US corn and soybean crops, the world?s largest, are in their worst condition since the last major drought in America?s breadbasket in 1988, pushing up grain prices and raising prospects of global food-price inflation
The India Meteorological Department (IMD) has said that a generally dry climate will prevail over interior peninsular India next week. This may further aggravate the rain deficit, now at 29%. This, coupled with the global heat wave, will definitely exacerbate global food inflation and I hope the Indian government is cognisant of this new challenge.
There are many once-in-lifetime occurrences taking place of late. The eurozone crisis is hotting up once again. The unwinding of the post-eurozone summit euphoria saw Spanish 10-year bond yields briefly pass the critical 7% level recently. The flood of cash seeking safety left German two-year yields negative for only the second time. In the US, the 10-year treasury yield has been lower only once.
But the people really feeling the heat are US farmers, scorched by the most serious drought in almost 25 years. Wheat prices are back to the levels that sparked the Arab revolts, and US maize (corn) futures for December delivery?the current crop?have soared 44% in three weeks. Soya bean prices have surged to their highest level since the 2007-08 food crisis and the price of this year?s corn crop has risen 30% since mid-June. Worries about the size of the US crop come only months after drought hit the Latin American soya bean belt of Brazil, Argentina, Uruguay and Paraguay.
A classic weather market is underpinning gains in the ?breakfast club? of commodities with benchmark corn and wheat futures surging to multi-month highs on the Chicago Board of Trade as a heat wave in the US Midwest wilts crops. The Food and Agriculture Organisation (FAO) expects world food prices to rally from three months of falls as concerns over the impact of relentless dry weather on US corn and soybean crops drive values up on international markets. FAO slashed its 2012 world cereals output forecast to 2.396 billion tonnes, 23 MT down from the previous estimate, driven by a 25 MT cut in its view of the US corn production to 350 MT.
The heat wave threatens to undermine forecasts of record output after the most widespread US corn plantings in 75 years. The Agriculture Department said that US farmers seeded 96.4 million acres with corn this spring, 541,000 acres more than they told government surveyors in early March. US corn and soybean crops, the world?s largest, are in the worst condition since the last major drought in America?s breadbasket in 1988, pushing up grain prices and raising the prospect of global food-price inflation. The CBOT July soybean contract set a record high of $16.65 a bushel on Monday July 9, and July corn jumped more than 5% to $7.77 a bushel. Corn prices have risen 30% in the past month to within striking distance of last summer?s record price of $7.99-3/4 a bushel.
The US Agriculture Department says its surveys showed only 40% of the corn and soybean crops were rated in good to excellent condition, the lowest rating at this stage of the season since the last severe US drought in 1988. Corn, which is used for a number of items ranging from fuel ethanol to livestock feed, has been hit hard by dryness and heat in its critical pollination growth stage, when yields are established to a great extent and drought damage can be irreversible. The outcome is critical to global food prices and the agri-business industry because the US accounts for almost half of global corn exports and a third of soya bean exports. Demand for both have risen as consumers in emerging countries eat more cereals.
The implications for the world food system of US crop losses are massive. The US exports more than half of all corn shipped worldwide and is a major supplier of soybeans to China, the world?s most populous country.
Food price inflation takes time to feed into the grocery counter, but dairy, meat and poultry?all dependent on corn for feeding animals?generally feel the brunt first. Drought-shortened US crops would also reduce America?s ability to supply food aid to needy nations at a time when South America?s farmers have also been hurt by drought. The drought is also likely to hit already the strained US government budget through disaster-aid payments and hurt insurance companies selling crop insurance.
Before the drought, the Agriculture Department estimated farmers would produce a near-bumper corn crop and harvest an average of 166 bushels of corn in 96 million acres. But traders said the recent price rise reflected a yield closer to 140 bushels to 145 bushels an acre. Moisture demands from the plant have increased during this time period but there is no moisture in the soil?you still need the moisture, especially at this time of year when the crop is pollinating. The US government said the rating on soybeans had dropped to 40% good to excellent from 45% the prior week.
Even a modest further reduction in crops could send ripples through global food commodities markets. The US Department of Agriculture on July 9 said less than half of US corn was in good or excellent condition while 22% was in poor condition, downgrading estimates from a week ago. The warmth that enabled farmers to plant seeds quickly has since escalated into damaging extreme heat.
Now, let?s come to cocoa?the main ingredient for Cadbury?s, Kit Kats, Hershey?s bars and Snickers. It may rally into the second-half of this year as low rainfall and drier weather forecast for Ivory Coast, the world?s leading cocoa supplier, threatens to reduce yields and deplete global stockpiles.
Low farmer prices, erratic rainfall in West Africa and the potential risk of an El Nino weather pattern developing all threaten the baseline production forecast for cocoa. Any reduction to our crop expectations increases the forecast new season deficit and tightens inventory levels. Tight cocoa stockpiles are a key upside driver for prices. The current forecast for cocoa grindings-to-use ratio for 2012-13 is 39.5%, the second-lowest in 25 years. With stocks low, there is little buffer available to offset further supply reductions. I consider the reduced stock-to-grindings ratio and the risk associated with downward revisions to production expectations under-appreciated in the current curve. The prospect of tight supplies and possible crop shortages is starting to be reflected in benchmark cocoa futures markets.
September delivery cocoa futures quoted on the Intercontinental Exchange, or ICE, have hit their highest since March 28 at $2,375 a tonne, while Liffe cocoa futures, traded in London, have hit a five-month high at ?1,619 a tonne. Cocoa prices could be headed even higher as the year progresses. The Benchmark ICE cocoa prices will average $2,400 a tonne this quarter, rising to $2,600 in the fourth-quarter and $2,650 in the first-quarter of 2013. Liffe cocoa prices could average ?1,600 in the third-quarter, rising to ?1,750 in the fourth.
For the US, consumer food prices are likely to be offset by cheaper petrol and natural gas. But in the developing world, food has a big impact on inflation, so higher prices could limit central banks? abilities to continue slashing rates. Leaving aside the risk of revolution, changes in food prices offer a handy proxy for inflation risks. Industrial metals prices are a guide to growth hopes, so the pair tell us a lot about expectations for growth and inflation. At the moment, the message from commodities is deeply gloomy: the ratio of food to metal prices is the worst since early 2009, with metals falling for most of this year. Equities are on a different wavelength. US shares are up 9% this year, with the 10-year treasury returning only 5%. Germany has almost as big a gap, while the mining-heavy UK equity market is even with gilts.
Maybe commodities have decoupled from other assets. There are two interpretations: shares still have a long way to fall, or shareholders have spotted an imminent pick-up in real growth that commodities markets have missed. I will stick my neck out and say that I belong to the former camp.
The author is CEO, Global Money Investor
