?

Jon: In some ways it feels like the deeper threats to grain prices may come as a ripple effect from other wider macroeconomic or geopolitical events. Supplies are comfortable, and look poised to keep pace, and even exceed, the expected demand growth, particularly since there are no apparent demand shocks like the ones you mention above. At the same time, demand is growing right now, which seems to help underpin values to a certain extent.

However, what happens if, for example, the Chinese economy suffers a significant setback? The implications for oilseeds in particular, but also grain markets in general, would be huge. Of course, this isn’t imminent, and analysts have widely diverging opinions on how vulnerable their economy is. Who would be there to pick up that slack? Especially since that type of event would also certainly affect other countries that might otherwise step in with bigger buying.

The overall sentiment towards free trade and more open economies has also soured. This increases the risks for more protectionist trade measure, currency wars and ‘beggar thy neighbor’ policies. Even if these policies don’t specifically target agricultural markets, they are sure to be collateral damage. When it comes to trade wars, financial markets and the wider macroeconomic arena, the agricultural industry is a mere mice among elephants.

While it may be a bit of a cliché, there is a lot of truth in the statement that ‘people have to eat’. The world population is growing, living standards are continuing to rise, and the demand for grains and oilseeds is increasing. There will always be period supply scares, which provides pricing and risk management opportunities for growers. While we will see increasing competition from other parts of the world, the Prairies is still an attractive place for agricultural investment due to our rule of law, infrastructure, excellent farmers and overall relatively favorable business climate.

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