Slightly negative results for the month extend a run of near-flat returns as most of the main economic themes identified by the managers showed little reaction. The position in which we had substantially expanded our risk and volume was held as long as possible, until late on “last position day” prior to physical delivery, and still did not bear fruit. Our policy is to not hold overnight positions during the delivery period so as not to expose investors to large, albeit temporary, margin calls.Our “bullspread” strategy in corn – i.e., long nearby and short deferred – was based on projection that U.S. producers would tend to market supply slowly since they had already taken much income from selling soybeans and would wait rather than liquidate all 2013-14 production within a narrow timeframe. Our forecast of demand for U.S. corn was aggressive, as Argentine farmers held back supply for financial reasons and Brazil deemphasized exports to make sure it met soybean commitments.
These forecasts proved correct as to tendency on both sides of the ledger, but erred as to degree. Export demand developed far more strongly than we anticipated and appears now fully 50% greater than widely projected at beginning of crop year. Price advanced to a degree considered very unlikely even recently, eliciting larger producer sales than the trickle we forecast. Our spreads remained at firm levels but did not reward by strengthening further. We would expect this theme to recur in trade selection in months ahead.
It’s not uncommon for beginning-of-year projections of supply, demand, and price to change enormously by late in the year, but the degree of change this year stands out because it did not extend from a major crop failure. Paragraph two above shows the other factors which trumped lucrative corn prices to prevent much competition by important South American suppliers. Production in Ukraine has risen sharply and although exports are as yet unaffected, the world grain trade must assign a “risk premium” for obvious reasons. Though U.S. has therefore re-emerged as the by-far preeminent supplier, the area it will plant to corn this spring looks to be reduced from last year in favor of more soybeans.
The reasons behind this are complex, far-flung, and serve as an example of why the managers keep risk to investors tightly reined in by striving to maintain a portfolio of offsetting trades in asymmetric balance:
- In 2008 China had begun a huge surge of growth in soybean imports, which continues to this day. The Bush Administration enacted legislation which mandated use for auto fuel of up 40% of U.S. corn production. Since corn and soybean returns must compete for the highest quality land, market prices for both took off like a rocket.
- The big increase in U.S. corn production required to meet ethanol mandates effectively ceded most of the rapid, lucrative growth in soybean exports to the other major suppliers – Brazil and Argentina. Despite being handed this terrific opportunity, both governments channeled the initial windfall into social spending rather than moving towards policies that would allow them to increase market share, grow their flagging economies, and reduce high unemployment. For two consecutive years, Brazil has produced large crops of soybeans and corn, but dearth of investment in railroads and highways prevented it from reaching ports. The result is that world supply/demand statistics were misleading in their suggestion that enlarged supply would impact price.
- China is the dominant soybean importer, accounting for over half of world trade. Its government has raised interest rates for industries judged to be overheated, such as residential construction, while maintaining far-lower rates for strategic imports such as soybeans. This has given rise to “shadow banking” in which unrelated companies import soybeans for their lower interest rate, then re-sell and use borrowings in other endeavors. The result is volumes and opaque patterns of soybean commerce which, again, foil the supply/demand statistics which provide your managers with a fundamental viewpoint.
- Ukraine has expanded to become a significant competitor in corn, and together with Russia, wheat, both utilizing Black Sea ports. While recent events have not reduced export volume of either, and apparent Western appeasement suggests that it won’t be affected, capital flight may reduce their agricultural capabilities in the long run even if political unrest and military conflict do not in the short run. Here again, unpredictable influences extraneous to farming and logistics threaten a major price impact.
The net is that U.S. soybean plantings will increase at the expense of corn this spring because government policies in South America limit their economies. U.S. is enjoying a surge of demand for agricultural products – grains, oilseeds, and meat – reflective of world demand growth but also attracted by its commercial stability. Part of the managers’ challenge for the next several years will be to parse how much of this year’s business is in reaction to the above relative to how much represents sustainable economic expansion.