China is sowing the seeds of a bull market in wheat and corn

SHARP rises in food prices over the summer raised the ugly spectre of riots and civil unrest across the developing world and rampant inflation in Western countries. In August a Russian ban on wheat exports caused the price to spike, prompting some countries like Egypt to aim for self-sufficiency.

The surge was short-lived but the volatility and high prices have certainly not vanished. Although the United Nations’ Food and Agriculture Organisation (FAO) recently rejected the notion of a food crisis like we saw in 2007-2008, it nonetheless warned of greater volatility in food commodities markets in the years ahead.

On Friday US corn prices broke through the important $5-a-bushel resistance level for the first time since September 2008, fuelled by reports from US farmers of disappointing yields in the early stages of their harvests. The surge in the corn price also pushed up European wheat prices to a two-year high of €238 a tonne and above the previous peak set at the August spike. US corn prices have rallied 45 per cent since early July while European wheat is up 66 per cent over the same period.

While spread betters may be tempted to view such rises as unsustainable and go short, they should perhaps think again. Societe Generale’s perma-bear global strategist Dylan Grice evokes the example of a sea-change in the oil markets in 1973-74, which resulted in permanently higher real oil prices: “The cause was a structural shift which saw a rapid surge in the import needs of oil’s biggest consumer, the US, as its oil production peaked in 1970.”

He believes the same thing is happening in today’s grain markets: “With 7 per cent of the world’s land and water but 22 per cent of the world’s mouths to feed, China’s fight to retain grain self-sufficiency was always going to be a losing battle unless the economy was devoted entirely to agriculture.”

AGRICULTURAL PRODUCTIVITY
“None of this would be a problem if China was capable of increasing its agricultural productivity as spectacularly as it is increasing its living standards. But so far at least, it isn’t coming close,” he adds. Data from the US Department of Agriculture (USDA) shows that Chinese land productivity continues to decline.

While the long-term trend clearly signals rising grain prices, the short-term factors also point towards a more bullish outlook. USDA data published last week indicated that the coming US corn harvest would be the largest corn crop ever and would generate the second highest yield ever. But this was not as optimistic as the forecast it issued only a month ago. Weekly crop quality ratings are also deteriorating. And despite being the largest crop ever, it appears it is not large enough to prevent stocks from tightening further, says Societe Generale’s Emmanuel Jayet.

“It seems we have entered a period where data is likely to tighten further the outlook for the global grain markets. The weather, as always, will play a critical role. It can still impact the final results of the approaching crops,” he adds.

It’s not just weather that spread betters should be watching. Political events also have an impact on supply and demand. Witness the Russian export ban and Egypt’s aim for 70 per cent self-sufficiency. Meanwhile export quotas in the Ukraine, one of the world’s biggest wheat producers, push down domestic prices and weaken incentives for farmers to plant more.

Spread betters should be making the most of trading the grain markets, if they can stomach the volatility that is set to continue throughout the autumn.