“The ever more sophisticated weapons piling up in the arsenals of the wealthiest and the mightiest can kill the illiterate, the ill, the poor and the hungry, but they cannot kill ignorance, illness, poverty or hunger.” – Fidel Castro
“Feel what it’s like to truly starve, and I guarantee that you’ll forever think twice before wasting food.” – Killosophy by Criss Jami
“Agriculture is not crop production as popular belief holds – it’s the production of food and fiber from the world’s land and waters. Without agriculture it is not possible to have a city, stock market, banks, university, church or army. Agriculture is the foundation of civilization and any stable economy.” – Allan Savory, Zimbabwean ecologist, livestock farmer, environmentalist, and president and co-founder of the Savory Institute
‘Qu’ils mangent de la brioche’, that is, ‘Let them eat cake’, are allegedly the famous words uttered in the 18th century by Marie-Antoinette, the last queen of France, upon being informed that the French peasants have no bread. While these words may or may not have been spoken at the time, food shortages and the high cost of bread were most certainly the precursors to the rioting that led to the French Revolution.
With over 1.3 billion mouths to feed, members of the Communist Party of China (CCP) will be all too aware of the dire consequences food shortages or rapidly rising food prices could have on their political careers. This in turn is likely to make them sensitive to any sharp rise in agriculture commodity prices. And it is no wonder that the CCP has over recent years taken steps to influence supply-demand imbalances in key agricultural commodities.
In 2016, for example, the Chinese government announced that it was scrapping its price support policy and stockpiling program for corn, a policy that had been put in place in 2007 to encourage local production of corn. The price support policy worked well, too well some might argue, in boosting local production especially as the government kept raising the support price until the end of 2011. The support price meant that corn prices in China were higher than prices in international markets. Unsurprisingly, given the incentives, the level of corn imports into China increased and the Chinese government was left to buy ever increasing amounts of locally produced corn. Analysts have speculated, that by 2016, the Chinese government’s corn reserves amounted to around half of all global stockpiles.
Chinese Quarterly Corn Imports
Source: United States Department of Agriculture
Chinese corn imports dropped in response to the abandoning of the price support policy. The premium between Chinese and international corn prices also shrank – the premium started dwindling in 2015 when the support price was reduced for the very first time.
In May 2017, the government decided to heap further pressure on commodity markets by auctioning off parts of its corn reserves, causing an initial sell-off in futures markets. International prices have stabilised since and remain largely range bound; however, Chinese prices bottomed in January 2017 and have been gradually rising since.
Chinese Corn Price vs. International Corn Price
The divergence in Chinese and international corn prices witnessed since January 2017 has been witnessed in other agricultural commodities, such as wheat and soybean, as well. China’s “battle for blue skies” and reduced air pollution forced many producers, both industrial and agricultural, to suspend operations last year. These suspensions rocked Chinese commodity markets and pushed prices higher. The situation was exacerbated in the winter when government officials – in a bid to meet year-end air pollution targets and to free up natural gas supply for households forced to switch from coal-fired to gas-based heating – forced natural gas-powered fertiliser plants to shut in areas like Sichuan and Yunnan, forcing prices of nitrogen-based fertilisers, such as urea, higher.
China Urea Prill Spot Price
With year-end government targets met and the campaign set to end in March 2018, we suspect that the pressure will ease off and some of the suspended agricultural and industrial capacity will resume operations. The government has already reversed its ban on coal for heating as gas shortages left people freezing during the winter. As some of the shuttered capacity comes back online, we expect the premium in Chinese commodity prices to decrease. Nonetheless, with Xi Jinping highlighting environmental concerns in his speech at the CPC’s 19th National Congress, we think that campaigns, such as the recent crackdown on smog, will continue in fits and spurts over the coming years and add to the volatility in Chinese industrial and agricultural production.
