Not-So-Obvious Grain Market Drivers

03/07/2011 12:33 pm EST

Focus: COMMODITIES

Widespread social and political changes would have an extraordinary impact on the prices of soft commodities like corn and wheat, and traders should pay close attention with peak season approaching.

By Damian Sydor

The Middle East/Northern Africa region is currently undergoing a revolution, one that could have an extraordinary impact on that part of the world forever. The catalyst for this uprising is being reported as citizens finally fighting back against oppressive regimes and looking for a more democratic rule of their homelands.

The noteworthy part is that it wasn’t the longstanding oppressive nature of the ruling regimes in Tunisia, Egypt, Algeria, and (insert next country here) that actually drove the people into a revolutionary spiral. These regions have been under the same power structures for many generations now. Some outlets have reported that the Internet (social networking sites), with its increased reach, was a major contributing factor in toppling several regimes thus far, and in stirring unrest in others. However, the Internet was simply a forum that enabled coordination of the masses; it wasn’t the actual tipping point that knocked over the first proverbial domino in the Middle East.

The tipping point was a factor that is not new in inspiring revolutions throughout history: hunger. Yes, the people in these countries did build pent-up anger, as they do not live in conditions as free as those of us in more democratic regions of the world are so fortunate to enjoy. However, their anger did not boil over until recent dramatic increases in food prices set the stage for a desperate revolt, leading to what is playing out today with the latest major unrest happening in Libya.

You might be wondering how this brief thesis of hunger being a root cause of revolution relates to trading. In this case, it serves the purpose of transitioning into a brief fundamental analysis of a potentially profitable trade idea as we move into what should be a noteworthy 2011.

Grain prices have increased significantly over the past year. If you haven’t been keeping an eye on the corn, soybean, canola, or wheat markets, you most surely have noticed the rise in prices at your local supermarket. All across the board, grains have nearly doubled in prices since early 2010, and it seems that they will continue setting new highs. Fundamentally, corn seems to be the grain that will lead the way, and it’s looking to be a profitable trade in the near term, as I’ll explain below.

A Literal Fight Against Global Hunger

The first fundamental reason is highlighted in the introductory paragraphs. The situation described above provides a possible clue to what might take place in the regions that, similar to Egypt et al. weeks before, are teetering on the brink of revolution.

Public protests are nothing new to any country or ruling party. Protests take place in peaceful democratic countries, as well as in the most oppressive states, with dictators of those lands typically not overly concerned.

However, when protest shows signs of spiraling into revolution, this sets fear into the hearts of the ruling class and their supporters. If the remaining dictators and ruling monarchs have a desire to remain in power, it would be no surprise that one way to do it would be to increase their subsidies and imports of basic food staples for the simple purpose of appeasing their peoples’ most basic need, affordable food.

To no surprise, this has already begun. According to the Hightower Report on February 24, 2011, South Korea, facing its own mini unrest, bought 55,000 tons of corn overnight. They weren’t the only ones to buy grains. Egypt bought 235,000 tons of wheat; Tunisia, 75,000 tons of wheat; Iraq, 100,000 tons. The United Arab Emirates bought 40,000 tons, and Morrocco bought 280,000 tons, all to be used for subsidized flour. Saudi Arabia made their first large purchase in over a year, that being 275,000 tons. The Saudi Arabian purchase came just days after its rulers pledged to provide $35 billion in benefits for its citizens. It doesn’t take an economist to connect the dots: The remaining ruling parties understand cause and effect, and this leads to a strong increase in demand for the staple grains.

NEXT: China's Ever-Growing Appetite

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China’s Ever-Growing Appetite

The second reason for strong uptrend in demand for grain is a more long-term dynamic shift, but nonetheless, it serves to prop up demand for the foreseeable future. That reason is the rise of the middle class in China. According to statistics published by the Boston Consulting Group, the McKinsey Global Institute, and the World Bank, China is on pace for a dramatic increase in household wealth. In 2010, there were a reported one million “rich” households, 48 million “middle class” households, 61 million “emerging middle class” households, and 93 million designated as “poor.” By 2020, those numbers are estimated to shift to 12 million “rich,” 134 million “middle class,” 66 million “emerging middle class,” and only 62 million “poor.” As incomes rise, so do appetites and the collective appreciation for finer foods, especially juicy meats and processed products.

Corn Is King

Premium meats and processed foods all rely heavily on corn input. This will undoubtedly be a major factor in the continued unprecedented rise in corn demand. Corn is not only a major staple in today’s food industry, it is also increasingly used in the production of energy worldwide. Today, between ten and 30% of corn grown in the US (the world’s largest producer) is now being used to produce ethanol fuel instead of ending up on the dinner table.

Most vehicles on the road in North America today already run on fuel that contains over ten percent ethanol, and the auto companies continue to produce vehicles that can run on even higher ethanol blends. Whether you’re a believer in the peak oil theory or not, you can’t debate against the fact that there is an ongoing global shift away from fossil fuels and toward alternative energy sources. This will continue to provide support for corn prices.

The long-term fundamentals are in place, and although the laws of economics state that in response to an increase in demand, growers will provide more supply in the long term, the short-term signs point to very tight supply outlook, and thus, there is potential for accelerated short-term price spikes. According to the most recent USDA report on supply and demand, current corn stocks were at an estimated 18-day supply, the lowest levels in 15 years, and another 20 years before that. Couple this abnormally low supply outlook with the mid- to long-term fundamentals described above, and sprinkle in the very real rise in inflation, and you will understand why corn still looks undervalued, even amid its recent rally to above $7 a bushel.
There will be corrections that may shake out many traders (as we have seen in recent days), but going into the summer, I think there could still be room to continue moving up from current levels. Until the fundamentals change, this should be a market eyed by traders looking to hedge their own cost of food, and then some. Please feel free to contact me if you have any questions about this article, or would like to discuss specific trading strategies based on your particular goals and risk profile.

By Damian Sydor of Lind-Waldock

Damian Sydor is a market strategist and works with John Kurgan in the Toronto office. He is accepting new clients from Canada and can be reached at 877-840-5333 or 416-369-7946, or via e-mail at dsydor@lind-waldock.com.

Futures trading involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results. Please consider your financial condition prior to making any investments. Not to be construed as solicitation.

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