Buyers brace for volatile markets and perhaps higher prices

by Jay Sjerven and Ron Sterk
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KANSAS CITY — Expect no relief from market volatility and brace for the possibility of higher ingredient prices in the next several months and perhaps all of 2011, according to market analysts and food industry executives interviewed by Milling & Baking News. The recent wide declines in agricultural futures markets should be viewed as an opportunity to extend coverage through the first quarter of 2011 or even beyond in principal ingredient markets such as flour, corn products and soybean oil, they said.

Paul Meyers, vice-president, commodity analysis, Connell & Co., Berkeley Heights, N.J., provided an overview of three likely market movers in the next few months.

“First, U.S. and world corn demand/supply fundamentals are much more bullish than they’ve been in 15 years,” Mr. Meyers said. “The U.S. Department of Agriculture has forecast the lowest corn stocks-to-use ratio in 15 years, the second lowest in at least 60 years. So, we have an extremely tight corn situation.

“We have a soybean carryover in the United States that will be on the low side of average, and we have declining world and U.S. wheat stocks, although they are not abnormally tight. So, we’re going into the next growing season with two of the three principal commodities in fairly tight supply/demand situations, which increases the price risk going forward because you have to depend on good crops in 2011 in order to help address the tight supply problems for corn and soybeans and not make things worse for wheat.”

Mr. Meyers said another important market feature was low soil moisture and other weather concerns in parts of principal world production areas. He said these areas include the central and southern Plains in the United States and Russia and Ukraine for winter wheat, and Argentina, which was dry, and Brazil, which saw delays in soybean planting. He also noted it was important to monitor South American growing areas because of the prevailing La Nina weather pattern that typically means warmer and drier weather in South America that may adversely affect crop yields.

“And third, we have high prices for most major agricultural commodities and a limited number of acres to plant in 2011, so competition for acreage likely will be more pronounced this year than it was even in 2008,” Mr. Meyers said. “Cotton prices recently reached all-time highs, we’ve had corn prices above $6 a bu, wheat prices above $8 a bu, and soybean prices above $13. We can’t increase the acreage of all four of those commodities. Something is going to have to give. It’s most likely to be soybeans.”

Steve Freed, vice-president, ADM Investor Services, Chicago, said agricultural markets also may be influenced by increased money flow. Mr. Freed said unlike 2008, when pension funds began to perceive agricultural commodity futures as an asset class and established long-only positions, money currently seems to be flowing into agricultural futures markets through more active traders who are willing to be either short or long. There also are new investment

vehicles such as exchange-traded funds that are having a daily effect on agricultural markets. The upshot may be more extreme market swings and wider spreads, he noted.

Mr. Freed emphasized the “huge role” China plays in agricultural futures markets. He pointed to the recent announcement by China it intended to tighten monetary policy and take other steps to curb domestic food price inflation, which was 10% in October alone.

“The markets are very sensitive to China saying they will raise interest rates or bank requirements in efforts to shut down food inflation,” he said. “The market feels, though, the only thing that is going to correct their problem long term is higher, not lower, imports. While they don’t acknowledge that, they have been buying soybeans at a record pace, and they are buying a lot of vegetable oil. The big question is: Will China import corn?”

Generally, there should be enough wheat to satisfy demand in 2011, Mr. Freed said.

“We don’t have a real weather problem,” he said. “We dodged a bullet in wheat when we got rain across two-thirds of the winter wheat region, but we still have to worry about Russia and the condition of its crop.

“In corn, you could make the case if the 2010 crop turns out to be a little smaller, if demand is a little greater, or if China comes in as a buyer, we will need many more corn acres, and when you look at nearby corn prices at around $5.15 a bu, that’s not high enough to secure the increase in acres we want. And if we do plant more corn acres, that means we’ll plant less soybean acres, and the soybean supply situation may become the tightest it ever has been. Some predict a 2011-12 soybean carryout at a negative number.

“So, whether it is money flow, or China, or competition for acres, there certainly are a lot of issues that will make 2011 a very active and volatile, high-risk period.”

With agricultural futures prices so high and so volatile, it was understandable ingredient buyers may hearken back to the rampant food price surge of 2007-08. But there are differences as well as similarities between the current situation and that of 2007-08, Dan Dye, president, Horizon Milling L.L.C., Wayzata, Minn., pointed out.

“In recent weeks and months, there has been significant price volatility across a number of commodities such as wheat, corn, barley, sugar and soybeans,” Mr. Dye said. “The primary cause of this has been adverse weather conditions in some of the world’s major growing areas. In some instances, this led to lower-than-expected crop yields.

