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Alpha How Has The Impending Trade War With China Really Impacted The Agricultural Markets?

by Jessica Darmoni

Hehmeyer Trading + Investments is home to a plethora of experienced and knowledgeable managers.  One of the reasons we launched this blog was to create a space to share their expert insight and observations.  This week we are featuring commentary from Chad Burlet of Third Street Ag Investments.  The opinions and views expressed in this commentary are that of the author.  Hehmeyer Trading + Investments may not necessarily agree with the opinions of the author.

We entered July with agricultural markets that were focused on the impending trade war between the U.S. and China.  Soybeans were already $1.80/bushel into what would become a $2.30/bushel price break. On July 6th the U.S. imposed tariffs on $50 billion of Chinese imports.  As promised, China immediately imposed a 25% tariff on U.S. soybeans.  By the 12th of July soybeans had pulled wheat to 6-month lows and corn to 11-month lows.

While most of the market’s attention was on the tariffs and their impact, wheat crops in the EU, Former Soviet Union countries and Australia were rapidly deteriorating.  No single crop would become a total disaster, but the long list of 10-20% reductions finally pushed the world balance sheet past the tipping point.  Prices for most major classes of wheat are $20-$50/Metric Ton (MT) above their mid-June lows.  Two triggers that led to significant futures rallies were an unexpectedly large purchase by Egypt, and disappointing yields reported by a northern U.S. wheat crop tour.

These developments leave the wheat market with an interesting dilemma.  Most major wheat exporting countries have reduced availability and the U.S. is the natural choice to cover that shortfall.  Unfortunately, in the Variable Storage Rate (VSR) era, the U.S. has shown a strong propensity to run away from business.  The large index fund long and the ready availability of speculative capital has made our futures market buoyant. At the same time the generous storage income provided by VSR has kept our cash basis elevated.  Thus the U.S. needs to do more export business, but it rarely stands still long enough to do much.  If the U.S. starts doing “cheapest wheat” business, it’s time to buy U.S. futures.

While wheat and soybeans have been roiled by international weather and a trade war, corn has taken its lead from U.S. weather which has been generally favorable.  There are areas that have been too wet or too dry, but nationally the crop has consistently been rated as one of the best in the past 20 years.  That has allowed corn to be the least volatile of the three markets.  However, as we look forward to August, the risk of unfavorable weather is increasing.  In some areas the crop is virtually made, but important finishing weather lies ahead for much of the crop.  That risk and the “hot/dry” forecasts have allowed us to close out the month at 7-week highs.

Corn is also finding support on the demand side.  Ethanol production will meet or slightly exceed the USDA’s projections, but it is the export market that will carry the day.  Thanks to smaller crops in South America and Ukraine the U.S. is the cheapest origin for the entire crop year for the first time in nearly a decade.  We expect record exports for 2018-19, possibly approaching 2.5 billion bushels.

The trade war with China has hurt the U.S. soybean market, but it has been a huge gift for South America where they are collecting an extra $2/bushel.  China buys two-thirds of all the soybeans that trade internationally, and South America can’t supply all their needs.  Thus the 25% tariff on U.S. soybeans means that South America is “over subscribed.”  Market participants understood that clearly and the South American market rallied as soon as China raised the possibility of a U.S. soybean tariff.

That cash market “bonus” and weak currencies have created a windfall for South American farmers.  Not surprisingly, they plan to increase their soybean acres when they start to plant in mid-September.

In Brazil there is another major disruption which is adding to the push to switch from corn to soybeans.  Following a paralyzing truck strike this spring the government has put truck tariff rates in place that are far above cost and far above what the market can bear.  This has delayed fertilizer deliveries and puts interior bids for corn far below the cost of production.  Also, the weak currencies raise corn production costs more than they raise soybean costs.  We expect total South American soybean acres to be 3-4% above last year.

To this point indications have been that both the U.S. and China expect a long trade war.  The U.S. has set up a $12 billion program to offset farmers’ losses, and the Chinese government is giving guidance on reducing protein levels in animal feed.  In their July WASDE report the USDA projected that the trade war would reduce Chinese soybean crush by 5.5 MMT and their imports by 8 MMT.  If those numbers are realized the market’s function will be to shift acres out of oilseeds and into grains, the exact opposite of what is happening in South America.

In closing we would like to emphasize the “headline” risk that exists in all our markets but particularly in soybeans.  The U.S. and China have not entered any meaningful negotiations.  A headline on July 31st, which stated they hoped to start talking, caused a thirty-cent (3.3%) rally.  If talks commence the rotation of optimistic and pessimistic headlines will keep our markets extremely volatile.

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