Agricultural Commodities: The Bigger Picture
During mid July this year I had a series of conference calls and also a meeting with a gentleman based in Geneva, Switzerland. The topic of our conversation was centralized around agricultural commodities ...
The topic of our conversation was centralized around agricultural commodities, now, at that particular moment I was quite sure that the soft spoken Suisse gentleman was yet aware that I in fact, write my own Brazilian grain focused blog which not only gives readers a chance to gain more understanding of the agricultural commodity markets from Brazil, but it also incorporates elements of macro and micro economics, paper asset classes, soft commodities and on the occasion calculus and logarithmic dynamics. This giving birth to a multitude of variables whilst eliminating possible criticism that http://www.cordealagricola.wordpress.com/ is "yet just another one dimensional blog".
"......what do you see in the future" he asked, yes as very expansive question indeed. Whilst trying to remain realistic about the current market conditions, and trying to conjure-up a fairly articulate response to a seemingly 'loaded' question, I responded with a mind brimming full of confidence-"Firstly, I think it’s important for us not to ignore the bigger picture and remain open-minded about what we can't always see or read".
Today I stand by that statement more than ever, and relate it in-part to the concept of; economic growth in emerging, frontier and break-out markets/nations, vs. supply/demand& physical delivery in grains vs. feed usage (which can also plan into the hands of meat consumption, although I won’t be covering this in depth.) The interesting thing is that, from all of the global commodity research reports that I happen to read during a week or month, only a maximum of 10% seem to have any meaningful analysis, forecasting and detailed outlooks focusing on this concept.
Thus, I think it’s only fair that we look at this in more detail.
In the case of Brasil, from the beginning of the 1960’s to a further 40 years later just before the turn of another decade, we saw not only the country’s income per capita/GDP per capital shift from $2,581 USD - $8,160 USD but annual growth move in a linear growth pattern at a average rate of 2.38%. To give you an idea into how much weight this carried for the country, already industrialized countries such as; UK, USA, Canada & France had only experienced growth 2.5%. This then provides farmers, like the ones I’ve discussed in previous blogs with increasingly sustainable levels of PPP (purchasing power parity) when it comes to planting crops like corn, as wages have increased, without the need for currency or interest rates manipulations.
Source: WDI- World Bank
Given the rates of GDP from the 60’s to the early 2000’s, Brazil has since witnessed its dependence on agriculture as a key driver in its way towards moderate growth move towards the downside, as with economic growth comes income increases, incomes give birth to purchasing power and purchasing power provides areas of new investment. Sovereign international entities saw this as a way to take advantage of an already booming agricultural producing nation, as we witnessed global commodity giants (names not included) by pumping more investment, this time in the form of foreign investments into the country and gaining access to areas like Santos through control of ports or Mato Grosso, one of Brasil’s biggest corn growing regions. The unfortunate thing is that whilst global entities where (and continue) to sleep on beds made of money, the smaller, local companies where slowly but surely forced to sell their businesses to these powerhouses or risk losing them through sheer price wars.... quick frankly a war in which they lost. Besides this, we need to look at the opportunities this has created due to this, for not only have countries like Brasil moved into positive growth as its agricultural market acts as a variable towards income increases, but it also provides foundations to the supply and demand segments of the commodity cycle. For example due to certain favourable, often described as post-seasonal weather conditions farmers in areas like Rodônia, can now produce a second corn crop most commonly known as ‘safrinha’. Essentially it’s the way of producing two crops in a single season. This has put for many years, Brazilian farmers in particular at a distinct advantage against producers in regions such as Ohio, Nebraska and Minnesota, who have in recent year struggled to gain a strong hold on the market as they had many decades ago. Reports have shown that the safrinha crop is now the most important in terms of revenue streams for these Brazilian farmers, for example according to a report produced by CONAB, they estimate that in the state of Parana, the safrinha will produce some 10.9 mmt worth of safrinha corn which would produce an increase of almost 7.2% from this time last year. More fundamentally, agricultural policies are central to the successes of small scale farmers and enterprises in this region.
Another important statistic recently released by CONAB shows that 56% of annual corn crops in the country are accounted for from safrinha, with areas like Mato Grosso, Mato Grosso do Sul, Goias & Parana being the most profitable regions. However it’s not all that rosy, this is part of the problem that farmers are facing and we’re not talking champagne problems! A prime example being the pressure that the large safrinha crop is putting on global prices and also in the regions that grow them, recent reports out of Mato Grosso show that prices were being sold as of July 19th 2013 between R$ 10.17- 11.00 a sack (60 kilos) which are far too low for farmers to realise any significant profits this then gives birth to ‘reluctance of vendor’- as farmers hold onto their produce in an already insufficient storage space environment , in actual fact the prices are the lowest in the region since 2010, these extremely low prices are also credited to the inventory recovery in the U.S grain belt following last year’s disaster- putting further force on international prices shifts.
As a result, the government, through the agricultural minister Mr Antonio Andrade has pledged to set aside a record R$ 700 million to purchase up to 10 million tons of corn through a series of auctions or Contratos de Opção de Venda (COV) which will not only help farmers and small business owners to receive a fair price for their stock but, also send a message to others within the country whom are feeling the heat of global prices on their investment for the following year(s) replanting & reinvestment. Over recent years demand has risen to out shine supply, especially in the grain market which serves as much more potent component to peoples’ lives, whether it’s through food, energy or livestock feed, the point I’m making is that stability reduces risk for investors, whether they are multinational conglomerates or grain farmers considering planting more crops for the investment next season.
