January 2017 month-end comments
As we began the month of January it appeared that flooding and wildfires in Argentina would be our dominant stories. However, just as conditions in Argentina started to improve, a new U.S. President was being sworn in. It quickly became clear that the new administration would create far more risk and uncertainty than this year’s South American weather.
A number of President Donald Trump’s top priorities will have a direct impact on agricultural production, trade, and prices. They include:
Withdrawal from Trans-Pacific Partnership (TPP) Trade Agreement. This will help Brazil and Argentina compete with the U.S. for Asian business.
Labeling China a currency manipulator or imposing import taxes. If we start a trade war with China, soybeans will be one of their primary targets for retaliation.
Building a wall and/or imposing a 20% tax on imports from Mexico. They will surpass Japan next year as the world’s largest importer of corn. If they reciprocate and tax our exports to them, South American corn will immediately become their cheapest source of supply.
A freeze on new regulations at the EPA has delayed the increased RFS mandate for 2017. Also at the EPA, any roll back in Waters of the U.S. (WOTUS) regulations would give farmers greater flexibility in land and chemical use.
What all five of those items have in common is that they would all be bearish on U.S. grain prices. When we talk about market risk it most often relates to a risk premium that exists, or should exist, in the current price. In the current situation we need to evaluate the risk discount. The question becomes: “How far below fair value should the market price itself in order to reflect the probability that one or more of these changes occur?”
Looking beyond the world of politics, we continue to believe that the greatest price dislocation lies in the new crop soybean:corn ratio. We are now entering the month of February when crop insurance prices are set for corn, soybeans, and spring wheat. The current SX7:CZ7 ratio of 2.6:1 is a February record for the Freedom to Farm era, 1996-present. Calculations for farmers across the country show better financial returns for soybeans than corn. If prices don’t readjust in the near future, we believe the U.S. will plant at least 90 million acres of soybeans.
The current strength in the ratio reflects a significant risk premium in the soybean price because of the uncertainty regarding the final size of this year’s South American crop. The corn price is reflecting the reality of a 2.3 billion bushel U.S. carryover and China’s ongoing efforts to reduce its corn stocks.
A year ago China committed itself to reducing its corn stocks and it has made meaningful progress in that effort. Last spring and summer it auctioned 15 million metric tons (MMT) of government owned reserves into the free market. At the same time it took steps to reduce the importing of feedgrains and feedstuffs. Recently released statistics for calendar 2016 show real progress in reducing imports when compared to the previous year: (MMT) corn 3.2 (-33%); sorghum 6.7 (-38%), barley 5.0 (-53%), DDGs 3.1 (- 55%), a total reduction of nearly 20 MMT. China has also provided subsidies for industrial processing of lower quality corn, and some provinces are providing incentives for planting soybeans instead of corn.
At this time of year, as we approach spring planting in the northern hemisphere, there is always a level of risk and uncertainty. The new U.S. President has raised those levels considerably.