Weather Returning as Dominant Fundamental on Grains

06/02/2020 5:50 am EST

Focus: COMMODITIES

Chad Burlet

Co-Founder, Chief Trading Officer, & Principal, Third Street Ag Investments, LLC

While we are still in the midst of a global pandemic and US-China relations remain tense, with growing season upon us, weather will be dominant factor on grain market, reports Chad Burlet.

This month we saw outside factors continue to play a dominant role in grain markets. Supply chain disruptions, Coronavirus-driven shutdowns, crude oil’s recovery and U.S.–China relations were front of mind for everyone. However, we believe that is changing quickly. There will be stumbles as cities and countries re-open, but we believe the greatest risks and greatest disruptions are behind us, at least from a Covid-19 standpoint. The importance and the uncertainty of the U.S.– China relationship will not change, but we now see Northern Hemisphere weather as much more important than the temporary closing of a processing plant or a port.

We see the U.S. corn situation as less burdensome than a month ago as we expect planted acres to drop from 97 million to 93 million. That reduction will come through a combination of switches to soybeans and prevent plant. It seems illogical to discuss prevent plant in a year when the planting pace is ahead of average, but this year’s low prices are taking a huge toll. A year ago, the market was rallying, the U.S.  farmer was optimistic about even higher prices and he planted well into June. This year that optimism is gone, planting is not profitable, and many farmers are stopping as soon as they hit their crop insurance date.

While a 600-million-bushel reduction in production does not turn the corn balance sheet bullish, it does put us in a situation where we need to pay closer attention to yields. For that reason, the duration of the high pressure ridge that is forming in the western corn belt has taken on increased importance.

The corn demand picture improves every week as ethanol production ramps back up, but we will still fall short of the current World Agricultural Supply and Demand Estimates (WASDE) for ethanol projection. The small reduction in Brazil’s safrinha corn crop will probably help our fall exports more than our summer exports. We currently see next year’s carryout below three billion bushels, but not significantly below.

As with most of our markets, China is an important wild card for corn. It is highly profitable for China to import U.S. corn right now, but they continue to tightly control that flow with their Tariff Rate Quotas (TRQ’s). We got a taste of what China pursuing their Phase One Targets would feel like when they bought U.S. corn, soybeans, cotton, sorghum, pork and soybean oil during the second week of the month.

Unfortunately, relations soured soon after that and Chinese buying has slowed noticeably. It is important to note, however, that despite some very strong rhetoric this past week, both sides remain committed to the Phase One Trade Deal. The two possible extremes of the China scenario – Phase One goals fully met or a new trade war – probably represent a 20% difference in U.S. agricultural futures prices, across the board.

Soybeans will probably be the beneficiary of some lost corn acres because they show a better (less negative) return and because they’re cheaper to plant. Repeated federal subsidies have helped farmers survive the Trade War and the Covid-19 Recession, but finances for many remain tight. Some lenders are steering farmers toward soybeans because they require a smaller cash outlay.

China is the dominant user and importer of soybeans. Their pig herd was cut almost in half in 2019 by African Swine Fever. Their intensive effort to rebuild that herd has been forced off the front page by the Coronavirus, but it has been ongoing. A good measuring stick for their demand is their weekly crush, which set a new record last week of 2.1 million metric tons. The Chinese government has projected they will import 93.6 million metric tons of soybeans in the 2020-21 crop year; if they maintain their current crush rate that estimate is too low.

In the May WASDE report the USDA told us we’re on the way to a record world wheat carryout. Shortly after that, the old crop export quotas that Kazakhstan, Ukraine and Russia had recently put in place were basically discarded. That helped the old crop-new crop inverse in the Black Sea collapse from $30 to $10 a metric ton.

Six weeks ago, India, the world’s #2 wheat producer, was looking at the potential for a record wheat crop, but fearing they couldn’t harvest it because tens of millions of migrant workers were in Covid-19 lockdowns. Fortunately, rules were relaxed, and the harvest has gone well. The government procurement program is also on pace with last year.

Key producer Australia was also concerned about the dryness in Western Australia, but a heavy late-month rain has put them in good shape to recover from last year’s drought ravaged crop.

The most closely watched wheat areas right now are the EU and the Black Sea. Recent rains appear to have stabilized the Russian and Ukrainian crops, but they are a combined eight million metric tons below their high-end estimates of six weeks ago. Meanwhile, crop estimates in the EU have continued to drop. French crop ratings are at a nine-year low for late May and this past week the European Commission lowered their crop estimate to 121.5 million metric tons, 7% lower than last year.

Hours after the Commission issued their reduced estimate, Russia’s state-owned United Grain suggested that the country should increase its strategic reserves to 6 million metric tons. With a tradition of a minimal carryout every year, Russia would have to reduce this year’s projected exports by 5 million metric tons to accomplish the proposed objective.

The combination of those two announcements quickly rallied U.S. futures 5%. There has been no official comment from the Russian Government, but adoption of that proposal would help the U.S. do more “cheapest wheat” business in the second half of the crop year.

Going forward we think the dollar is headed lower and that will provide underlying support. Of the competing theories of inflation driven by an infinite supply of capital or deflation driven by cheap energy and surplus labor, we think the latter has more relevance to agriculture. The accelerated expansion of acreage in Brazil does not bode well for the U.S. farmer.

Chad Burlet is Co-Founder (along with Bob Otter), Chief Trading Officer, & Principal, Third Street Ag Investments, LLC

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