Some better signs

While the rally in canola has stalled somewhat, there are some better longer-term signs emerging for world grains markets on the prospects for significantly lower Canadian production.

Already there was some expectation that barley and wheat would ease this year as lower plantings and a return to average yields would see production levels decrease from the peak levels of the past couple of years.

This combined with the Canadian situation will see some grain take a bite out of heavy stocks levels this year. This will be particularly the case for grains where Canadian production is predominant: durum wheat, higher protein spring wheat, barley, canola and pulses.

The barley situation bears watching as we continue to hear reports of crop problems in the EU. On top of this EU feed barley has been the focus of market's attention of late with reports that China purchased up to four Panamax vessels of EU feed barley.

With the Euro easing and a lower import tax on barley than corn in China, EU barley is now competitively priced against imported corn by around US$20/t on a CIF basis.

The high cost of domestic corn is also a factor that has made feed barley imports attractive to feed compounders. The EU is in a strong position to meet demand for shipments this year as Australia is almost sold out of old crop and in view of the crop situation, Canada is out of the market. Black Sea exports are banned from China, due to strict import protocols.

The elephant in the room that is anchoring coarse grain prices at the moment is an expected record large US corn crop. However, if something goes wrong with this crop, there could be a scramble on to secure future supplies. In light of this, the risk/reward matrix dictates that we continue to hold on forward selling barley.

Time to pull the trigger on canola

There are strong signals that the canola market may be topping out. For those who haven't made use of the rally to hedge forward production, now is the time. Earlier last week we made a recommendation to hedge 15% of expected canola production.

The market has moved higher since then on longer-term forecasts calling for more wet weather in Canada - which may affect yield potential on canola crops already on the ground. We are advising to take advantage of this and make a further 15% forward sale.

Canola has now pushed to a US$76/t premium to beans, its highest in two years and back to the high end of the range (excluding the 2008 period when canola briefly shot well into the 100/t’s above beans).

Canola board crush margins have dropped $50/t in a week (the lowest in 2 years) and Canadian canola is trading a premium to EU rapeseed, which is very unusual.

These all suggest canola is doing (or has probably already done) a great job in rationing demand even with a 10-11mmt Canadian crop (they had been expecting +13mmt on large plantings).

On top of this, there are reports that the European rapeseed crop won’t reach earlier potential.

Nonetheless, canola is part of the global oilseed complex and cannot escape the fact that potential price upside will be limited to the prices of other vegetable oils (due to the high degree of substitutability between veg oils). The US soybean crop is in excellent condition and there are still plenty of soybeans available in Sth America.

Short-term short covering might see some further upside, but really it seems that once that is done, in order to sustain the rally we need to see something from beans and/or grains (which appears unlikely given strong US growing season conditions).

Canola, hard wheat on the way up

The big news in the past week has been wet weather in Canada that is threatening to prevent some 15-25% of its cropping area from being planted this season.

Canada had a very dry winter and early spring, however, in the past month, many Canadian cropping areas have received 200-300% of their normal rainfall. The excessive moisture has resulted in the slowest planting pace in recent history and an expectation for the largest abandoned acreage in Western Canada since Government programs in the early 1970's intentionally idled acreage.

In an industry briefing last week, the Canadian Wheat Board (CWB) said that exceptional spring rainfall will severely impact 2010 crop production and projects anywhere from 8 to 12 million Prairie acres will be left unplanted this year.

Of this total, 3 million acres will likely be wheat, 1.6 million barley and 5.4 million of other crops (mostly canola, but also oats and peas). On top of this, there will also be lost production from crops suffering under excess moisture conditions. The CWB is estimating wheat and barley production

Canada dominates global canola exports and, therefore, canola prices have responded sharply, moving to a wider price premium over soybeans (back to 20%). The price premium has been tight (neutral up to 6-8%) to encourage increased exports after China imposed export restrictions on canola late last year.

Canola prices have a little more room to run, however, they will be capped by strong soybean production potential out of the US. Last week, the USDA said 85% of the US soybean crop was in good/excellent condition – you don’t get much better than this. Apart from a small amount of labeled product demand, vegetable oils are highly substitutable and demand for canola will ease sharply if prices move out of whack with the rest of the global oilseed complex.

Hard wheat should also benefit from the problems in Canada. Canada is a significant producer of higher protein wheat and is the latest in a list of global hard wheat producers to suffer production and quality issues. Early harvest results suggest the US Hard Red Winter (HRW) crop is low in protein, whilst cool, soft growing season conditions do not augur well for the US spring wheat crop (which is normally high protein).

In Australia, some of our best producing hard wheat country – in southern QLD - has not yet been planted. These events should soon start to widen the premium good quality, high protein wheat holds over other wheat.

All eyes on Chinese corn imports

The first US corn shipments to China in 4yrs left the US this week, bound for China. So we will know their fate in about 3 weeks from a Chinese import protocol prospective. This is important because if trade channels are opened, it could promote significant trade in corn between the US/China - aka what has happened in soybeans.

China has strict GMO import protocols and if it decides to enforce them, it could lead to a rejection of these imports – which have been organised by the private sector.

Currently the price of corn in China is about double the world price. Chinese Government authorities have some policy dilemmas to work through. Do they allow imports and depress farm incomes; or reject imports and prevent access to cheaper forms of protein for its growing population.

With natural resource limitations in China (particularly water), many think it will be impossible for China to meet the future demands of its growing population itself. Already it has made a policy determination to sacrifice its soybean industry.

Eventually its Government will decide that it is more important to provide its population with cheap protein sources than fight a losing battle with its farm sector (that is declining in importance anyhow).

So it is a matter of when, not if, they will allow corn imports. It may not be this time around, or the next, but when it eventually does, you can bet it will have widespread implications for global agriculture. Just look at the impact of Chinese soybean imports on the global oilseed industry (the size of this industry has virtually doubled in the past decade).

With global stocks comfortable and not many new crop production issues around at the moment, prices are likely to take their cue from any developments on the China corn front, outside markets (crude oil/equities) and currency movements.

Two horse race for grain prices

Just like the AFL premiership which even this early in the season appears to have boiled down to a two horse race between Geelong and Fremantle (spoken in the words of a true Freemantle optimist). The fate of grain prices this year, at this stage, seems to rest on two key factors; how much corn China needs and the movements in the $A.

On the Chinese corn front, recent purchases may have revealed more information on the situation in China. Firstly the Chinese cancelled some 2010/11 corn purchases and secondly they purchased more corn for immediate delivery. This suggests that they are more concerned about the nearby corn supply situation and growing confidence in the new crop situation.

With most other global crops enjoying excellent growing season conditions, despite lower plantings in 2010, the longer-term supply situation doesn’t appear to be an issue at this stage.

What will happen with the $A is a little more difficult to predict, mainly due to the erratic behaviour of global capital flows. The $A has been hammered due to concerns far beyond our shores that may have little consequence for our medium term growth and economic prospects. Sure it will probably scare some international investment away and force the RBA, but the decline to me seems to have been overstated.

But while many things can change between now and harvest you can only play what’s in front of you. For example it was not long ago that St Kilda were cup favourites and Fremantle rank outsiders. So take advantage of any opportunities that the unexpected may throw up. Any decent rallies in grain prices or unexpected collapses in the $A are selling opportunities, given an analysis of the best information available to us today. What happens after that is largely out of your control and may require readjustment to your strategy as we near September finals action (aka make or break time for crops).