“Last summer, some of the former Soviet Union states experienced unusually high temperatures that led to drought, fires and shortfalls in crops such as wheat and barley. The effects of those weather events were amplified by government interventions such as the implementation of grain export bans and by market sensitivity to ongoing news about weather conditions, crop sizes and investment fund activities.

“As a result of a challenging growing season, U.S. final harvested corn yields were disappointing relative to early season expectations. The U.S.D.A. has reduced its estimate of corn production from an initial forecast of 13.3 billion bus to 12.5 billion bus in November.”

Two years ago, a convergence of factors led to simultaneous problems across a number of commodities, Mr. Dye said.

“Global grains stocks were at a 35-year low,” he said. “The price of oil was significantly higher than it is today, which raised the cost of growing, transporting and processing raw materials. Many national governments responded to the shocks by implementing artificial trade barriers that inadvertently made the situation worse. These trade barriers affected well-established trade flows, damaged trust between nations and created a scarcity of basic food staples in some countries.”

Mr. Dye added simultaneous adverse weather events in 2007-08 helped create a tipping point that led to supply problems in many countries in the developing world, and riots in instances ensued.

“Today, global stocks are significantly higher,” Mr. Dye said. “Despite the Russian export ban, wheat stocks and production are sufficient to meet global demand, while the corn outlook has grown tighter.”

Mr. Meyers, turning to the wheat market outlook for the next six months, said, “Wheat prices from current levels (Nov. 22) are likely to be well supported until we get a better idea of the condition of Northern Hemisphere winter wheat crops coming out of dormancy in March and April. In addition, with Russia out of the export market at least until next July, the European Union having shipped wheat aggressively during the past few months, and Australia having some issues with quality, demand for U.S. wheat is likely to be well supported during the next six months, so I think futures prices will be underpinned by that.

“Wheat prices have a reasonable chance of moving higher into the spring if we don’t see an improvement in the moisture situation in some of the dry areas. I don’t look for them to go significantly higher because expectations are in 2011 we’ll have a bigger world wheat crop and with some recovery in countries that had very poor crops this year, so we shouldn’t have a significant drawdown in world stocks like we’re having this year. Longer term, if we get average rainfall and normal weather, world wheat production is going to rebound. That’s long term bearish, but there’s a long way to go before harvesting the crop next summer.”

Regarding corn, Mr. Meyers said, “The biggest question is how do we get enough acres to meet the demand for 2011 given we’ve already planted more winter wheat, soybean prices are still relatively strong compared with corn and with corn prices themselves having dropped about 90c from their highs. I’m not sure at these price levels, say $5.30 March corn, we’re going to have the price rationing we’ll need to give us an adequate carryover. Between the acreage uncertainly and the need to ration given the ethanol expansion that’s going on, I think corn prices are likely to strengthen from here. And because of that, soybeans may strengthen as well because if corn prices go up much more than soybeans, you’re going to lose more soybean acres.”

Mr. Meyers said with the selloff in agricultural futures in the past few weeks, markets may be undervalued, with the corn market more undervalued than the others.

“This is an opportunity for people who need coverage, particularly in the first quarter of next year, to put on that coverage,” he said.

Mr. Freed said it was difficult to say exactly what’s ahead.

“Will we have a drought in Argentina, or a wet spring here in the U.S. Midwest and a drought in the summer?” he said. “Will China buy corn? Will the economies around the world, particularly China, slow down? All those will have an impact on price discovery.”

He said assuming normal weather, March-April-May may be the timeframe for agricultural markets to set their highs for 2011, and he didn’t exclude the possibility of all-time highs under certain circumstances in some markets.

“March-May is when we’ll know a lot about the South American crops,” Mr. Freed said. “We’ll know a lot about the Russian wheat crop, and we’ll know a lot about China demand, especially on the corn side. March-May also is when we begin fighting for acres. In all that hodgepodge, wheat is a follower. It doesn’t have all of the same potential problems that corn and soybeans do, but you can be caught on the wrong side if you don’t have wheat priced as an end user during that volatile timeframe. Look for buyers after the holidays to add to their coverage through that timeframe and perhaps through the beginning of the next wheat harvest.”

Mr. Freed cautioned bakers’ margins may be worse than they were in 2007 and 2008.

“There’s a tremendous amount of competition for market share,” he said. “So margins are thinner. So you have to look ahead. You have to control your costs and plan accordingly. There is the possibility that profitability will be lower in 2011 than it was in 2008.”

Mr. Freed said corn market direction likely will be determined by the final size of the 2010 crop, whether China buys corn, and if farmers plant enough acres.

