Friday, May 27, 2011

China Aims to Diversify Reserves in Agricultural Space

Talking Points China Should Invest FX Reserves In Agriculture Abroad -Govt Researcher
China should use its huge foreign exchange reserves to expand investment in the agricultural sector overseas, in an effort to increase domestic market supply, a researcher with a government-owned economic institute said.

China's foreign exchange reserves, the world's largest, rose to $3.04 trillion as of the end of March, with a substantial portion invested in U.S. Treasurys.

China should build grain production bases abroad, especially in South America, Africa and some neighbouring countries with great potential to increase grain production, Chen Jie, a researcher with the Research Center For Rural Economy, a consultancy under the Ministry of Agriculture, said in an essay published in the state-owned Farmer's Daily dated May 21.

We must not rely on imports to meet domestic demand for grains," she said in the article.

"Otherwise, the issue of grain supply could become a national security problem anytime," he said, adding that cereal exporters could easily embargo trade in grains when supplies are tight.

Chinese agricultural companies are eager to tap overseas resources as domestic demand is rising quickly and domestic grain and edible oil production is approaching full capacity due to rapid urbanization.

Both the Chinese government and marketers also want to insulate prices from volatility in major markets such as the Chicago Board of Trade, and controlling upstream resources including land and crop selection would be the best way.

Local media have reported that the state-owned Chongqing Grain Group Co. to spend more than CNY2.5 billion to purchase land in Brazil for soybean cultivation, as part of a $3.4 billion plan to build oilseed and rice production bases overseas including bases for rapeseed in Canada and Australia, palm oil in Malaysia and rice in Cambodia.

The Tianjin-based Julong Group, a privately-owned palm oil trader and importer, has spent $200 million to buy 20,000 hectares of land in Indonesia to plant oil palm. The company plans to expand its oil palm planting area overseas to 200,000 hectares, with a total investment of $2 billion.

Meanwhile, China's state-owned Cofco Group is seeking to acquire Australia-based sugar producer Tully Sugar Ltd., competing with the New York-based Bunge Ltd.

China, the world's largest importer of soybeans and palm oil, is attempting to maintain a grain self-sufficiency rate above 95%.

Source: CME News for Tomorrow

Monday, May 23, 2011

Why Germany Should Learn to Love the Euro

Have you ever wondered why German politicians are so supportive of the Euro? Besides attaching a great deal of their political currency (and hence careers) on the Euro, there is another more fundamental reason behind supporting the single currency.

Export subsidies. The Euro acts as an export subsidy for German manufacturers and exporters. But one may glance at the forex charts and say the Euro is so expensive! Not really - the Euro is very cheap compared to what the Deutschmark would be trading at now. Remember that Euro trading prices in factors such as deterioration of the peripheral PIIGS countries.

The Euro is also a blessing in another guise. In continental Europe, economic activity has always gravitated towards the center - in particular to Germany. The EU is a 2 engine economy led by Germany and (and to a much lesser extent) France. Wage growth is being kept relatively low by migrant workers from Eastern Europe and the periphery imposed legally per the EU treaties.

The last blessing in disguise is the German consumer and investor's rise in purchasing power. Sure, the EU is in horrid economic shape but the Euro is still trading at a premium relative to the dollar. As a result, things are cheaper for travelers and asset managers who wish to engage in speculative carry trading.

The Bottom Line: German taxpayers may grumble about the Euro but the elites have, ironically, their best interests at heart.

Emerging Markets' Biggest Threat is Deflation - Not Inflation

Brazil and other emerging markets are also leveraged in another way - to the dollar. The commodities trade in particular for exporters is prone to violent swings. Oil and many agricultural products are tied to benchmark rates set on the CME and CBOT in the USA b/c futures contracts continue to be priced in dollars. Recent margin hikes on oil and precious metals are warning signs to me to contain volatility. For Brazil, agricultural commodities are capped w/lock limit prices on the Chicago exchanges so volatility won't come from that corner. Instead it will come from base metals traded on the LME like copper (see prior article about China and copper for a more reasoned explanation).

