More "noise" from the futures markets

Lean hogs: Aug-14 contract -

Source: Barchart

Live cattle: Aug-14 contract -

Source: Barchart

These price increase are mostly driven by exogenous factors such as the 2012 drought and the Porcine Epidemic Diarrhea virus. Nevertheless combine this with higher energy and shelter prices and it's not simply Yellen's CPI “noise”:

Steve Liesman, CNBC: Is every reason to expect, Madam Chair, that the PCE inflation rate, which is followed by the Fed, looks likely to exceed your 2016 consensus forecast next week? Does this suggest that the Federal Reserve is behind the curve on inflation? And what tolerance is there for higher inflation at the Federal Reserve? And if it's above the 2 target, then how is that not kind of blowing through a target the same way you blew through the six and a half percent unemployment target in that they become these soft targets? Thanks.

Chair Yellen: Well, thanks for the question. So, I think recent readings on, for example, the CPI index have been a bit on the high side, but I think it's-- the data that we're seeing is noisy . I think it's important to remember that broadly speaking, inflation is evolving in line with the committee's expectations.

________________________________________________________________________________

SoberLook.com

Sign up for our daily newsletter called the Daily Shot. It's a quick graphical summary of topics covered here and on Twitter (see overview). Emails are distributed via Freelists.org and are NEVER sold or otherwise shared with anyone.


From our sponsor:

Can the rally in global commodities be sustained?

We are seeing broad improvements across global commodity markets. To be sure, commodity valuations are still at depressed levels relative to the past decade, but after a prolonged decline, broad indices seem to have stabilized.

CRB BLS broad commodity index (source: barchart)

The rally across a number of commodity sectors however resulted from a variety of factors, most of which are believed to be transient. For example the cold winter pushed up US natural gas prices (though exports could provide a floor - see post) and hot/dry conditions in Brazil sent coffee prices flying (see chart). Some argue that the two unusual weather patterns are related - a scary thought.

The Ukrainian crisis on the other hand pushed up wheat and corn prices.

WSJ: - Wheat prices rose as much as 6.8% before easing in midday trading. Wheat for March delivery at the Chicago Board of Trade settled at $6.26 a bushel, up 27 cents, the highest closing price in nearly three months.

May US corn futures (source: barchart)

Corn futures also gained from the Ukraine unrest, finishing at their highest price in more than five months. Corn for March delivery rose 6 cents, or 1.4%, to $4.64 a bushel in Chicago.

Ukraine grain exports continued Monday despite the unrest. However, looking ahead, grain buyers that would normally consider the country for grain shipments are largely turning elsewhere, three Europe-based traders who deal in physical grain supplies said Monday. The traders said difficulty obtaining financing due to the country's turmoil is slowing business for Ukraine-based grain companies.

Gold has also been recovering recently - up 12% for the year on slow Fed taper and better demand.

It's not clear if these higher prices across a number of commodities can be sustained. Slower growth in China (combined with weaker yuan) is not helping base metals such as copper for example. Many analysts are also quite bearish on crude oil. Should the geopolitical risks subside, we may get a correction there. Nevertheless we haven't had a commodities rally like this in quite some time.

SoberLook.com

From our sponsor:

Global wheat markets seem to be well supplied

US wheat futures fell to new lows today not seen since 2012. Some had hoped  wheat prices would stabilize as Egypt, the world's largest wheat buyer, entered the market.

WSJ: - Egypt's less-frequent purchases has been a reason why wheat futures were one of the worst-performing commodities of 2013, when they slumped 18% on the year.

Analysts are now optimistic that prices are low enough to mean the North African country will continue ramping up its purchases this year in a bid to avoid public discontent with food shortages.

At the weekend Egypt's state-owned wheat buyer, the General Authority for Supply Commodities, bought 535,000 metric tons of Ukrainian, Russian, French and Romanian origin wheat at an average price of $317 a ton. This is one of the North African country's biggest purchases in the international market in recent years, topping a 475,000-ton Black Sea order in September 2012 and a 420,000-ton purchase of Russian wheat a year before.

Another factor providing support for wheat in recent days has been the frigid weather in the US, which may pose risks to dormant wheat in the Midwest (see story).

Nevertheless the March-2014 CBOT wheat futures declined some 1.4% today.

March 2014 whet futures

It seems that increased production in Canada and Australia may keep the global markets well-supplied. Stronger dollar due to better than expected ADP employment report today (see story) is not helping overall commodity prices either.

Note: Here is an interesting article discussing how low wheat and corn prices could be damaging to some Republican candidates in the upcoming elections.

SoberLook.com

From our sponsor:

Soy, corn futures spike on scorching Midwest weather

Here we go again. While the early part of the US Midwest summer has been fairly benign for crops, farmers' luck has run out in late August. The central part of the US is experiencing a broad heat wave, putting a number of crops at risk.