“If China buys corn, we may have at least $7-a-bu corn,” Mr. Freed said. He said some estimate the upside risk in corn even higher. “It’s a hard time for analysts because there are so many variables,” he said. “They give better odds in Vegas.”

With regard to soybeans, attention should be on South American weather and the La Nina weather pattern. Also, he asked, will China continue to buy at a record pace, and will they continue to build their hog herds?

Both Mr. Meyers and Mr. Freed said soybeans may lose acres to the other principal crops in 2011.

“Winter wheat acreage is likely to be up nearly 4 million acres,” Mr. Meyers said. “Most looking at supply and demand suggest we need 3 million to 4 million more acres of corn just to get to a low side of adequate carryover. And because we’ve seen all-time high cotton prices, we’re likely to see a good increase in acreage there. Add all that up, and soybeans may have to come down a couple of million acres.”

Mr. Freed said cotton may gain acres in the Delta states. He said Midwest farmers seemed to be buying more seed corn than last year, but what actually is planted also may be tied to crop rotations and forecast spring weather.

“At the end of the day, you’d figure you’re going to have more wheat and cotton and corn acres, although not enough,” he said. “Soybean acreage may be the same or lower.”

Should soybean acres decline in the United States, the market will need another round of record South American soybean crops just to meet world demand, Mr. Meyers and Mr. Freed agreed.

Linked to the direction of the soybean market were the U.S. and world soybean oil markets. U.S soybean oil prices were on an upward tear along with the rest of the soy complex until just the past few weeks, when agricultural markets generally turned lower mostly in response to worries China’s import demand may be curbed and a three-week rise in the value of the U.S. dollar.

The China announcements had a “domino effect” where it was appropriate for index longs to start taking some profits from a market that “had gotten ahead of itself when compared with the true soybean supply-and-demand situation,” said Brian Harris, vice-president, Global Risk Management.

“The break we’ve been getting should be an opportunity to extend forward soybean oil coverage,” Mr. Harris said. “We feel strongly this market is going to hold well in the mid-40c-a-lb range. As we get down to 45c to 46c a lb, we have a good opportunity to extend coverage.”

Mr. Harris noted the entire South American soybean-growing season lay ahead, and “we will depend on that South American crop to satisfy import needs of the big users.” Uncertainties over the South American crop set a floor under the market, he said.

“Soybeans will have a really tough time getting back down to $10.50@11 a bu until we’re certain of a big South American crop,” Mr. Harris said. “If you spot that back to a soybean oil level, you’re at around 44.5@45c a lb.”

Domestic soybean oil stocks have been heavy “forever” and currently were around 3.3 billion lbs, Mr. Harris acknowledged. Biodiesel hasn’t been a demand factor because Congress hasn’t renewed the blender’s credit to stimulate soybean oil usage. But even if there is no renewal of the credit in 2011, it was expected U.S. soybean oil stocks will decline year over year. Additionally, world soybean oil stocks have been declining since 2000, Mr. Harris noted, and for 2010-11, the world soybean oil stocks-to-use ratio was forecast at just under 6%. Broaden the perspective to include vegetable oils in general, and the world was having difficulty keeping up with demand, especially with the voracious appetites of China and India for oils and other agricultural products.

The “big picture” was one of declining overall world soybean oil stocks and increasing usage.

“Getting the U.S. market back into the high 30c-per-lb or low 40c-per-lb range is going to be a very difficult proposition unless we have record crops in South America and a record crop again in 2011 in the United States,” Mr. Harris said. “And that’s going to be hard to accomplish due to the acreage battle with corn.”

Mr. Harris said buyers should take significant soybean oil coverage through the first quarter of 2011.

“It’s important to cover the quarter as it encompasses the major part of the growing season in South America,” he said. “An approach may be to cover up to 60% of your needs through January-March, leaving yourself a bit open in case all proceeds well and the market continues to drift lower, or you can sell puts at around 44c and buy calls up around 52c or 53c just to make certain you have catastrophic insurance in the event the market makes a run to 60c a lb.”

Mr. Harris said buyers might want to be a bit more patient with the second quarter. The flat price buyers may want coverage for the second quarter of about 40%, and they also may want to be less aggressive in options.

“But, the first quarter is a no-brainer,” Mr. Harris said. “The current price break is a gift.”

Mr. Meyers and Mr. Freed suggested similar strategies.

“With the selloff we’ve had, particularly for wheat, buyers have been extending coverage into the first quarter,” Mr. Meyers said. “With the price levels we’re seeing, you should be at least 50% covered for January-March by now.”

