Perspective: Morning Commentary, 01/13/2016

Wednesday, January 13, 2016

January 13 – China’s Shanghai Composite Index dropped 2.4% overnight, keeping the spotlight on its economic problems. The world’s largest importer of raw commodities continues to struggle, with regulators frantically working to earn the trust of investors, but thus far failing to do so. Its economy is slowing – some would say already in recession – and the government doesn’t appear to investors to have the answers that it once did for correcting the problems at hand.
That’s generally seen as bearish for the commodity sector, although much of that has already been factored into the market. A sluggish economy does reduce demand for many raw commodities, but a reduction in demand for the food-based commodities would require things to get so bad as to change the eating habits of its consumers. Thus far I do not see that happening. It didn’t happen in the Great Recession of 2008-2009 and it hasn’t happened yet to this point.
Chinese citizens still increasingly love their pork and poultry. Producing that meat requires large quantities of feed grain and protein. Policies put in place nearly a decade ago resulted in an over-abundance of feed grain being produced, but those policies are being reversed and protein remains in demand. Data released this week indicated that Chinese soybean imports reached 9.12 million metric tons in December, up 7% versus the previous year and the second highest on record. Total 2015 soybean imports reached a record 81.7 mmt, up 14% year-on-year. The demand for soybeans is present, but unfortunately a larger share of it comes from our neighbors south of the equator, where significant investments in production and port infrastructure have been made.
Energy prices for the most part are rebounding this morning after West Texas Intermediate probed briefly below $30 per barrel on Tuesday. The drop captured the attention of the media, as it should have, but also raised fears on Wall Street. The “2” in front of crude oil prices spoke of a deteriorating global economy that no longer needs oil, with the market dropping to stimulate demand while discouraging production. It didn’t take long for cries of $20 crude oil to be heard once again, with the funds selling the broader commodity indices, pressing the Thomson Reuters CRB index to its lowest level once again since 2002.
The global economy certainly is struggling, with most major economies remaining in stimulus mode. That indeed is expected to keep upward pressure on the dollar as the Federal Reserve ponders another 25-basis point hike in the months ahead. A stronger dollar creates headwinds for the commodities, yet I caution against buying too much into the “sky is falling” sentiment that is so popular these days. Low prices do stimulate demand. Bottom-pickers will become bolder at these price levels in the commodities; both among speculators and end users. We likely will not see a robust recovery without fiscal policy changes that free up this great economic engine, but it is nonetheless still a resilient engine that finds ways to grow.
As for Tuesday’s USDA crop report, the most massive of the year, there was nothing bullish about it. Rather, it was less bearish than anticipated by the trade. Corn and soybeans still need a significant weather event to justify a sustained rally. That is certainly possible as El Nino shifts toward La Nina later this year, but still at the possibility stage. But keep an eye on wheat, where the speculative hedge funds have grown quite comfortable holding large short positions. USDA’s winter wheat acreage fell short by 1.6 million acres shy of our estimate of 38.25 million, which was the lowest submitted estimate in the industry. My balance sheet still shows surplus stocks topping 1 billion bushels in the 2016-17 marketing year, but U.S. wheat prices actually correlate stronger to European stocks and to headlines of problems elsewhere in the world. Drought in India, along with adversity in the Black Sea Region certainly have the potential to capture the headlines while increasing demand for European wheat later this year.

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