The long term fundamentals of supply and demand for agriculture are expected to remain strong for the next several years -supportive of continued inflation of land, inputs and machinery.

But what comes up must come down. Demand destruction is real - the world cannot survive for long on oil >$100/barrel and oil is considered a leading industrial indicator. The velocity and supply of money has turned from a stream into a river in many developing countries. Some of this can be attributed to Western investors but a lot more is sourced from the native governments.

The biggest culprit I see now is China - M2 has jumped despite efforts by the PBOC to play games ( M2 is STILL up b/c the Politburo has focused its efforts on blaming Western foreigners (US and British investors) instead of looking in the mirror - the explosion in money supply is due to FORCED domestic lending by banks from the 2009 stimulus effort. Simply put, loans are being made to people who should not be receiving them - all in the effort to keep employment high.

China's leaders are following this policy b/c they value social stability above all. But the policy is ruinous and leading to a credit bubble. Already we are seeing signs of a coming deflation in wage growth. I was reading in the Financial Times where the reporter stated China and India are leading the world in wage inflation by repeatedly raising minimum wages . In the short term that is a good policy to have - but the 2 countries are already losing their competitive advantages to smaller, cheaper players like Vietnam, Philippines, and Indonesia.

Conclusion: Emerging markets' biggest threat now is deflation - NOT inflation. The current runup in inflation is due to a massive increase in credit since the Lehman bubble popped in 2008. But this rise in inflation is only short term - it will pop as over-capacity in capital stock comes downstream. Politicians are stuck between choosing growth or choosing inflation. Instead the choice will be made for them by the markets. I predict a hard landing for many markets w/in the next 9-15 months, 2013 by the latest.

Friday, May 20, 2011

European Wheat Weakness

Any strength in bullish prices can be tempered by the seasonal weakness in associated equity markets. In a POMO liquidity driven world, computer trading has followed into commodities to push prices higher.

European Wheat Prices To Revisit 3-Year Highs On Drought-Analysts
Forecasters and traders said wheat prices could hit the three-year highs touched in February if drought in Europe and the U.S. continues to stress next year's wheat crop.

New-crop wheat prices have gained sharply this week, hitting three-month peaks of EUR251.50 a metric ton on the November Paris milling wheat contract on Thursday, driven by concerns next season's harvest could be irreparably damaged.

But now analysts say the current bull run may continue, taking futures above the near-record highs of EUR281/ton touched in February as the worst drought in decades tightens its grip on Europe's fecund farmland.

"I think there are still significant risks that wheat prices could push back to the highs we saw in February if weather doesn't improve in the coming weeks," said Erin Fitzpatrick, an analyst at Rabobank.

Production expectations for next season are falling by the day as drought across key growing regions of France, Germany, the U.K. and Poland--which account for 65% of EU-27 output--wilts the young crops in the fields.

Parts of Europe received less than 40% of their average rainfall between February and April and analysts now say up to 12% of France and Germany's crop will be lost even if rain does arrive.

"If we do not get the right mix of rain and sun in the coming 8-10 weeks, then later this year we will see record price levels," said Charles Robertson of Renaissance Capital.

Concerns about crops in the U.S., Australia, Canada and Russia are also keeping the market nervous. Last year's rally was sparked when an historic drought in Russia prompted the Kremlin to ban exports and take tens of millions of tons of the world's cheapest wheat out of the international market.

Although initially delayed by poor weather, at the end of last week Russian farmers had planted spring crops on 18.921 million hectares, only 4.5% less than on the same date last year, the Agriculture Ministry reported.

In forecast generally regarded as over-optimistic by the trade, the U.S. Department of Agriculture last week forecast that wheat exports from the Black Sea region, including Russia, Ukraine and Kazakhstan could double to more than 26 million tons in 2011-12.

But Eugen Weinberg, analyst at Commerzbank, said with weather so unpredictable at this stage, any production estimates are very much uncertain until the grain is in the storage bins.

"We're still in the development stage," he said. "The troubles last year only came in June to July.