Source: Intellicast.com

After what happened last summer (see post), this is particularly an unwelcome development. Crop conditions have been decent through early August, but all that is about to change.

Corn crop conditions by years (source: USDA)

Agriculture.com: - Crop conditions in many key areas may be going from bad to worse in the next few days. Temperatures will scrape the triple-digits around the nation's center to begin this week. With the exception of a quick pass-through by a "weak cool front" bringing some spotty showers later in the week, the weather will remain hot and dry for the next week and a half or so, forecasters say.

Prices on soy, corn, wheat, and other grains spiked this morning as a result - with the soy crop being particularly vulnerable at this stage. Here are the most active contracts for corn and soy.

Source: barchart

This does not bode well for emerging economies who import some of these products and have recently experienced significant currency depreciations.

SoberLook.com

From our sponsor:

Commodity prices under pressure

As oil prices retreated from the refinery demand driven spike (see post), the CRB BLS Spot Index of 23 commodity markets (see description) hit a new low for the year. Per earlier discussion (see post), the equity markets have been discounting the rally in crude and so far have been proven right.

Source: Barchart

Recent price declines in commodities are not limited to energy however. Corn, coffee, copper, and several other products are under pressure.

CORN FUTURES

Deceleration in emerging markets' economic growth (particularly China) and increasing competition among commodity producing nations have been responsible for some of the declines. Tighter current or expected monetary policy, whether in India, China, Turkey, or in the US (accompanied by higher interest rates) has also added to weakness in a number of commodity sectors.

SoberLook.com

From our sponsor:

Hedge funds hurt by drop in corn, wheat prices, but the decline may be short-lived

Agricultural commodities got slammed last week as a result of two news items.

1. Corn planting acreage is expected to hit the highest level since 1936. With supplies low and prices expected to stay firm, farmers are planning to expand the number of acres used for corn. This points to an immense flexibility of the US agricultural economy.

Farm Futures: - The Farm Futures survey of more than 1,750 growers found farmers ready to plant 97.43 million acres of corn, up .3% from 2012. If achieved, the total would be the most since 1936.

The increase in soybeans could be even more dramatic. Farmers said they want to plant 79.09 million acres this spring, up 2.5% from 2012 and easily an all-time record if achieved.

2. While corn supplies are materially lower than last year, the latest USDA data showed stocks did not decline as quickly as expected. Apparently the demand for animal feed has been relatively weak.

Farm Futures: - May corn futures dropped their daily 40-cent limit this morning, after USDA shocked the market once again with a March 1 grain stocks number that showed much bigger supplies than expected.

At 5.399 billion bushels, inventories are down 10% from a year ago. The government's estimate was above even the forecast from Farm Futures survey, the largest pre-report estimate in the market, and almost 400 million bushels above the average trade guess.

The data suggests lower than expected corn feeding during the second quarter of the marketing year and perhaps greater 2012 crop production as well. Wheat stocks of 1.234 billion were also greater than expectations, implying less wheat was also fed than traders anticipated.

Anecdotal evidence suggests that a number of hedge funds got caught being long corn and were forced to unwind. CFTC data shows speculative net positions in corn as of 3/26 at the highest level (net long) for the year.

Speculative corn net contracts (source: CFTC)

The unwind forced a violent selloff across agricultural futures, particularly corn - hitting daily down-limit.

May corn futures (source: Barchart.com)

With speculative players licking their wounds, some agricultural commodities may present a good investment opportunity. Here are some reasons the selloff in corn may be short-lived after the market digests the news.

1. Demand for soybeans from China may yet encourage a shift from corn and wheat acreage into soy. It won't take much of a shift to send prices higher.

Farm Futures: - "With stocks of both corn and soybeans projected near historic lows, strong acreage this spring is a must to rebuild inventories," says Farm Futures Senior Editor Bryce Knorr, who conducted the research. "... Some 18% of those surveyed said they could still shift 50% or more of their acres."

2. South American crops are expected to remain moderate, as logistics and weather have curtailed significant crop improvements.

3. The US may be in for another 2012-style drought in 2013.

Inside Climate News: - Drought conditions in more than half of the United States have slipped into a pattern that climatologists say is uncomfortably similar to the most severe droughts in recent U.S. history, including the 1930s Dust Bowl and the widespread 1950s drought. 

Source: U.S. Drought Monitor

The 2013 drought season is already off to a worse start than in 2012 or 2011—a trend that scientists at the National Oceanic and Atmospheric Administration (NOAA) say is a good indicator, based on historical records, that the entire year will be drier than last year, even if spring and summer rainfall and temperatures remain the same. If rainfall decreases and temperatures rise, as climatologists are predicting will happen this year, the drought could be even more severe.