The same advice would apply to corn and soybean products, he said. Flour buyers also might want to consider covering needs into the middle of April or even May because of the concerns over the winter wheat crop.

“I think there’s quite a bit of risk going forward, particularly during that March-April-May period,” Mr. Meyers said. “If we get further weakness, buyers should take advantage of it and get additional coverage on.”

Mr. Freed said many large ingredient buyers, particularly flour buyers, have covered needs through April. Smaller buyers may be buying more near term.

“Between now and the end of the year, whatever you’re buying, you have to get cash coverage during that March-April-May timeframe when some price may go to all-time highs,” he said. Flour buyers also may want to consider booking a portion of their needs into the early wheat harvest.

“No one person can sit here and say he or she knows what will happen in 2011,” Mr. Freed said. “There’s a saying about corn trading, though, that says if you buy too much, you may be reprimanded, but if you buy too little, you may be fired.”

Sugar, cocoa and other ingredient prices also seen firm in 2011

KANSAS CITY — Ingredient buyers in 2011, in addition to high or rising grain and oilseed prices, also may be facing strong to higher prices for sugar and cocoa, with the caveat some “steady” prices already were at or near historic highs.

“We’ve had roughly two years of price stability,” said Ian S. Trood, vice-president sales, industrial baking and milling, Caravan Ingredients, Lenexa, Kas. “We offer a wide range of products, most of which are driven by commodity costs such as soybean oil, sugar and grain products. Anything with sugar is up at least 15%, corn and wheat are up over 40% and soybean oil you need to look at day to day.”

Caravan recently sent a letter to customers alerting them to the prospect of higher costs in 2011 for ingredients affected by various market forces, citing upward pressure on ingredient markets, specifically the impact of production problems in Russia and Europe on wheat and corn prices, strong demand from China on soybean oil prices and reduced production in Brazil, Europe and Pakistan on sugar prices.

With nearby domestic bulk refined sugar prices currently quoted at 57c a lb, f.o.b., and at 55c for January through September 2011, prices will begin 2011 at the highest level in Milling & Baking records going back more than 30 years. And some processors already have booked as much as 90% of their prospective 2011 production.

“We’ve almost sold out of 2011, so we know what pricing will be,” said Steven J. Hines, director of marketing for United Sugars Corp., Bloomington, Minn. “Almost everyone is contracted.” While not pinpointing actual or average prices for 2010 or 2011, he noted timing made a tremendous difference in how pricing in the new year varied from 2010.

“It would be easy to say something like ‘prices are 10c a lb higher,’ but that would be an oversimplification because markets were so volatile due to significant developments,” Mr. Hines said. He cited tight world raw sugar supply, strong domestic demand due principally to conversion to sugar from high-fructose corn syrup and erratic production from the Imperial Sugar Co. plant in Savanna, Ga., which was rebuilt after an explosion and fire in February 2008.

While a number of other domestic beet sugar processors indicated they still had a higher percentage of sugar to book for 2011 than did Mr. Hines, they at least know how much supply is available from the 2010 beet crop. But supply is a bigger issue for cane refiners, who have to supplement domestic material with imported raws.

“Since the May forecast, 2010-11 world sugar production is down, consumption is up and prices are increasing,” the Foreign Agricultural Service of the U.S. Department of Agriculture said in its November “Sugar: World Production Supply and Distribution” report. The department forecast 2010-11 global sugar production at 161.9 million tonnes, raw value, down 1.9 million from its May forecast but up 8.4 million from 2009-10. Consumption was forecast at 158.9 million tonnes, up 1.2 million from May and up 4 million from last year. Ending stocks were forecast at 26.5 million tonnes, down 564,000 tonnes from May but up 311,000 tonnes from 2009-10.

While tight sugar supplies this past summer pushed U.S. bulk refined sugar prices above 60c a lb f.o.b., traders were not expecting similar highs in 2011, barring weather or other problems.

Cocoa powder prices were at 30-year highs for much of 2010 and edged still higher in the final quarter of the year. Pricing for 2011 is steady with spot values, which are in a range of $2.15@2.30 a lb for 10% to 12% butterfat natural cocoa powder.

Unlike sugar, global cocoa supplies are expected to be at least adequate if not surplus, but an ongoing problem of heavy cocoa butter stocks, the result of weak demand for higher-quality chocolate, continues to keep a lid on powder production. With nearly equal amounts of powder and butter resulting from cocoa bean processing, processors have been running below capacity until butter stocks are drawn down, which traders indicate isn’t any time soon. Lead times to deliver new powder orders were running into the second quarter of 2011.

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