"EUR280/ton is definitely on the cards at the moment."

Source: CME News for Tomorrow

Tuesday, May 17, 2011

China, The IMF, and Dominique Strauss Kahn

What do China, the IMF, and Dominique Strauss Kahn ("DSK" hereafter) share in common? Most media have become transfixed by front page coverage of how the now disgraced banker's political career was destroyed by a low paid, immigrant maid. Rather than go into the increasingly lurid details, of which many other sources are covering, I will attempt to explain the potential ramifications on the IMF and China.

There is now a power vacuum in place at the IMF. While an interim head has been selected, no permanent selection mechanism has been activated. Instead, we are witnessing an intense, behind the scenes political jockeying for power and influence that stretches around the globe. I speak of course about China and her ambitious rise to prominence.

For years, the IMF has been dominated by a succession of figures chosen from the ranks of Western European and American financial and government elites. The selection process is a delicate balance that in theory has a foundation in its quota system. Quotas are broad reflections of member states' econonomy. Dues or quota subscriptions are 25% paid in a major international currency (e.g. typically $, Euros, or yen w/the dollar being preferred) and the remainder 75% in their own currency.

The quota system for emerging economies was raised in April 2008. The system is reviewed every 5 years - w/the next review having been completed earlier this year (2years ahead of schedule) in January.

So, how does the above apply to China? January is not so far away from May that a re-assessment may be called for by some members on the governing council. China's has strong incentives to get a native representative (or at least someone loyal to Beijing's cause). In 2010, China surpassed Japan to become the world's second largest economy. In 2011, she remains the world's most populous state. Chinese loans are supporting the economic backbone of the West - a teetering EU and a profligately consuming USA. It is w/regards to American spending that this tense dynamic that is currently underscoring international trade and public policy.

In multiple speeches during the past two years, Chinese officials have repeatedly voiced their concerns about the viability of the dollar's role as a reserve currency.

Open calls to American politicians to preserve the value of their investments have been ignored. Actions always speak louder than words and while US officials publicly support a strong dollar policy their actions speak to the direct opposite. China is not entirely w/o fault however as Congressional calls for China to revalue the renminbi have an air of truth about them.

One interesting angle of critique has been the proposal for a new SDR currency that would place the renminbi among the basket of currencies allowed to be held in the 25%quota.

Besides the symbolic value, a Chinese Managing Director (CMD) of the IMF would secure substantial political leverage against the American's weak dollar policy and ensure a margin of security against Congressional voices against a strengthening renminbi. From the IMF's podium, the CMD would be able to issue damning critiques against the Federal Reserve and US Treasury w/the full force of international law (for what that's worth).

A more focal point is the IMF's control over the purse strings of emergency bailout loans to sovereigns. The IMF has historically made loans to developing nations (formally referred to as the 3rd world). If a global cooling in commodity prices does occur, these emerging market nations that have been the recipients of so much hot money would face capital flight and enormous political/economic devastation. China itself has been pumping large amounts of capital into sub-Saharan Africa, Latin America, and South Asia. A CMD would be able to direct the organization to help offset any losses the Chinese state would suffer on these investments. More ominously, the day may come in the not so distant future that the IMF's funds may be directed in the explicit bailout of a Western European or (and previously unthinkable) America itself.

But it is not so cut and dry. The United States has a major say in determining who will head the IMF, in part because it holds the largest number of votes at the 187-nation international lending agency, in the quota system. Both sides have likely begun marshaling allies to support bids for respective candidates.

The bottom line: DSK's fall from grace is not the main story. China has been lobbying for years to obtain a stronger international voice. Placing a Managing Director favorable to Beijing would ensure it greater leverage against the USA.

Monday, May 16, 2011

A Penny Saved Is Not a Penny Earned: Copper Pricing and China

"A penny saved is a penny earned" is a famous quote from American Founding Father, Benjamin Franklin. However, this maxim is hardly true today - the modern penny having been diluted by a 97.5% base of zinc and a thin copper covering of 2.5% after prices had become too expensive.

