Grain prices and futures: What does the future hold?

TEMPE, Ariz. –  Joel Karlin, a market analyst and feed merchandiser with Western Milling in Central California, told dairy producers at the  ninth annual Arizona Dairy Production Conference that things could get worse before they get better.

Like most producers, Arizona dairy producer have been subjected to a sharp escalation in feed costs, their number one expenditure combined with a historic plunge in milk prices. Feed values, for a number of reasons appear to have made a structural shift to higher price ranges than seen in the past.

According to Karlin, “Arizona producers fare worse than others in U.S. as larger amount of feed is procured ‘off-farm.’ Large part of ration imported from out of state or even out of country. Hike in rail rates over the years comes on top of steep increase in price of many bulk agricultural commodities.”

Karlin dissected the average Arizona dairy ration. Forage: Alfalfa hay, cottonseed, and silage costs have increased due to high grain corn, better returns from alternative crops, and scarce water. Hay and cotton acreage in west has plunged.

Concentrate: Higher corn and soybean prices linked to rising demand in developing nations, increased usage for renewable fuels, and investor demand linked to falling dollar, desire to own hard goods, and realization that consumption has outpaced production.

Micros: Increased energy prices leading to higher nitrogen costs (fertilizers, urea) and increased tangible and investor demand for key minerals like selenium, copper, iron, magnesium.

Why are feed prices so high?

For 25 years, grain prices were flat to lower providing little financial incentive to increase production via higher acreage or invest in research for higher yielding hybrids. A rise in world GDP growth, especially in developing countries (China, India, Brazil, Russia), has translated into rising personal incomes with change in diet to one featuring increased consumption of meat and dairy protein. This necessitates more feed grains and protein meals to feed cattle, hogs, and poultry, Karlin said.

For many reasons, big push for renewable fuels and this increases competition for bulk commodities. Also, the steady depreciation of dollar has helped buoy prices for a number of commodities that are valued in greenbacks.

Dollar weakness has also undermined performance of traditional portfolio instruments like stocks and bonds. With money managers looking for alternatives, ag commodities are being seen as a separate asset class and a large amount of capital have poured into commodity index based funds helping buoy values of corn, soybeans, and wheat along with crude oil and gold, the analyst said.  After tech stocks and real estate, commodities has been the hot new investment.

What feed markets are pondering

Part I – Trying to reconcile unprecedented deterioration of U.S. corn crop this summer.

– World course grain stocks about the tightest ever linked to drought in large grain producing areas in the Former Soviet Union and 700 million bushel decline in U.S. corn production seen from August to October.

– Function of corn prices now is to move higher to ration demand and encourage huge increase in planted acreage here and abroad.

Part II – World and foreign oilseed situation much more relaxed than that for corn and wheat amid high production and ample stocks.

– Soybeans and protein meals will be supported by booming demand, especially to China and sentiment that South America will not see a repeat of huge 2009-10 production.

– Big acreage battle looming with very attractive forward corn, wheat, and soybean prices. Which one will get short end of the stick?

Part III – Dollar weakness and compelling fundamental grain story has led to huge fund buying.

– Very tepid economic expansion instead of leading to ideas of reduced demand for grain and oilseeds instead has hiked sentiment that Federal Reserve Board will have to resort to extraordinary easing measures, which has depreciated dollar and stoked inflationary expectations, both of which have helped support markets.

– With regard to demand rationing, which of major users; domestic feeders, industry (ethanol and biodiesel) or foreign buyers will blink first?

How quickly things change

Karlin reminded producers that in January of 2010, USDA reports “were very bearish” with record 2009 U.S. corn and soybean production. The dollar rallied through the first half of 2010, which pressured markets. Brazil and Argentina had harvested record corn and soybean crops and record yields were expected in the U.S. Endusers were looking for the lowest corn and protein meal prices since the fall of 2006.

The tide turned, however, starting the second half of 2010. USDA’s June stocks and 2010 planted acreage for corn were much lower than expected. The net impact was loss of 500 million bushels from the 2010-11 balance sheet, Karlin said. In addition, large areas of Eastern Europe endured the worst summer drought in more than 100 years, slashing global wheat and course grain supplies.