Looking away from the obviously (China), most analysts and investors in the grain markets fail to look at the fundamental difference between an economy like China’s- whose economy grew at an average rate of 6.18% for the best part of 40 years between 1960- 2009 and a country like Nigeria who, in contrast showed a GDP growth rate of 0.37% between the same era. Our concentration is on break-out nations, those countries who for many decades these countries have sustained levels of growth above the world measured benchmarks to move into more(but not yet ‘ideal’) political stability, effective governance and institutions & favourable environments for private enterprise, all of which are basic characteristics of rapidly growing economies. Placing these into the light of the S&D model which is grain focused, I realise that firstly; population growth is at the forefront of the demand scope for these nations. Indonesia at 243 million, South Korea at 50 million, lets include Nigeria into this equation also- 170 million and an economy which is set to have a larger population than the U.S by 2050. Secondly, these countries are also behemoths when the situation of importing grains comes to mind. Nigeria for example, unfortunately are no longer a major wheat exporting nation that they once were, they also have a major reliability on corn as a cheap staple, feeding over 70% of its poor. Indonesia and South Korea (and soon to be Japan) have both in recent weeks returned to purchase U.S western wheat after they banned imports following a GMO scandal, this also places pressure on nations like Kazakhstan, Ukraine and Australia to feed nations who are world wheat producing nations. Yet with the threat of import tariff increases being placed on wheat from the Ukraine, this only adds to the S&D imbalance, prices hikes and subsequently an underlining responsibility for lesser exporting nations (in this particular case- Brasil) to fill a void.
Unlike trading in the paper markets, we here in the physical market need to provide the delivery of the contracts in which we analyze/trade, this has been a recurrent problem for certain countries, especially Brasil-not least given their heavy responsibility in the global commodity markets, therefore if a sustained price of local sales in soybean, wheat or corn cannot be agreed with buyers in Mato Grosso for example, this only gives traders & large buyers an additional problem when discussing insurance prices on their supposed freight of goods, which then (although not immediately) gets passed unto global consumers through higher prices.
For the feed market, the whole concept of growing economies, land locking of commodities, population growth, they all have the same problem-weighting as each other. For example, look at Africa as a continent, a population of 1.1billion people 70% of which have been living on less than$ 1.30 a day. To put this into some sort of perspective, that’s 82% of Chinas population that live in the whole continent, better yet it equates 57.4% of the 134 billion people living in China or 770 million people that are yet to feel the positive effects of increased income (many still bearing the effects of civil and cross-border conflicts/wars, and political instability). Note that the African continent’s efforts to strength itself have yet to fulfil its potential (unlike China who is now experience slowed growth), so what’s often seen as unstable investment potential for affluent individuals and colossal corporations I see as the driving force behind the increased demand in grain market within the next two decades, supported not only by an increased income per capita which gives birth to improved health, thus longer life expectancy and therefore a demand for various types of foods to support a diet connected with a more affluent lifestyle, also population growth cannot go unnoticed. According to the World Bank, the population of Africa is to double to just over 2 billion people within the next 37 years. It takes one eight grain calories to produce one protein calorie which is the staple diet for the majority of feed for livestock, therefore the more demand for meat alone “should” drive production of corn towards the upside.
Pro cyclical relationship(s)
In order to combat against higher demand for grains in the long-term, strictly from a major producing nation prospective, it’s clear that we must first begin with the gross nation income increases of that economy and how coupled with its ability to enforce fundamental plans on factor accumulation productivity growth subsequently allow new investment increases through the increase of capital stock, provide better means of re-investment towards areas such as agriculture production. The illustrative growth calculation that I’ve prepared (presented below) is based on simple, yet highly useful mathematical techniques’; it incorporate elements of the Solow growth macro model and others.
This measures the contribution to production on efficiency and other influences on overall production. For example; an expansion of the labor force (due to better initial economic growth) makes it possible for the expansion of capital stock, or for the purpose of agriculture and farming- reinvestment for next season’s crop and therefore growth in the overall production to overall economic growth . This equation results in "Xe" as GNI (gross national income) or GDP (gross national product), "Wc" representing wages for capital (or reinvestment), "Wl" is wages for the labor. Both "Ac" and Al" being accumulations of growth on capital (again, reinvestment) and labor. P is production (on a crop such as ‘safrinha’ for example). Yet this doesn’t provide a measurement relating to actual delivery of produce in the whole concept. In other words, it’s great to have record numbers of corn, sugar, wheat, coffee and so on, but if a nation has imposed unnecessary high costs on small medium enterprises in the form of licensing, permits not to mention market manipulation where smaller, yet rather successful producers cannot sell produce due to extremely low prices.
The reason behind the exclusion of ‘possibilities in physical delivery discrepancies’ – high licensing costs, bottlenecking at ports, market manipulation and other variables which can directly slow down or halt delivery of product and therefore change the P measurement of the equation, is because it is what’s known as a ‘normative concept’: Essentially, how can you measure, determine or calculate when, where and to what extent high licensing costs, insufficient manpower at ports, flaws in basic infrastructure etc will surface and become a liability to production?
That said, it’s been proven through studies from institutes such as Oxford University & the World Bank that the early stages of transition from emerging economies into developed and ones all showed an improvement of domestic agricultural markets as the main driver behind such powerful transitions and vice versa, thus creating a unconstrained cycle.
Até logo.
Mr Cordeal Agrícola-July 2013
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