Copper is an industrial metals bellwether and more importantly, a risk on trade bellwether (dollar down/risk on assets up). Unlike oil, which has a substantial political volatility premium built into its pricing, copper's output is constrained by mining difficulties. Both commodities take years for efficient resource extraction, but base metals had been comparatively neglected in the past 2 decades compared to energy.

Consequently, any fall in copper prices are likely to be due to falling demand as opposed to speculative swings in prices. Technicians can see this trend outlook in the MACD in the above charts.

Compare copper to the volatile price swings in other risk on assets such as gold and silver. While precious metals retain intrinsic value in preserving wealth they had also taken on bubble like characteristics in recent months - just look at silver's dramatic rise to near $50/ounce before its violent 1 week correction earlier this month. Of course, no discussion about copper would not be complete without mentioning China.

China has been the biggest source of demand for copper with anecdotal reports of manufacturers stockpiling the shiny metal in warehouses. But authorities have been on a decidedly hawkish stance since last year with persistent interest rate increases and bank reserve requirements. The renminbi has also been allowed to appreciate the most in its history - by differing accounts from between 3.5% - 4.5%. This rate rise may sound small compared to swings in other currencies but remember that China's exchange rate remains tightly controlled for political and economic reasons.

An appreciation on the order of AT LEAST 5% is needed to be effective in constraining runaway inflation. Official inflation rates for April 2011 were 5.3%. Real inflation rates are estimated to be much, much higher - on an order in the double digits. Volatile food and energy costs are estimated to comprise much of this increase. To be truly effective in constraining price pressures, Chinese authorities would have to allow the renminbi to appreciate to double digit percentage levels. Of course, this will never happen. Allowing the currency to appreciate to such levels would devastate the export manufacturing sector and lead to a massive loss of jobs.

The Chinese government is left w/alternative policy controls such as raising bank reserve requirements, hiking margin on stock exchanges, loosening currency flow restrictions (e.g. allowing renminbi denominated accounts to be opened elsewhere outside Hong Kong), and allowing wage increases among broad swathes of the employment sector (more on this topic in the next post). These methods have had varying levels of success in cooling the economy. One thing is certain though: as inflationary pressures continue to rise, Chinese authorities will ultimately be forced to allow the renmimbi to appreciate to higher levels.

The bottom line:
Bulls on risk on assets are now engaged in a fight w/the Chinese central banking authorities.

Saturday, May 14, 2011

The Shadow Banking System in Emerging Markets

Shadow banking. These two words have come to encompass everything that was wrong about the 2008-2009 financial crisis. Shadow banking was first used by Paul McCulley of PIMCO in 2007 to describe the giant "soup" of non-depository institutions but later popularized by supremely bearish economists such as Nouriel Roubini in 2008 (then among a small list of contrarian opionists) to include all forms of financial institutions like hedge funds, insurance companies, and investment banks. But this term is not just confined to the West.

The superficial forms may be different but the underlying structures and intent - off balance sheet money creation - remain just as potent in a broad swathe of regions ranging from Latin America to the Middle East, Far East, South Asia, and Eastern Europe (including the CIS countries).

Most economists ignore these capital flows b/c it is hard to capture systematic data on such a diverse group but their influence is equally hard to dismiss - surging inflation, and frenzied speculation on (insert favored asset class of the month - real estate and stocks remain favorites but other speculative targets include precious metals, art, jewelry, and even wine). Sources include remittances from foreign workers and family, off the book transfers to SOEs (state owned enterprises), grey market additions or subtractions on trade letters of credit, unofficial lending systems like "hawala" prevalent in many Muslim communities, and even funds from organized crime syndicates.

I would argue that in some cases (depending on the country's level of official financial innovation), these flow of funds can surpass the volume of funds issued by the central bank and can add huge pressure. While the individual actors in the system may be small their collective impact is overwhelming. Certain regions receive their funding sources from a small but dominant group. For example, Latin America tends to receive a huge number of remittances, so much so that in countries like Mexico, remittances are the number 1 or 2 (depending on whose counting and what political agenda they may have) source of GDP growth. In other states with Communist backgrounds (the CIS, China, Vietnam), off balance sheet transfers to SOEs are prevalent.

