Crop price moves subject to new range of influences

by Morton Sosland
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Examining prospects for food ingredient prices is a process that has radically changed in recent years. It doesn’t require long experience to be able to recall the time when such analysis depended almost entirely on the supply-demand situation of a crop. This was the era when wheat prices for a season, for example, were determined largely by whether the ending carryover would be larger or smaller than at the year’s start. A carryover increase almost always meant average prices on the decline, while a likely decrease in ending stocks meant strength. The simplistic approach was upended by the intrusion of global or national politics, prompting actions like export embargoes. Of course, growing season weather and currency fluctuations could bring a surprise, but the supply-demand calculations generally prevailed.

All of that changed when grains and the other crop markets found themselves no longer analyzed as single crops or as a group of crops. Instead, they are now often viewed as commodities. Suddenly, price moves in crude oil, precious metals and other non-agricultural products loom as significant influences. This has happened mainly as the result of commodities being counted as a financial asset, not unlike bonds, equities and increasingly complex debt instruments.

Frequently overlooked in this joining of agricultural and non-agricultural products into a single group called commodities is the huge difference in assessing what causes price moves in these two sorts of products. One of the most important aspects of crop price analysis is the so-called spillover effect represented by the self-correcting impact on the supply side. Strong prices almost always drive production increases, while weakness often brings about a reduction.

At the same time, the spillover effect on demand for agricultural commodities has been much less a factor due primarily to inelastic demand for most foods. Of course, the introduction of ethanol mandates, using a third of the annual corn crop, has brought a new demand-sensitive factor into a market that had been governed on the demand side by food stability as well as feed use forces. The demand exception for ingredient markets has, if anything, been strengthened by the rising prominence of emerging nations where growth is more commodity oriented than in developed countries. The lack of demand easing in the face of price escalations is proof positive of this aspect.

If the spillover in food prices affects supply more than demand, it is astounding to realize that the opposite rules in non-agricultural commodities. Numerous examples may be cited showing how advances in non-food commodities have curtailed demand. On the supply side, though, the response of most non-agricultural commodities to even dramatic price moves is hardly measureable. Oil output has grown little as prices have climbed. In base and precious metals, the average time needed to confirm a discovery following initial exploration takes as long as 20 years, with nine years the average time from discovery to production. In contrast with yearly crop cycles, supply gains in these non-food commodities extend over a long time. That is especially so when restraints due to environmental concerns are considered.

The result of this divergence is reduced correlation of price moves between the two commodity classes. That is especially the case as it is recognized that food prices have shown little sensitivity to changing expectations of global growth or to dramatic shifts in global financial markets. It was in 2008-09 that the co-movement of prices reached its apex. That this now has changed means markets recognize the striking differences between commodities. The food ingredient crops in particular face an array of forces that underscore the need to avoid looking at media headlines that do not reflect these differences. Supply shocks have played an increasingly significant role in food ingredient prices this season. Indeed, what has happened particularly in wheat raises questions whether the capacity to absorb these shocks may be limited in the same way demand maintains its inelasticity.

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