Monday, July 28, 2008

Commodity weakness wreaks havoc

General weakness in commodities has wreaked havoc over the grain sector over the past fortnight. There is evidence that recent massive price rises have now caught up with the consumptive sector, leading to a slowdown in demand for commodities. Weaker oil and hard commodity prices have encouraged an exodus of fund money from the soft commodity sector as well.

Some of the consumptive weakness may be related to China’s finalization of its pre-Olympics buying spree; trader folk there getting ready to celebrate China’s coming of age, as evidenced by an easing in the bulk freight market in recent weeks.

Regulation threats
Threats of stiffer regulations of commodity markets are also at work. This has no doubt frightened some speculative interest away from the sector for the time being. Are fund managers around the world sending fervent US regulators a message ‘what do you want – high or low prices?’

Better weather is also playing a role. Northern hemisphere winter crops are getting larger; fragile US summer crops are leading a charmed life; and lo and behold – it is raining where and when it should in Australia.

Wheat/corn spread blown out again
We have been surprised at the extent of the sell-off in corn. This market now contains very little risk premium. Unless corn recovers, wheat is susceptible to further falls. The wheat/corn spread has blown out again, even though wheat has a much more comfortable balance sheet and a big crop is nearly in the bin. Sometimes markets don’t make much sense.

But strong end-user demand should now start to pull corn prices up by the ears. The break lower in prices has put a lot of profitability back into sectors that use thecorn. Moth-balled ethanol plants are now coming back on line, and some profitability is creeping back into the livestock feeding sector. The corn market could fire on any hint of a supply issue, which would provide good support for prices across the entire grains sector.

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