The federal researchers also say there is less than a 20 percent chance the drought will end in the next six months.

SoberLook.com

From our sponsor:

Midwest drought continues; winter wheat in trouble

Agricultural commodities are in the news once again. While corn and soy prices have stabilized, wheat continues to rally.

Wheat futures (ZWN13; source: Barchart)

For those of us on the East coast of the US, the drought of 2012 seems like a distant memory, given the recent weather conditions (see post). So what's driving these prices higher? Sadly as the East Coast got hit by Hurricane Sandy and the nor'easter that followed, the Midwest has been in the middle of an ongoing drought. Here is the latest drought monitor map from the University of Nebraska.

Source: the National Drought Mitigation Center at the University of Nebraska-Lincoln, the United States Department of Agriculture, and the National Oceanic and Atmospheric Administration.

The focus now is on winter wheat. This is the wheat that is planted after the fall harvest. It sprouts before temperatures drop to freezing levels and stays dormant through the winter until the soil warms in early spring. Winter wheat is then ready to be harvested by early summer. The current drought is damaging wheat across Oklahoma and Kansas. Once again we look to the latest USDA report on crop conditions (see post), which shows the percentage of wheat in good/excellent conditions below 40%.

US wheat crop rated good/excellent (%; source: DB)

The Republic: - ... dry conditions intensified in Kansas, the top U.S. producer of winter wheat. Thursday's update, put out by the National Drought Mitigation Center at the University of Nebraska in Lincoln, showed that the expanse of that state in extreme or exceptional drought climbed roughly 6 percentage points, to 83.8 percent.

Three-quarters of hard-hit Oklahoma — another key winter wheat state — is mired in the two highest forms of drought, up 8 percentage points from the previous week. The Oklahoma Mesonet, a statewide network of environmental monitoring stations, said that 18 of its stations recorded less than one-tenth of an inch of rainfall in October, while 66 measured less than an inch.

"The combination of warm and dry weather was taking a toll on grasses and small grains" such as winter wheat, which as of Monday was running out moisture, David Miskus, a senior meteorologist with the Climate Prediction Center, wrote in authoring Thursday's report.

Thirty percent of Oklahoma's fledgling winter wheat crop was found to be in poor to very poor shape, a decline of 18 percentage points from the previous week, as topsoil moisture in the state continues to grow increasingly parched.

"With so much of Oklahoma already in (extreme or exceptional drought), it is getting difficult to degrade the state further," Miskus wrote.

A major driver of the overall winter wheat harvest yields will be the amount of rain in the spring. With a great deal of wheat already in trouble, the "weather premium" will be priced into wheat futures until there is clarity on precipitation levels next year.

DB: - Concerns about production and quality of global wheat crops have intensified. Focus is also shifting to the US as crop conditions for winter wheat are poor on an historical basis. However, spring rainfall is the key to wheat yields. Our work shows that precipitation before dormancy has a greater impact on abandonment than yields. We expect a weather premium to remain until the outlook for spring weather becomes clearer.

For now however, wheat prices will remain near recent highs.

SoberLook.com

The impact of commodity index rebalancing

Every year the two major commodity indices (S&P GSCI the DJUBS) are rebalanced based on the sizes of specific commodity markets. This year's changes are smaller than last year's adjustments, which materially impacted the Brent/WTI mix (see discussion). Nevertheless the rebalancing is expected to generate flows in or out of certain commodities by institutional investors and funds that track these indices.

The chart below from Credit Suisse shows what the impact of the next rebalancing is expected to be. Once again, the largest move will be a reduction in WTI and an increase in Brent weights. But flows in other commodities are expected as well.

Source: Credit Suisse

The overall impact will be a net inflow into energy commodities, and a net outflow from agricultural commodities and an outflow from base metals.

SoberLook.com

Uncertainties about South American harvests are keeping global grain prices elevated

In spite of promises of record wheat and corn harvests in South America (discussed here), grain prices continue to stay elevated.

May 2013 wheat futures (Source: Barchart)

All eyes are on the soy, corn, and wheat sowing in the Southern Hemisphere, as buyers of agricultural commodities expect these spring crops to replenish the supplies lost to the summer's drought. But is it possible that the South American harvests will be worse than expected? That certainly seems to be the case with respect to Argentina.

Reuters: - Argentina's upcoming wheat harvest is expected to shrink 17 percent from last season, the Agriculture Ministry said on Thursday, as farmers skirt government export curbs by shifting to other crops.

The forecast drop to 11.5 million tonnes is bad news for consumer nations looking to Argentina to help make up for thin supplies caused by droughts in bread basket producers such as the United States, Russia and Australia.

In its monthly crop report, the Argentine ministry stuck by its view that 3.7 million hectares were sown with wheat in the current crop year, down 20 percent from the 2011/12 season.

