Commodity Market Outlook
Global economics have always driven commodity prices and that is certainly true for grains, like corn and wheat, and oilseeds, such as soybeans. Several market observers weigh in on their long-term views for grains as weather, technology and Asian demand continue to push and pull on the market.
Plain and simple, world demand for grain will grow. The U.S. Department of Agriculture (USDA) released two key reports March 31, providing the market with opportunities for short-term grain traders, whether bullish or bearish. The USDA estimated that U.S.-intended corn acreage in 2009 will be down only about a million acres from the previous year and that soybean acreage will be the largest ever, but these are only temporary snapshots in a more significant macroeconomic picture.
That trend is clearly positive for agricultural commodity prices, according to Bruce Scherr, chairman of the board and chief executive officer of Informa Economics, a Memphis-based consulting and research firm, which focuses on agricultural and commodity markets.
The USDA estimates that corn production of 12 billion bushels and soybean production of three billion bushels in 2009 appears to be inadequate to meet projected annual demand, so it is no wonder that supply is a constant concern.
Still, there are enough uncertainties that keep strong commodity prices from becoming a given, says Terry Roggensack, partner at The Hightower Report, a Chicago research and consulting service.
Typically, the big uncertainty is on the supply side. Planting intentions are not the same as acres planted. Before the next USDA estimate comes out in June, farmers may decide to plant more or less of a certain crop due to weather, expected prices, soil conditions and other factors. And weather scares in the growing season often move prices before a crop gets into the bin. Long-term, prices may also be tempered by advances in farming techniques in developing countries, which will allow them to produce far more than they do today. This is the long-term bull and bear debate over grains.
From Supply Glitch to Demand Focus
Scherr’s bullish case is not based on this year’s supply/demand estimates but on longer-term rising incomes and higher standards of living worldwide. Commodity prices, represented by the Commodity Research Bureau Index, the most widely recognized measure of the global commodities markets, have gone through a series of several distinctive increases since 1970 (see rectangles on graph opposite), culminating with the sharp rally to record price levels for many markets in 2008.
“The four previous rallies were the result of supply glitches that resolved themselves in 18 to 24 months,” Scherr points out. “Generally, commodities were not in short supply last year with the exception of wheat. If buyers needed energy, steel, corn, etc., it was fully available. They just had to pay up for it. After the price decline early in this decade, it has been demand that has pulled prices up in a global adjustment that is unprecedented.”
From the crop failures in the Soviet Union that led to the great “Russian grain robbery” of the early 1970s to the drought years that reduced U.S. crop production in the 1980s and 1990s, weather has been the main culprit for reducing crop yields, causing prices to surge and then, inevitably, to fall back when a new, more favorable crop season or two replenished supplies. Overall, though, commodity prices were in a disinflationary pattern from 1977 through 2001 (indicated by the yellow arrow on the graph opposite), resulting in inefficient use and poor returns on investment.
The most recent commodity price surge dwarfs the previous four as prices moved up to a new plateau, but the key question is: Will commodities be able to sustain real economic value, which Scherr places at $80.00 to $100.00 a barrel for crude oil or $4.00 to $5.00 a bushel for corn? Will agriculture and the industries that depend on it offer an appropriate return on investment in the years ahead?
“As world economies continue to improve over the next five to 10 years, prospects for commodity price strength and sustainability increase,” Scherr says, noting that in the last 20 to 30 years China, India, Brazil and other developing countries have seen about a billion people migrate to what is culturally defined as a wage-earning, middle-income level.
While that growth trend is undeniably bullish, Roggensack ticks off several issues that could stand as obstacles. For starters, agricultural markets have not had a chance to adjust yet to grain and oilseed prices coming off all-time highs in 2008, much less to the new economic environment created by the global financial downturn.
And there is the question of what effect the massive monetary stimulus programs and federal deficits will have on inflation, which could weaken the U.S. dollar and boost commodity prices. Roggensack also asks if the Obama administration will push ahead with energy standards that make corn ethanol a stepping stone to other biofuels.
Finally, how will foreign producers respond to crop price incentives of the last year? U.S. corn yields are well above yields elsewhere (see table opposite). But if other nations adopt genetically modified organisms and other seed and herbicide improvements to bring their output up to the level of U.S. farmers, Roggensack says there is tremendous potential for food production that could dampen price prospects from increased demand.
Rising Income, Rising Types of Food
The significance of rising incomes on food consumption and agricultural prices is illustrated by Scherr’s diagram showing trigger levels of gross national income per capita for different types of food. With a per capita income of $5,000, for example, consumers begin buying basic packaged food. When per capita income reaches $10,000, they start to buy basic frozen products.
The smaller populations of Japan, Hong Kong and South Korea are already in the higher per capita income ranges and are markets for all types of foods. But look at the impact a developing country like China, with a population of 1.3 billion people and a per capita income around $2,500 will likely have on commodity demand and prices. China may have 500 million people – 200 million more than the total population of the United States – migrating to higher income levels averaging $10,000 a person, triggering value-added consumption.
“It took the United States 100 or 200 years to move from the coastal areas to the interiors – to build the Pittsburghs and St. Louises – and to
connect these commercial centers by rails and roads and other infrastructure, including agricultural development,” Scherr says. “That progression created the most phenomenal middle-income society in the world.”
“China is doing this in 20 or 30 years,” he continues. “That’s a giant hook for commodities.”
Expanding the Commodity Base
As this process to a higher standard of living gains momentum, it will act as a driver of growth underpinning the strength in commodity prices.
“It would not be socially appropriate or politically expedient to hold back the development of these new consumers,” Scherr adds, pointing out that it is to the benefit of these countries’ governments to encourage the development of their middle-income classes to expand their national growth and geopolitical influence.
Even with an expanding global demand base, it does not mean that prices will always be at $16.00 a bushel for soybeans, $12.00 a bushel for wheat or nearly $8.00 a bushel for corn as they were in 2008. Yet with the globalization of markets, Scherr says we are looking at considerably higher mean values for commodity prices than in the past, barring events such as a global economic collapse, further institutional failure, major financial crises, wars, pandemics or other unforeseen circumstances.
“I’m not predicting a particular price level, but it’s not a return to the $2.40 corn or $5.00 soybeans or $3.30 wheat that we have seen in the past,” Scherr concludes.
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