Food Price Surge Is Unlikely to Revert
Agricultural commodity prices have surged almost 50% since mid-2020, causing concerns over food price inflation around the world and sometimes resulting in increased export taxes and quotas by producers at a time when importing countries want to import more. We can identify four major factors driving the surge across agri commodities that will remain active in 2021: 1) US dollar weakness: Rabobank forecasts the US dollar to remain soft through 2021 (US dollar index -7% lower since mid-2020), but no further weakness is expected. 2) Weather: La Niña could extend into the US spring planting season. 3) Global demand: Good global demand (either for animal feed or storage) to continue through 2021. 4) Speculation: Speculative appetite is likely to support prices through 2021.
Weather woes were experienced in many key producing regions. The current Russian and US winter wheat crops saw a moisture deficit going into the winter and recent cold weather damage. Furthermore, drier-than-normal weather in southern Brazil and Argentina since mid-2020 continues to negatively affect the crops grown there: soybeans, corn, cotton, sugarcane, and coffee. This drier-than-normal weather in parts of South America and the US tends to correlate with La Niña. Some weather models forecast La Niña to continue for longer than originally expected, possibly affecting the northern hemisphere planting season.
Import demand has been outstanding for many agri commodities, even though the total consumption for some of these commodities is negatively affected by Covid-19 (cotton, coffee, cocoa, and sugar).
A quick look at the balance sheet of large public food companies reveals some are operating with higher-than-normal working stocks because of the threat of disruptions to their supply chains. If a company usually operates with ten weeks of working stocks (~20% of annual demand, which is normal for companies buying FOB), a 10% increase would mean a 2% increase in global demand (from ‘just in time’ to ‘just in case’). All in all, supply chains have been remarkably resilient during the pandemic, but there were some disruptions and delays. Even though we may not see 40km of trucks waiting at EU borders again, like in March 2020, there have been recent delays in several ports. In the UK, for example, we recently saw large queues at ports, and not only because of Brexit but because the new Kent variant of Covid-19 led to a temporary border closure. A new variant may arise almost anywhere at any time. Moreover, there has been an astronomical increase in container shipping costs, particularly from Southeast Asia, with prices more than doubling since November, as Chinese exports are running high. Containers are particularly important for coffee, white sugar, dairy, meat, and packaged products. Given further potential disruptions, storing a little bit more near factories and at destination seems like the rational decision, and this is likely for at least 1H 2021.
Many countries would also like to accumulate stocks. Many importing countries have been front-loading imports, while some exporting countries are trying to lower exports. With a large proportion of the population discontent due to the pandemic, food inflation is the last thing governments want. For example, Russia, the largest wheat exporter in the world, battles with high domestic food prices and has introduced export quotas and taxes on wheat. Argentina also partially banned exports of corn (and later replaced it with quotas) in an effort to contain meat price inflation earlier in the year.
Most importantly, Chinese imports have been surprisingly high as the Chinese economy continues growing strongly and the country rebuilds its hog herd from massive African swine fever losses, resulting in a surge of feed grain (mostly corn) and soybean imports in particular. High Chinese imports will likely continue for years to come.
The agri Non-Commercial net long position reached record net long levels in early January (1.06m lots) and remains not far below. The main factors driving this, beyond fundamental views, are extremely low interest rates, inflation concerns, and momentum trading. While the two former drivers will likely continue to tend to push prices higher through 2021, momentum could be quickly reversed – at least temporarily – increasing price volatility.
Low central bank benchmark interest rates usually result in money flowing away from government bonds and into other assets, like commodity futures. Low interest rates also reduce the cost of finance and therefore facilitate storage. Rabobank currently forecasts no increase to the US Federal Reserve’s target rate (0% to 0.25%), with a similarly flat forecast for other developed economies over the next 12 months.
The use of agri commodities by speculators as a hedge against inflation is evident in the increase in index fund position from 1.1m lots in mid-2020 to 1.6m lots. Inflation expectations derived from inflation-linked five-year bonds are at multi-year highs, at 2.5% (‘real inflation’ is arguably even higher). Finally, momentum, combined with increased access of retail investors, may also be providing some extra demand for commodity futures. For example, US agricultural-only ETFs saw an inflow of USD 430m in the last year, or +18%, according to the ETFs listed on Bloomberg.
Although the speculative appetite for agri commodities may seem exaggerated, it is hard to see it going down too much. Low interest rates, potential further fiscal stimulus packages, good global demand (not so much for the plate but for storage and animal feed), and potential adverse weather are likely to sustain high prices in agri commodities through 2021.