Farmers have shied away from wheat to avoid export limits that do not apply to Argentina's main agricultural export, soy, which will start being planted this month and could be headed for a record year.

Furthermore, at least so far, the weather in many parts of South America has not cooperated - one uncertainty that all harvest forecasts can not fully incorporate.

Agrimoney: - Prospects of South America replenishing world corn supplies are taking a dent from excessive rains which are delaying plantings, and mean that the crop has got off to a "below average start".

The Buenos Aires grains exchange on Thursday said that the pace of corn sowings in Argentina, the second-ranked exporter, had slowed to 6.9% of area in the last week, leaving 32% of corn planted.

That is 11 points, equivalent to some 370,000 hectares, behind the average pace.

"Planting of commercial corn has slowed due to continuous rainfall that has been recorded over much of the agricultural area," the exchange said, flagging amounts of up to 300mm (12 inches) in some areas.

As discussed before (see post), elevated food prices over a prolonged period of time will generate more uncertainty and even civil unrest in emerging markets nations. The risks of food inflation (which can have a strong impact on inflation expectations) in some countries will also prevent central banks from shifting to a more accommodative policy during periods of slow growth (see post).

SoberLook.com

More agricultural commodity price increases expected before the South American harvest next spring

The drought of 2012 has pushed agricultural commodity prices to new highs. In spite if these price increases, demand has remained strong, putting pressure on inventories. Now the focus will be on the harvest progress in South America, as the planting season approaches. With prices remaining at lofty levels, Brazil, Argentina, and others are preparing to plant record harvests, which should ease the supply disruption in late spring of next year. Until then prices will stay elevated and could spike further, particularly if the weather does not cooperate. In fact according to Goldman, prices are going to rise on tight supplies alone, but the path will clearly depend on the weather.

GS: - The current spike has come in response to the summer drought in the US Midwest, which was one of the worst in the past century. In addition, a wide set of agricultural commodity producing countries have experienced adverse weather conditions (such as Brazil and Argentina in the past winter, and Russia, Ukraine, Kazakhstan and India). Damien Courvalin from our Commodities Strategy Team points out that these disruptions have caused substantial losses in global food supply.
...
Despite the resulting 40% spike in the S&P GSCI® Agricultural Index between mid-June and mid-July, demand for agricultural commodities has remained robust. The net result has been a decline in inventories, with the USDA’s September 1 stocks of corn and wheat well below expectations...

Our Commodities Strategy team expect demand to remain resilient and supply to remain binding, leading soybean and corn prices to new highs in the coming months. Higher prices will eventually be followed by a supply response, and if weather returns to normal, we should expect a large crop in South America (harvested next spring) and in the US (harvested next autumn). In the interim, prices are likely to remain high.

However, there is a clear weather dependency to this assessment; further weather adversity is likely to pose further upside risks to food prices.

Source: GS

This projection suggests that we may not have seen the highs for the year in agricultural commodities. Prices could rise further before the South American crops bring much needed relief.

SoberLook.com

Those pesky inflation surprises

Inflationary pressures, particularly food inflation, continue to percolate across some emerging markets nations. Central bankers don't like openly discussing the problem, fearing just talking about it could raise inflation expectations. But that does not make the problem any less real.

India: Even though the wholesale inflation (WPI) remains under 8%, it has not declined further in spite of India's economic slowdown (see post), and actually rose last month. At the same time food prices remain elevated.

Bloomberg: - The Reserve Bank of India may focus on inflation as it meets today, especially after the U.S. Federal Reserve’s decision to embark on a third round of quantitative easing. Previous rounds of easing have stoked foreign capital inflows and increases in commodity prices, especially oil.
...
[Indian] wholesale price inflation accelerated to 7.55 percent in August, the highest level in three months, and remains well above the 4 percent to 4.5 percent range where the RBI intends to anchor inflation expectations. The central bank will also be concerned about potential spillover effects from the spike in global food prices.

Russia: The central bank actually had to raise rates due to concerns about inflationary pressure.

WSJ: - The Bank of Russia unexpectedly raised interest rates across the board on Thursday for the first time in nine months, as it struggles to contain increases in food prices and inflation while the economy slows.

The central bank said its decision to raise rates by a quarter of a percentage point was driven by a sharp rise in the rate of inflation in August and early September that had exceeded the bank's "medium-term targets."

The benchmark refinancing rate was increased to 8.25% from 8%.

The decision caught some economists off guard. Eight of 11 economists polled by Dow Jones Newswires before Thursday's announcement had said they expected the central bank to leave rates.

Some other nations are seeing a pick up in prices as well.

Bloomberg/BW: - Indonesia’s inflation unexpectedly accelerated in August on rising food costs, limiting scope for the central bank to cut interest rates even as exports slumped for a fourth month.

