The fundamentals driving agricultural markets have shifted in the last two weeks. A recent crop tour identified more drought stress than most anticipated, dry weather has continued in the western corn belt -- but the biggest factor has been demand.
Chinese purchases of U.S. corn and soybeans have continued to exceed most trader expectations and have created a dynamic shift from asking “when will they start” to “when will they stop?“
As of this writing (including daily announcements) China has bought 7.143 million metric tons (mmt) of U.S. corn and 13.2 mmt of beans for new crop delivery. According to all the data that we get from USDA as well as private sources, China has likely purchased around 8.2-9 million metric tons of corn year to date from the world. Strangely, we believe they had purchased a total of about 7.2 mmt on the day of the last USDA report. Yet, USDA left Chinese imports estimate at 7 mmt and production at 260 mmt which is unchanged from last year.
Chinese crop deficits
Using USDA’s numbers, China will have a 17 mmt deficit between production and consumption. However, it is logical to think that flooding in the South, droughts in the North, army worm in the northeast have likely reduced the Chinese crop to 250 mmt or less. This would create a 27 mmt deficit.
With most of their reserve stocks drawn out (we are told they are down to the 2018 + inventory), China could be facing a significant challenge in meeting demand. (for an earlier blog that pretty much nailed it, click here.
Domestic demand surging
Domestic use of U.S. corn has also outpaced trader expectations. Many traders were expecting as much as a billion bushel loss in ethanol demand after the COVID-19 shut down reduced driving and fuel use.
However, demand for ethanol products for sanitary uses, and a significant shutdown of less efficient plants, caused the profitability to quickly recover as supply fell and demand rose.
Last week’s grind of 93.3 million bushels actually exceeded the 88 million bushels needed to meet USDA's projections.
Feed use has also remained very strong as feedlots aggressively place cattle and the poultry industry maintains annual expansion despite poor margins. The hog industry in the United States is probably the biggest question mark as long term losses continue to force tough decisions for production facilities.
Using private yield estimates for the U.S., ending stocks are likely to drop the 2.4 billion bushels versus USDA at 2.7 billion bushels. Ultimately if final yield is 177.5 bushels per acre, ending stocks would drop to 2.2 billion. If China buys 12 million metric tons of corn from the U.S., demand would exceed USDA's current projection by nearly another 200 million bushels and stocks could fall to 2.0 billion bushel.
Is that a number that could be seen as bullish?
In the big picture the answer is no -- unless you're having a supply problem somewhere in the world. No one knows what La Niña will do or how long it will last, but it is currently causing a drought in Argentina. (More on La Niña here.)
The U.S. fiscal policy continues to be very bearish. The U.S. dollar and unprecedented stimulus worldwide continues to set the stage for inflation. Both are friendly to cheap commodities. Rallies in lumber, gold, silver, copper, sugar, cocoa are just a few examples of what can happen when money starts to chase a cheap commodity.
Even so, we do know from an economic standpoint and long term valuations, that an ending stocks number below 2.5 does not warrant $3.00 to $3.20 corn. Thus, the combination of reduced supply, growing demand, inflationary pressure and a weaker dollar all suggest long-term lows have been made.
Will we see the market trade to a major rally? That will depend on acreage expansion and how supply can meet the demand trend in the long run.
Market strategy now
Our clients are approximately 40% sold on corn and catch up sales are being made against the $3.60 summer high. Long term we want to maintain ownership into 2021. We have replaced some of this with long term options using July 21 and December 21 contracts.
We have also been selling soybeans aggressively as prices have rallied to the year’s high and based on our www.AgMarket.App, clients are able to sell at a profitable level. These positions for the most part have been bought back in July 21 or November 21 option strategies.
Our approach is to concentrate in strengthening clients’ cash flow position while maintaining ownership as these macro factors play out. If you would like more information on our approach, please feel free to call us.