Fundamentals not strong enough

Just as prices started to claw their way into hedging territory, canola prices copped a sudden hammering this week. Grower bids have fallen the best part of A$50/t for both old and new crop after nearing our targets of A$600/t. But these big falls were mainly isolated to canola with bean markets only softer to the tune of A$10-15/t.

These big falls come at a time when the Canadian crop is getting smaller - last week the Canadian Wheat Board cut their crop to 10.2mmt, down 19% from last year’s 12.6mmt monster and the market range continues to contract with estimates in a wide range from 10-11.5mmt. Canadian weather forecasts have improved but plenty of damage appears to be done and unless the rain is extensive and widespread, much more will be required to attain average yields.

Rumours that China has cancelled some forward orders may have played a role, but it seems these cancellations were at the margins and haven’t significantly changed the S&D outlook. With global oilseed production and canola likely to fall this year, we are moving towards a much better fundamental situation.

Canola prices vs. beans are at the lowest levels in 5 years (for spot months), at a US$50/t discount, and back to near contract lows for new crop (at a US$11/t premium), both down US$30/t in a week.
It appears that much of the recent weakness has been inspired by the funds which have been pulling back their exposure in commodities. As one of the more thinly traded markets we feel that the punishment dished out to canola may have been overdone.

That said, we can’t see much on the fundamental horizon, near-term, that is going to be strong enough to push markets back to recent highs. We are a little wary of the Nth American planting intentions reports, due out on the 23rd and 30th of this month, from Stats Can and the USDA respectively. These agencies both produced surprising reports in March, where the trade felt they low-balled canola and bean planting intentions across Canada and the US.

Canada could find another 0.5-1m acres – although recent weather will negate the impact. The wild card could be beans. The USDA could easily find 2-5m acres thanks to switches from corn, wheat and idle land to beans as planting delays and higher prices have encouraged farmers. A plantings shock is all we need in the current environment where outside markets are providing limited support.

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Markets Sending Mixed Signals

There were some very mixed signals being sent by markets last week. Firstly the USDA lifted wheat end stocks after they were expected to fall, while oilseed and corn stocks were projected lower. Projections for a fall in corn stocks – a result of lower yields – should provide the fundamental support for grains markets, taking the batten from beans which have carried markets higher over the past quarter.

Markets still seem to be transfixed on oil, the $US and inflationary expectations. Oil prices have quietly skipped above US$70/bll with the International Energy Agency (IEA) revising its 2009 demand upwards, despite signs that US gasoline demand has peaked (a result of more ethanol blending). While we have outside markets pulling our way, the greater the chance that prices could spike higher on further weather scares. Outside money is gently rolling back into commodity markets.

Already, torrid early season conditions in Canada have seen the Canadian Wheat Board reduce Canadian production expectations by around 20% for wheat and canola. US wheat production is expected to fall by the same amount (delayed plantings and lower yields). It is still dry in Argentina, conditions have improved in Europe - although it is dry in south-east Ukraine - and we have seen a good general plant in Australia (with only central and south-eastern WA needing more planting rain). Strong carryover wheat stocks are keeping prices in check, but the margin for error has narrowed and further major production issues will have an impact.

Heavy losses on pork production (swine flu and weak demand) and very narrow cattle feeding margins and poor dairy prices suggest that the impact of the economic slowdown on demand for commodities is very real. Demand for our commodities from the traditional food sector isn’t showing signs of recovery, but with oil prices on the rise, demand for corn for ethanol will help take up the slack and provide the backbone for prices across the commodities sector.

Prices have neared hedging targets the past couple of weeks, but we are only entering the period of seasonal volatility associated with the maturity of the US corn crop. The next market mover could be the USDA 30 June prospective plantings report which is likely to show a further shift from corn to ethanol from earlier reports.

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Bio-fuels we can take - but no subsidies and no mandates

I am speaking at a Sugar Conference in Cairns this week. To be honest I have been roped in as a favour but at least most of the big end of town will be there. Most of the final day constitutes an assessment of the impact of bio-fuels on the agricultural industries.

I think they envisage me as being supportive because we are involved in the grains industry that has been one of the major beneficiaries of bio-fuels. Two of the founding principles of Profarmer are free trade and minimal Government involvement (along with absolute independence). So to support the Australian bio-fuel industry in its current form would be to turn our back on these principles. While it may prove unpopular with some of our subscribers (like our opposition to the Single Desk), we have to remain true to our principles.

Anyway here is my argument. Declining global grain stock trends are undeniable and bio-fuels have played a role in these trends and the extreme price rises witnessed over the past couple of years. A lift in demand, ignited somewhat by the euphoria surrounding bio-fuels, increased demand at a time of inelastic demand as grain stocks fell to historically low levels. Trends in grain consumption from the ethanol sector in the US are undeniable and are linked to rising mandates (not price sensitive).

A leading US Ag Economist Keith Collins reckoned bio-fuels were responsible for lifting prices 25-60%. In the US, rightly or wrongly bio-fuels will stay, mainly because it makes political sense - it is a palatable way of selling farm subsidies and is a vote winner.

But why are we doing it here? They don’t seem to be a major vote winner politically. It won’t create jobs and may destroy jobs in industries built on our sustainable competitive advantages.

• They won’t save the environment (2-5% mandates in oz?)

• We aren’t world competitive in producing bio-fuels so it will result in a tax on consumers/industry• We aren’t world leaders - at least 10yrs behind in producing ethanol from grain

• If we were genuinely concerned about the environment lets import it from the lowest cost supplier

So bio-fuels sure, but no subsidies or no mandates.

To us mandates and subsides stink of populous follow-the-leader - silly politics where all we will do is make ourselves busy for no real gain. Shouldn’t we be concentrating on building infrastructure to support our industries built on our sustainable competitive advantages.

But we recognize market failure does exists and if the Government were to get involved how about we lead the world in research in 2nd generation bio-fuels produced from waste from feedstock that we produce on a scale which is globally competitive?

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