Clearly slower global growth and weak manufacturing should keep inflation in check, but as monetary expansion in the US and the Eurozone picks up, these "inflation surprises" may become more commonplace.

SoberLook.com

It's the food prices, stupid

Once again the world is shocked to see how quickly unrest can erupt across the Muslim world, spreading almost overnight into numerous nations: Tunisia, Egypt, Sudan, Yemen, Pakistan, etc. The trigger this time happened to be an idiotic YouTube post called Innocence of Muslims which pokes fun at Prophet Muhammad and the origins of Islam.

Time: - In a saner world, the trailer for Innocence of Muslims would get no response other than as an example of terrible filmmaking. The 14-minute video, purporting to be excerpted from a larger movie propagandizing present-day Muslims and the life of Muhammad, is confoundingly bad, filled with incongruous accents, haphazard cuts, ludicrous dialogue and green-screen so bad that the actors appear to be floating in the air. 

But how is it that this fringe video could suddenly generate this much hatred and violence - taking numerous lives in the process? The answer is that just as Arab Spring had little to do with zeal for democratic freedom (discussed here), these new violent protests have little to do with a new surge in anti-American sentiment (which has been strong for generations).

The unfortunate reality is that this unrest in numerous Muslim nations (as predicted here) is driven, far more than anything else, by the rise in food prices across the region. This is the same phenomena that toppled brutal dictators who were able to cling to power for decades.

The Economist: - “The food-price spike was the final nail in the coffin for regimes that were failing to deliver on their side of the social contract,” says Jane Harrigan of London's School of Oriental and African Studies.

And once again these price increases bring about severe hardships among the populations of these nations (that are difficult for people in the developed world to fully appreciate), fueling unrest and hatred.

Ahram: - As the United Nations issues warnings over soaring global food prices, Egypt may have more to worry about than most. A net food importer and the world's biggest consumer of foreign wheat, the Arab world's most populous country would be wise to keep an eye on consumer prices indices as well as its budget, say experts.

In late August, three UN agencies made a joint statement suggesting the world could be on the brink of a repeat of the 2007-8 food crisis, citing "sharp increases" in the prices of maize, wheat and soybean caused by summer droughts and scorched crops across the globe.

Global food prices soared a monthly 10 per cent in July, the World Bank said in August as it warned of the effect on domestic prices.

"Africa and the Middle East are particularly vulnerable, but so are people in other countries where the prices of grains have gone up abruptly," the Bank said.

The situation described above is by no means unique to Egypt. Of course the danger going forward is that agricultural commodity prices will stay elevated. What the Great North American Drought had started, the Fed will continue (via monetary expansion), as food inflation is exported globally. And someone will be blamed - if not the local dictators, it will be the US. This (and not any YouTube video) will ultimately translate into dangerous geopolitical uncertainties and further hardships and loss of life.

Diapason Global Agriculture Price Index (Bloomberg)

SoberLook.com

It's not just about corn: world food prices jump 10 percent

In July after the post on the drought conditions causing food inflation globally (see this discussion), we've gotten a number of comments stating that it's a North American problem. In particular emails from India and the Middle East stated adamantly that many poor regions of the world rely more on rice - therefore corn prices in the US would not be an issue. The statement about rice is in fact correct. But it's not just about corn (see discussion on soy), and stable rice harvests are not going to prevent global food inflation that is threatening a number of nations. Unfortunately it will be the poor communities that will be hit the hardest.

Reuters: - World food prices jumped 10 percent in July as drought parched crop lands in the United States and Eastern Europe, the World Bank said in a statement urging governments to shore up programs that protect their most vulnerable populations.

From June to July, corn and wheat prices rose by 25 percent each, soybean prices by 17 percent, and only rice prices went down, by 4 percent, the World Bank said on Thursday.

Overall, the World Bank's Food Price Index, which tracks the price of internationally traded food commodities, was 6 percent higher than in July of last year, and 1 percent over the previous peak of February 2011.

Let's just hope that our friends on the FOMC are keenly aware of this situation and consider the full ramifications of their actions.

SoberLook.com

The soy price shock in the US will reverberate across China

The Chicago Board of Trade soy futures hit a new record Sunday evening as attention now shifts from corn to soy. Traders are coming to the realization that soy supply may not last long enough to be replenished by crops from South America.

Bloomberg: - “Corn was the story going into the crop tour and now soybeans are the story after leaving the fields this week,” Peter Meyer, a senior director of agriculture commodities at PIRA Energy Group in New York, said in an interview in Owatonna, Minnesota, after completing his sixth Pro Farmer tour. “Mother Nature shut down the soybean crop well before it reached its potential. The U.S. may run out of soybeans before the start of the South America harvests in February.”

Soy nearby contract (Bloomberg)

Again, a number of analysts continue to argue that the North American drought should not have a significant impact on Asia. That is just not true. Some economists simply don't appreciate just how global agricultural markets have become.

