With fall quickly approaching, the US farming industry is facing a record corn harvest. Yet, the balance between supply and demand for the new crop year looks incredibly tight. Certainly the drought induced reduction in coarse grain production from the former Soviet Union (FSU) is a factor. However, there is a more significant fundamental reason for the tight supply problem; exploding global demand.
Everyone is aware of the tremendous economic growth in Asia over the last two decades. The accompanying rise in incomes has led to improved diets and thus greater food consumption. While improved genetics and increased acreage have boosted world grain production, supply is still struggling to keep up with demand. That trend will likely continue. Consider that it was announced recently that China’s economy had surpassed Japan’s in overall size. But that is only half the story, as China’s GDP per capita is still only one tenth that of Japan’s. Despite the huge economic gains in Asia over the years, there is still plenty of growth potential left!
Grain traders often refer to a metric called the stocks to usage ratio to gage the balance of supply and demand. It is calculated by dividing the amount of grain left over at the end of the crop year by the total amount that was available immediately after the initial harvest. Despite record production for 3 out of the last 4 years (including 2010), the stocks to usage ratio for corn, as currently projected by the USDA, will be at 8.3%. That metric has only been below 10% twice since 1973. Each one of those events eventually caused corn prices to move significantly higher. There is no guarantee, but it is quite possible that this crop year will result in a similar resolution.
As world food consumption continues to grow, more supply and demand imbalances are likely to build. Next year the price incentive will probably convince farmers to plant more corn acreage. The problem is that this will come at a cost, by a reduction in wheat and soybean production. That will mean tighter stocks of those crops in following harvests. This will be a cycle that will most likely be seen for many years.
The interesting point to make on an investment level is that this process is developing in an environment where in general, yields have been good. The FSU drought not withstanding, the world seems to be one bad crop away from running out of a variety of important agricultural supplies. Look at the charts of sugar, coffee, cotton, and cocoa as examples.
Given the structural imbalances, it appears that over the coming year’s agricultural commodity prices will be volatile (with an upward bias). It would behoove investors to develop some type of investment strategy that will take advantage of these potentially explosive moves. Remember the adage, “Plan your work, then work your plan.”
