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MARKET by
Brian Doidge, |
U.S. & WORLD:
The last several monthly USDA Supply & Demand reports have only served to reconfirm the notion that a record large U.S. corn crop is required, but increasingly unlikely to materialize. One would think this thought should sustain Chicago futures contract pricing, and one would be wrong. Since the first of June, nearby Chicago corn prices have plummeted nearly 50 cents (as of June 15); almost 60 cents since Good Friday (April 9). With widespread rains, flooding, replanting, and acreage switching throughout this U.S. corn planting season, how is it possible that corn futures have lost ground while corn market fundamentals remain solid?
Two answers: The most recent price plunge in June has been driven by selling on the part of managed trading funds following the U.S. Memorial Day holiday. Part of the reason may be the sharp increase in Chicago Board of Trade margin requirements for corn contracts implemented June 4. Margin requirements (the amount of money that must be posted ahead of time in order to trade a contract) for old-crop corn contracts were increased 38% for initial and 33% for maintenance and hedge accounts effective Friday June 4. Increased margins meant that managed trading accounts had to have more money posted thus tying up more cash and reducing their reported percentage return on money invested. Knowing this increase in margin requirement was coming, many funds tried to clear out of "short" (sold) positions in trading Tuesday June 1. With all the funds trying to buy their way out at the same time, prices locked "limit" up for the day; thereafter, price plummeted as traders exited the corn pit. Price action had nothing to do with supply or demand or weather or exports or anything other than this CBOT ruling on margin requirements.
The larger answer involves China. As long-time readers of this column will know, we have been saying for the last decade or more that China has evolved into "the" major market factor in agricultural commodities. The Chinese economy grew at an annual rate of 9.8% in the first quarter of 2004 - far in excess of the 7% target for the period and for the year as a whole. Growth in the second quarter is expected to also be 9.8%. The Chinese economy expanded by 9.1% in 2003, 8% in 2002, and has grown at a rate of 8%-9% for many, many years far exceeding any other large nation. Chinese officials are trying vigorously to avert potential inflation caused by such aggressive growth straining supply and infrastructure. The worry is that such stresses and strains will bring a host of other economic problems, social unrest, and political upheaval. As a result, in the last two months, the Chinese government has severely restricted lending, increased interest rates, and sharply curtailed credit to processors, exporters, and importers alike. Chinese oilseed crushing plants have been caught with orders (especially for Brazilian soybeans) for which they cannot pay. Chinese processors have resorted to rejecting shipments from 23 Brazilian suppliers on trumped-up claims that shipments are contaminated with the fungicide to control Asian rust. As of mid-June, more than 240,000 tonnes of Brazilian soybeans have been rejected since May with market cynics pointing to credit problems as the real culprit. Regardless, Chicago November soybean contract prices have dropped more than US$1.40/bushel in the same time frame as Chinese buying has evaporated. Weakness in the Chicago soybean pit has taken the Chicago corn pit down with it. Corn prices have ground lower irrespective of corn fundamentals.
But that can't continue. USDAs last four monthly reports have projected record usage in excess of 10.5 billion bushels. Even with a projected record average yield of 145 bushels/acre, the crop of 10.4 billion bushels was less than needed to meet demand. With mounting crop production problems, it is likely impossible for a record average yield to be achieved. Reductions in the estimate of crop size are expected in upcoming USDA reports, especially the August report when the USDA uses actual field surveys to estimate yield for the first time every crop year.
And China comes back into the picture yet again. The Chinese Ministry of Agriculture said in mid-June that it would slash corn exports by 47.5% from the record 15 million metric tonnes in 2002/03 to only 8 mmt in 2003/04. Decreasing domestic corn stocks, thanks to exploding demand, have dropped to the lowest level in a decade. China has usually been the world's second largest corn exporter supplying 20% of world trade, but such a sharp curtailment in export quotas will force China's usual customers to seek corn supplies elsewhere. Cutting exports in order to maintain domestic stocks is yet another sign that China is vigorously trying to head off inflationary pressures inside that nation. As China vacates world markets, U.S. corn export sales (already running 27% ahead of last year's pace) will remain firm. Coupled with surging domestic demand to meet U.S. ethanol production needs, strong exports will help to keep Chicago corn prices solid.
Bottom line? The current trend downward in Chicago corn futures prices has been overdone.
ONTARIO:
As we pointed out last issue, the strong demand scenario painted above has served to drive Ontario basis offers up. Since the turn of the new year, old crop basis has strengthened by 60 cents and new crop has gained 40 cents. We are projecting that only 1.6 million acres was planted to corn in Ontario this spring versus the 1.9 million intended. This shortfall will keep basis offers strong well into next winter.
Bottom line? Basis will continue strong. If we get an early frost, look out!