Bloomberg: - China, the world’s largest buyer and consumer, purchased 165,000 metric tons of soybeans and 55,000 tons of soybean oil from the U.S., the USDA reported yesterday. China may import a record 59.5 million tons of soybeans in the year that begins Oct. 1, the agency said Aug. 10.

World soybean supplies may shrink by 33 million to 35 million tons in September to February, compared with a year earlier, forcing China to reduce imports by 4 million tons, researcher Oil World said Aug. 21.

Tight global supply of soy will translate into government subsidies and/or food inflation in China and elsewhere in Asia. Fear of food inflation is one of the reasons China has not been as aggressive with its stimulus programs in spite of slowing economy. Here is a quote from the LA Times that describes how these skyrocketing soy prices will reverberate across China.

LA Times: - Construction laborer Yi Jichun has never heard of Illinois or Iowa. But the migrant worker's favorite comfort food comes straight out of the U.S. Midwest: soybean oil.

The world's biggest consumers of edible oils, Chinese households have developed a taste for the stuff that would make a county fair fry cook proud. Be it a simple stir-fry, poached fish or deep-fried pork ribs, many Chinese diners love their grub covered in an oily sheen. Jugs of the golden liquid make popular gifts for Chinese New Year.

"Without the oil, it would taste too plain," Yi said as he tucked into a lunch of sliced cucumbers and chicken drumsticks slathered with grease. "I wouldn't want to finish it."

And that has officials in Beijing worried. The worst U.S. drought in half a century is sending global grain prices soaring. The fallout is almost certain to be felt at dinner tables across China. The No. 1 foreign buyer of American soybeans, which are pressed into cooking oil and used for animal feed, China last year purchased about half of U.S. exports, more than $10.4 billion worth, according to the American Soybean Assn. China has also stepped up purchases of U.S. corn and wheat to feed the nation's growing appetite.

Poor U.S. harvests could fuel Chinese food inflation and social discontent. China has already begun tapping its grain reserves to ensure price stability. The government has ordered the nation's biggest cooking oil producers twice in recent months to keep their prices in check. And it's scouring the globe for alternative supplies.

It won't be easy. More than two-thirds of cooking oil consumed in China comes from soybeans, and most of those soybeans are supplied by the U.S., according to Ma Wenfeng, an analyst with Beijing Orient Agribusiness Consultant Co. For now, Chinese consumers are bound to the fortunes of farmers in the American heartland.

"Soybean oil is the most important edible oil in China ... which makes us vulnerable to the drought" gripping the U.S., Ma said.

SoberLook.com

Europe not insulated from agricultural commodities shock

Some readers have commented that Europe is unlikely to be impacted as dramatically by the North American drought conditions and rising agricultural commodity prices as the US. But in these markets a local exogenous shock quickly becomes a global one. And this year the shock was actually global to begin with as crop damages, though most severe in north America, have been seen around the world. Given the recession in the Eurozone, the area is particularly vulnerable to these price increases.

Meanwhile prices continue to rise. The US agricultural commodities hit new records today.

Reuters: - Soybeans rallied 2.5 percent on Tuesday to hit another peak, while corn rose nearly 2 percent on evidence that the worst drought in half a century has shrunk the crop and that demand must be tempered through even higher prices.

Corn and soybean futures at the Chicago Board of Trade resumed their climb after a setback last week, making a push to retest record highs as money managers bet that end-users would scramble for the dwindling supplies.

Chicago wheat rose more than 2 percent in tandem with corn and soybeans and on a sharp drop in the dollar amid growing expectations that European officials will put together a plan to tackle the region's debt and economic crisis.

US corn futures

But things are not much better in Europe. Here is the price of corn (futures) traded in Paris. This spike is not just due to arbitrage opportunities with the US corn prices, but also to poor crop conditions in southern and eastern Europe.

NYSE Liffe Corn futures (euros per tonne)

The fact that the French wheat harvest is expected to be decent this year is not helping matters, as prices are driven by global fundamentals and livestock feed substitution (farmers substituting wheat for corn). Substitution has driven feed wheat price in London to new highs.

NYSE Liffe Feed Wheat futures (GBP per tonne)

As much as some in Europe think they are insulated from this food price shock, the futures markets are telling a different story.

SoberLook.com

Signs of food inflation seen across emerging markets are now visible in China

China's Ministry of Commerce blamed the increase in vegetable prices on "strong winds and rainfall in the country's eastern regions" that "disrupted production and logistics." Nevertheless vegetable prices are up 15.4% over the past four weeks.

China Daily: - The wholesale prices of 18 types of vegetables in 36 cities rose for the fourth consecutive week, up 2.9 percent week-on-week and 15.4 percent cumulatively over the past four weeks, according to the MOC.