Although China has built up significant agricultural production capacity over the last decade, most of this capacity is inefficient as the price support policy incentivised capacity not efficiency. With the price support policy removed and our expectations of increasing volatility due to government policies, we suspect a significant portion of the existing capacity is already or will soon be at risk of closure due to mounting losses. Despite the level of Chinese stock piles, China cannot afford to lose productive capacity as stock-to-usage levels for some of the key agricultural crops in China are at very low-levels – levels last witnessed prior to the launch of the prior support policies for critical agricultural commodities.
China Corn Percentage Stocks-to-Use
China Barley Stocks-to-Use Days
The global stocks-to-use level excluding China is even more precarious.
Global ex-China Corn Percentage Stocks-to-Use
Global ex-China Wheat Percentage Stocks-to-Use
Global ex-China Barley Percentage Stocks-to-Use
With global stocks-to-use levels ex-China at or near multi-decade lows – and our belief that China is unlikely to become an exporter of agriculture commodities anytime soon – agriculture commodities remain susceptible to supply side shocks. These shocks could be caused by an adverse weather event, like La Niña, that disrupts production across key regions and causes food prices to spike, trade sanctions or tariffs being placed by the US on imports from key agriculture exporters, or rising freight and input costs for farmers.
Investment Perspective
As it generally tends to be the case with commodity related investments ideas, there are a number of ways to construct trades around the agriculture commodities theme. Our preferred approach, in this instance, is to combine direct commodity exposure with feedstock producer equities.
Historically, sharp rallies in key agriculture commodities have either coincided with or been preceded by global stock-to-use levels of the commodities being low, much as they are today. Low stock-to-use levels, in our opinion, are a necessary but not sufficient condition for a sharp increase in the prices of agriculture commodities. Demand or supply side shocks are usually the catalysts that cause prices to rally. We think key agriculture commodities are primed for a rally should a catalyst materialise.
Global ex-China Corn Percentage Stocks-to-Use vs. Corn Futures Prices
Global ex-China Wheat Percentage Stocks-to-Use vs. Wheat Futures Prices
Managed money positioning in futures markets are also extremely bearish. Money managers, on a net basis, shorts in corn and wheat are at or near a record number of contracts. Unwinding of these positions, too, can add fuel to any rally in prices should a catalyst materialise.
CFTC CBT Corn Managed Money Net Total / Disaggregated Combined
CFTC CBT Wheat Managed Money Net Total / Disaggregated Combined
On the feedstock side, our preference is to allocate to the equities of nitrogen-based fertiliser producers as our analysis suggests that supply and demand dynamics are gradually shifting in favour of producers. Taking urea for instance, production capacity growth is expected to plateau in 2019 while at the same time exports from China have been dropping sharply despite the removal of export tariffs in 2017.
China 12-Month Rolling Average Urea Exports
At the same time, Indian imports of urea appear to have bottomed. India is one of the largest consumers of urea globally and its market went through significant disruptions over the last two years, which dampened demand for urea. Farmer subsidy payments were delayed by the government, the introduction of the general sales tax of 18% in July 2017 increased the financial burden on farmers, and the reduction of urea bag sizes from 50 kilograms to 45 kilograms reduced demand as farmers in India tend to base their usage on bags as opposed to weight.
India 12-Month Rolling Average Urea Imports
In terms of nitrogen-based fertiliser producers, we like Yara International (Yara) – the world’s largest nitrogen fertiliser producer. Yara has boosted efficiency as the global fertiliser slump has pressured margins and has increasingly shifted its focus toward higher margin products and high-growth regions. With fertiliser prices having picked up in the fourth quarter of 2017, Yara is well positioned to benefit from improved margins and increasing volumes should fertiliser markets remain resilient over the course of 2018.
We are long ETFS Corn ($CORN.LN), ETFS WHEAT ($WEAT.LN) and Yara International (Norwary).
Note: Yara International’s ADR is available is US OTC markets with ticker $YARIY.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.