Analyst Insight by Francisco Redruello.
Commodity futures reflect not only on current food inflation but also immediate trends in agricultural prices. Overall, trading at the Chicago and London stock exchanges suggests that higher food prices are here to stay, with few signs of prices coming back down over the short term.
An inflationary January
January 2011 is already proving to be a month loaded with exciting macro-economic data. Real GDP growth in Germany for 2010 has just been confirmed at 3.5%, the highest rate registered since reunification. Meanwhile, inflation in Spain reached 3% in 2010, a rate that might result in higher labour costs and bring about a second wave of inflation.
In the UK, the latest inflation data shows that producer output prices climbed by 0.5% in December 2010, taking the annual rate to 4.2%, the highest since April, according to data recently released by the Office for National Statistics. Earlier this month, the European Central Bank (ECB) decided to keep EuroZone interest rates on hold, but warned that inflationary pressures (2.2% annual rate for the month of December) might prompt interest rate rises later this year.
Crucially, manufacturing growth in economies heavily dependent on raw materials, such as Germany, on the one hand and inflation on the other is encouraging international traders to invest in commodities. In the case of inflation, commodity trading is being used as a hedge against price rises, as commodity trading tends to ensure higher returns and therefore increase profitability in real terms.
January is also proving quite eventful in terms of agricultural news. The United States Department of Agriculture's (USDA) Quarterly Grain Stocks Report, released on 11 January, shows a drop in US corn and soybean ending stocks. This has prompted an immediate increase in demand for futures contracts for both commodities. In addition, recent floods in Australia have raised uncertainties about global sugar supply, a factor that might be reflected on trading floors in the coming months. Conversely, political uncertainty in Côte d'Ivoire has not yet affected cocoa supplies and no major price fluctuations were noted in January.
Cocoa futures remain stable … for the time being
Cocoa futures are proving to be fairly stable in January. There is agreement in the industry that current political instability has not yet impacted distribution via the ports of Côte d'Ivoire, at least not yet. This, alongside high output prospects in other West African countries like Ghana, is keeping the peace among markets and minimising price fluctuations.
There is still concern, however, that a possible aggravation of the current crisis in Côte d'Ivoire could cause a sudden surge in demand for cocoa beans. Therefore, some traders are opting to spread futures positions in equal parts across 2-month (March) and 5-month (May) contracts. This strategy, given current stability, could provide some degree of hedging against price surges stemming from unpredictable political developments.
Lower wheat ending stocks than expected in the US
Analysts and brokers have been betting on their own estimates about 2010 US end-wheat stocks since the Christmas season. USDA's Quarterly Grain Stocks Report, released in mid-January, showed an increase of 8% in wheat ending stocks over the December 2009-2010 period.
Interestingly, this increase proved to be lower than anticipated by many traders, who relied on higher increases on the back of a larger output. USDA's report immediately increased demand for wheat futures on London and Chicago's trading floors, with prices rising by 2% in just one day. This rise reversed the decline in futures prices seen since the beginning of the year, when traders factored in a larger volume of ending stocks. Traders going long (buying) on 3 January have so far made an average loss of US$1,500 per contract (5,000 bushels x US$0.30) and are therefore unlikely to go short before more substantial gains help them to recover.
That said, USDA's recently released report suggests that stronger demand for wheat in the Asian market seems to be swallowing up any excess production, a trend that is unlikely to change in the short term. Those traders going short (selling) in March might well use their earnings to fund call options (right to buy) in May – to achieve hedging against unexpected wheat price rises in the coming weeks.
Corn – and thus corn trading – was another commodity feeling the full impact of USDA's latest report on grain stocks. US corn ending stocks decreased at a higher rate than expected – by 8% over the December 2009-2010 period. Demand for corn has been underpinned not only by a surge in cattle feed imports in Asian markets but also by the increase in ethanol production in the US market.
According to USDA's estimates, 36% of corn produced in the US in 2010/2011 will go to produce ethanol. Ethanol sales in the US are expected to rise to 13.95 billion gallons (54.27 billion litres) in 2011 from 12.95 billion gallons in 2010, according to the Environmental Protection Agency's (EPA) estimates. Ethanol consumption could be even higher than forecast if the EPA clears the way for gasoline blended with up to 15% ethanol to be used in older vehicles. The current limit is 10%.
Corn futures surged by 5% in just one day after the release of USDA's report and have followed an upward trend ever since. Traders going long (buying) just before 11 January will have made a US$2,500 profit so far (as of 18 January) per standard contract. Given current pressures on corn demand, traders who are still long in corn (holding contracts due to expire in March) are likely to maintain, if not increase, their current profit level. With current pressures on corn futures, any dip in price might well be used by traders to materialise FOK (fill or kill) orders, a trade order mostly used during periods of sustained gains in prices and that allows investors to benefit from any short-lived dips in prices.
Australian floods cast shadow of uncertainty over global sugar exports
January is also proving to be a rather exciting month for sugar trading on both sides of the Atlantic. There has been widespread speculation that exports might be delayed from India, the world's second-biggest producer, because industry officials in the country have suggested that sugar exports may start by the end of February – about a month later than expected – as sellers with smaller tonnages take time to find buyers.
Earlier in January, Australia had cut its forecast for sugar exports by 25% in 2011. This is because recent flooding has reduced the sugar content of canes and is set to reduce average yields. In addition, there was an announcement by the nation's biggest sugar exporter, Queensland Sugar, that it will have to buy more raw sugar from Brazil and Thailand to fulfil its own export orders.
While sugar futures continue to be at relatively high levels, they have failed to show further increases. This is because despite recent events, ending stocks in the coming year are still expected to be close to – or even higher than – those seen during the 2009/2010 season. According to the International Sugar Association's (ISO) latest estimates, ending stocks will reach around 58,000 million tonnes over the 2010/2011 season, up 1.3% on the previous year. This growth will take place on the back of relatively strong output levels in Brazil, the biggest sugar producer.
Future prices should stay at similar levels to the first week of January and there are currently no expectations of significant fluctuations in the coming weeks. Traders going short (selling) in March might opt to bid for call options (right to buy) as a hedge against 'unexpected news' of significance on current sugar global output projections.
No 1 Sugar Futures
Strong market fundamentals in global rice production
Rice is another commodity in which price stability is being maintained by strong market fundamentals. According to USDA's latest outlook report, published in mid-November 2010, global ending stocks will show little movement, despite stronger consumer demand. This is because US ending stocks are projected to increase by 36% over 2010/2011, an increase likely to take place on the back of robust output prospects. The latter will make US rice supplies in 2010/2011 the highest on record, according to the same USDA report.
Recent news suggesting lower exports in countries like Thailand has failed to have an impact on the global market. In November, President of the Thai Farmers Association, Prasit Boonchoey, said that the country was expected to produce about eight million tonnes of rice this year, compared to usual annual production of 10 million tonnes. This drop in expectations stemmed from heavy flooding in 42 out of 77 provinces in the country. That said, country officials minimised the impact of lower production on internal consumption and exports, given high existing stock levels.
Future rice contracts showed little movement in December, a trend that continued during the first half of January. Traders could opt, however, for going long on call options (right to buy) for March contracts. In doing so, they might achieve a hedge against hikes linked to unexpected floods in South Asian countries without incurring losses if the current price stability extends into the coming years.