Signs of food inflation seen across emerging markets are now visible in China. And anecdotal evidence (see these interviews by Radio Free Asia) suggests that official inflation gauges in China may be understating true consumer price increases. Wholesale food prices have definitely risen lately.

Source: ISI Group

A Bloomberg article this week even suggested that China may postpone some policy easing due to renewed inflationary concerns.

Bloomberg: - China’s slower-than-forecast cuts in banks’ reserve requirements show authorities are reluctant to shake their concern inflation will quicken, three months after Premier Wen Jiabao shifted priorities to boosting growth.

China has left the reserve ratio for the biggest banks at 20 percent since mid-May while lowering interest rates in June and July, bucking forecasts from HSBC Holdings Plc and Societe Generale SA that the government would build on three ratio reductions since Nov. 30.

The ISI Group had this to say on the topic of rising food prices, particularly in Emerging markets (discussed here a month ago) :

"This is an unexpected, supply-related problem for both consumers and policymakers around the world." 

SoberLook.com

Is ethanol impacting gasoline prices or are we looking at more political hype?

Bloomberg/BW: - The Obama administration is reviewing the country’s ethanol policy amid calls from both political parties and the United Nations to suspend annual targets as the worst drought in 56 years spurs corn prices.

Twenty-five U.S. senators, both Republicans and Democrats, asked Lisa Jackson, administrator of the Environmental Protection Agency, to halt or lower mandates on how much ethanol the country must use this year and next. The senators’ Aug. 7 letter followed an Aug. 1 petition from a bipartisan coalition of 156 members of the House of Representatives.

“I would simply say that the EPA, in consultation with the Department of Agriculture, is looking at this,” Jay Carney, the White House press secretary, said today in Washington. “I don’t have a statement one way or the other predicting what the experts are going to say.”

How material is the risk of US gasoline prices being impacted by the spike in corn prices or is this just a political maneuver on both sides of the isle? After all we are in the midst of what could turn out to be a close presidential election and such petitions should be taken with a grain of salt.

Based on the latest data, it turns out that these politicians are full of hot air. According to the US Energy Information Administration (EIA) the US ethanol production is expected to be reduced by only about 3%.

EIA: -  EIA has reduced its 2012 ethanol production forecast from 900 thousand bbl/d (13.8 billion gallons) in last month’s Outlook to 870 thousand bbl/d (13.3 billion gallons).  EIA expects ethanol production to recover in the second half of 2013, averaging about 880 thousand bbl/d for the year.

Also the elevated corn prices are not impacting ethanol price on a dollar for dollar basis. The spread between the two commodities has turned negative, with ethanol prices rising less sharply. The so-called "crush spread" is calculated as follows:

Crush Spread = (Ethanol price per gallon x 2.8) - Corn price per bushel

Source: EIA

This decline in spread means that ethanol prices are sufficiently sticky and will not rise in proportion to corn prices. And the 3% expected reduction in ethanol prices will simply reduce ethanol exports.

EIA does not expect the current situation in corn markets to have a significant effect on the pump price of gasoline. Given the year-to-date ethanol supply and the availability of banked renewable identification number (RIN) credits, the current relationship between the prices of ethanol and petroleum-based gasoline components, and the relatively modest share of ethanol in the overall gasoline pool [10%], we expect gasoline prices will continue to be driven by crude oil prices and refining margins. The impact of the forecasted decline in domestic ethanol production should be primarily reflected in reduced ethanol exports.

So when politicians begin taking credit for reducing gasoline prices by pressuring the EPA to relax the ethanol rules, it's nothing more than political gamesmanship. Changing the mixing rules will do little to impact the cost of gasoline because it's not ethanol but crude oil prices that determine how much we pay at the pump.

SoberLook.com

Drought showing up in steepening of hogs and cattle forward curves

Some readers may have a bit of trouble with this post, but these are the realities of the marketplace. The current spike in corn prices is already making its way into the forward prices for meat products. Cattle and hogs markets are pricing in the impact of higher feed costs cutting into margins. Cattle ranchers are also affected by the drought destroying pasture. Ranchers will be cutting herd numbers, sometimes simply because there is no fresh grass, while hay supplies are running low. Keeping barns sufficiently cool has also been a problem with misters and fans running full blast. As the stored feed begins to run out, cattle and hogs liquidation begins. Cattle sale barns are booked weeks in advance these days.

Reuters: - Cattle ranchers and hog farmers have been culling their herds because of high feed costs, scorched pasture and increased hay prices brought on by the drought.

This could result in a near-term boost to meat supplies and possible lower prices, but consumers might have to fork out more for meat next year when cattle and hog supplies tighten.

With the expectations of reduced supply in 2013, the futures curves for lean hogs and live cattle have steepened materially.