The falling dollar, strong Chinese GDP growth, and realization that global grain stocks again shrinking resulted in huge fund buying of various ag commodities. Despite historically high crop ratings, as growing season goes on, market realized that too much rain in certain areas of the Midwest, dryness in others, and generally hot August temperatures had negatively impacted 2010 U.S. corn yield, Karlin explained.

Global stocks remain ‘very tight’

He pointed out that despite record world and U.S. corn and course grain production over the past few years, global stocks have remained very tight. Even before current surge in prices, market was abuzz all spring about largest U.S. export sales to China in 15 years and likelihood that volumes would only increase in subsequent years.

According to Karlin, USDA was coming under increasing criticism for its inability to reasonably forecast U.S. corn feed demand. That task was complicated by increased use of byproducts, especially DDG, and the fact their feed model is horribly antiquated – using a 1970 dairy cow as their proxy for all grain consuming animal units, and budget cuts with on-field personnel and research staff.

Many questions concerning future renewable fuels output, but one of the few bright spots for end-users is realization that we are now on the backside of the huge increase in ethanol production seen over the past few years.

Uncertainty over timing of 15% blending rate, possible loss of both blender credit and import tariff, and negative forward margins imply just a small increase in corn used for ethanol production this year. And a rise in corn prices to record highs will resurrect “food vs. fuel” debate, he declared.

Industry data shows cool years are definitely associated with above trend yields, while hot years lead to below trend yields.

Specifics for protein meals

As opposed to corn, the world oilseed and protein meal situation is framed by rather comfortable stocks helped by record soybean production here and down in South America.

The generally warm and wet Midwest summer appears to have hurt corn yields more than soybean yields though no doubt dryness in August and September did adversely impact some late developing soybeans.

While U.S. is dominant corn producer in the world, we only produce 36% of world soybeans with South America accounting for 46%. So it is very important to monitor weather, trade policies, exchange rates, and other factors in Argentina and Brazil, Karlin said.

The trade will be looking at hog farrowing, egg set, and chick placement data to see if monogastric species are first to cut back on feed. Hogs and poultry consume largest amount of protein meals.

According to Karlin, history suggests further reductions in U.S. soybean yields along with dry September. A lot of attention will be focused on South American growing conditions over the next few months given need for another large Brazilian and Argentine soybean crop and knowledge that La Nina years such as this one can lead to erratic weather patterns.

Bottom line for feed

The horse has already left the gate and now only question is how high prices will go and how much of a setback in corn and protein meal values will occur

Only way for feed values to really set back is if weather is perfect in all areas rest of year, a double dip recession points to steep economic contraction, or stock market takes a major tumble forcing investors to raise cash

Looking for signs of demand  rationing and question is who will start it. Looks like ethanol and biodiesel may be first to slip.

Will need to monitor prospective cash budgets for 2011 to see which crop is most profitable to plant. Not much help from expiring CRP contracts but some marginal land may come back. Some say total U.S. acreage need to rise 8-10 million but that hasn’t happened in years.

All eyes will be on Washington as the trade debates how changed Congress will impact agriculture, Karlin said.

There is a lot of possible changes with regard to renewable fuels policy, EPA decision on blend rate, fate of blending credit and import tariff, with world food stocks tight can grains be used for fuel?

High budget deficits and revolt over increased government role in many areas of business suggests only monetary policy can be used as a tool to stimulate economy. Interest rates are close to zero so what can the Fed do? he asked.

There is a lot of uncertainty with regard to unemployment, interest rates, exchange rate of dollar, trade policy. Will foreign governments limit exports and disturb grain and oilseed markets even more like in 2008?

Dairy producers hurt by rising feed costs but does higher milk prices and component values offset this, especially if milk output increases (marginal analysis)?

A big boost for dairy will come if consumption improves. A 2% drop in demand probably was worse for dairy profitability than higher feed prices. The falling dollar makes U.S. dairy products more price competitive overseas which is important as exports have picked up.

The past two years, higher priced deferred milk futures have lost their gains the closer to expiry. Maybe this year the more discounted deferred contracts will move higher, closer to the more expensive spot contracts.

“Hopefully the pessimism imbedded in 2011 contracts is not justified if the 2010 holiday period shows much better sales of dairy than the past two years, the U.S. and global economies continue to expand, and high feed prices tempers gains in U.S. cow numbers and milk per cow figures,” Karlin concluded.