Source: JPMorgan

SoberLook.com

As food prices rise, Brazil begins to face inflationary pressures while growth stagnates

Brazil continues to be on the forefront of the global inflationary wave that will be sweeping developing economies as rising food prices make their way through the system.

FGV Brazil General Prices IGP-DI YoY ( (source: Bloomberg)

GS: - Inflation, as measured by the composite IGP-DI Index, accelerated to (a higher-than-expected) 1.52% mom in July, up from 0.69% in June. The July IGP-DI print was higher than 1.46% Bloomberg consensus and our 1.40% forecast. The acceleration of inflation in July from June was driven chiefly by the acceleration of wholesale agricultural prices to a very high 5.3% from 1.0% in June.

We've gotten some e-mails on the topic basically asking: who cares? The answer is that anyone who cares about global economic growth should pay close attention to this. Brazil is the world's 6th largest economy. Inflation will reduce the central bank's ability to ease monetary policy, significantly limiting the nation's growth potential. And Brazil's growth is already slowing materially.

Reuters: - Brazil's benchmark Selic rate is already at an all-time low of 8 percent after eight cuts since August 2011 as policymakers try to jump-start a stagnant economy.

The world's sixth-largest economy will grow only 1.85 percent this year, according to the survey, less than the forecast of 1.9 percent seen one week earlier.

That would be its worst performance since a mild contraction in 2009 in the aftermath of the global credit crisis, and a far cry from the 7.5 percent boom in 2010.

SoberLook.com

Food inflation spreading across developing nations

As the world's financial markets focus on the Fed and the ECB, another threat to global growth is showing up across emerging markets. Food inflation is spreading much faster than anyone had anticipated.

The major US media outfits are focusing on US-based food price increases of a few percent and the fact that burgers in the US will end up costing more. This is certainly painful for the US consumer, but pales in comparison with the havoc food inflation will create across developing nations. What's particularly troubling is that the North American drought has coincided with a number of other droughts globally such as those in Russia, India, and even North Korea. Here are a few examples of what may look like separate news events, but are actually part of this global trend. Food inflation is setting in.

Brazil

Reuters: - Brazil's broadest inflation index, the IGP-M, rose 1.34 percent in July, up from a 0.66 percent increase in June, the Getulio Vargas Foundation research group said on Monday.

The index was expected to increase 1.23 percent, according to the median forecast of 13 economists polled by Reuters. 

Brazil IGP-M inflation (YoY) (source: Bloomberg)

GS: - Consumer price inflation rose to 0.25% in July on higher food price inflation and the fading impact of the IPI tax cuts on auto prices (this more than offset the seasonal decline in apparel prices). In yoy terms, IGP-M inflation accelerated to 6.7% more than double the 3.2% March print.

China

Business Insider: - The drought in the American Midwest has sent corn prices soaring. And this is a very worrisome sign for Chinese pork prices.

Societe Generale analysts Michel Martinez, Wei Yao, and Jaroslaw Janecki write that nearly 90 percent of changes in Chinese domestic pork prices can be attributed to "global corn prices lagged by one quarter, and soybean prices lagged by two quarters".

Russia

Bloomberg: - Russia’s drought, which is cutting grain yields, may increase food prices and push inflation above the central bank target of 6 percent this year, according to Renaissance Capital.

Inflation may reach 6.5 percent “due to the unanticipated, and temporary, food price shock,” Ivan Tchakarov, Moscow-based chief economist for Russia and the Commonwealth of Independent States at the bank, wrote in a report today.

India

IRIS: - As delayed monsoons hurt production of vegetables, cereal and oilseeds, she expects WPI food (primary and manufactured) inflation, which is currently 9% y-o-y, to rise into double digits in the coming months. This will keep both WPI and CPI inflation elevated above the central bank`s comfort zone.

Indonesia

NASDAQ: - The country also is facing price pressures as drought in the U.S. pushes up soybean prices, and demand for food is elevated during the Ramadan fasting month. "With increasing prices of meat (products) and soybean, (on-month) inflation could be above 0.7% in July," Mr. Martowardojo said.

Sri Lanka

Reuters: - Sri Lanka's annual inflation rate may have accelerated to a 42-month high in July as a drought pushed up local food prices and a weaker rupee aggravated import bills.

Annual inflation is expected to have accelerated to 9.4 percent in July, its highest since January 2009, a Reuters poll of 13 analysts showed. In June, prices rose 9.3 percent from a year earlier.

"We will see the impact of the drought and rupee depreciation in food prices this month, too," one analyst said on condition of anonymity.

Food accounts for more than 40 percent of the basket of items used to compile inflation figures.

Other countries such as Malaysia and South Korea will see a spike in food prices as well. And of course nations like Iran will experience severe food shortages that could turn an already tense situation into an explosive one.

SoberLook.com