An additional note about China. Due to its enormous size, China has a proportionate impact on global levels of supply and demand, and - despite protestations of party officials - inflows and outflows of money. For years, the fixed (now tightly managed band) exchange rate contributed to all sorts of games played by exporters and importers on letters of credit, the trade documents that serve to lubricate wholesale trade. Parties to a transaction would routinely mark up or down their costs at the behest of their partners (usually for tax reasons) but also to import additional funds beyond the official limits. China also has its SOE legacy. It is hard to imagine now, but China used to be a Maoist state in every sense of the word. Money losing ventures in (sometimes) obscure parts of the country would produce goods for the sake of producing goods. These operations have more or less ceased to exist but their "losses" remain on the country's financial balance sheets (no one is really talking at Beijing much about this problem - did you really expect transparency from an authoritarian state?). But by some independent accounts, the scale of losses on these operations rivals the deflationary collapse in 1980s Japanese real estate.

Halwa, or the unofficial Muslim money transfer network, deserves special mention. The system incorporates scores - if not hundreds - of semi-independent brokers interwoven in a complicated network of trust. Deals are sometimes made on nothing more than handshake and accounts kept in paper ledgers. On this framework alone, funds can be sent from the rudest mountain village to the shiny cosmopolitan cities of Europe and North America. The system was developed in an effort to frustrate medieval tax authorities but was also molded in the cauldrons of internecine conflicts (called "brush wars" by Western analysts) when funds needed to be quickly sent and official lines of communication had broken down.

Organized crime has a special place in the role of money creation and transfer. It is prevalent in every society but really flourishes in regions where the rule of law is weak or more sinisterly, incorporated, into elements of the government. Profits from illegal activities such as the narcotics trade, piracy, human smuggling, prostitution, arms trafficking, counterfeiting, and credit card fraud (to name but a few sources of revenue) contribute unofficial amounts to GDP growth. The funds are sent through multiple channels - some of it is laundered to foreign operations and some of it is spent at home. The ruthless intelligences directing these funds make organized crime figures some of the shrewdest and most efficient capitalists of all. In their own ways, crime lords provide a source of jobs and growth to regions unmatched by official government stimulus efforts.

The sum effect of all this additional money sloshing around the globe is the same as that created by official government sources. The effects are currently inflationary, buoyed in large part by the interplay between central bankers - the doves of the West and the hawks of, well, everywhere else. But the pendulum can easily swing the other way - prolonged periods of economic malaise can send foreign workers packing back home and a key source of remittances would dry up. The same applies to cases of trade finance where importers and exporters depend on certain assumptions underlying their relationship - cheap, unofficial subsidies and exchange rates to artificially boost buying power. Even successful law enforcement efforts to clean up crime can have a short term deflationary effect on local economies.

The Bottom Line: The Shadow Banking system operates all over the world and should not just be applied to cases of large sophisticated fund managers. The collective force of many small actors can be enough to rival or even surpass official authorities. The global sloshing of funds is currently tilted firmly towards the inflationary camp but may swing the other way due to macro-economic developments in the West.

Tuesday, May 10, 2011

Mississippi Flooding Threatens US Food and Energy Stockpiles

More upwards pressure is being exerted on the price of food and fuel - the twin drivers of inflation and excluded from the highly sensitive "core inflation" metrics used by the Federal Reserve. Record flooding from the Mississippi River along w/holdover damage from the Tornadoes that swept through the American South several weeks ago are pushing commodity prices higher. But readers should take note that inventory levels of energy also reflect seasonal and historical trends. Also of note is this Friday's April Core CPI numbers which are expected to show an increase in headline inflation.

See here the EIA's natural gas storage analyses:

The US Dollar remains quite oversold in comparison to the Euro and Yen. Dovish central bank sentiment in Brussels and Tokyo have pulled the two major crosses back against the dollar in the past week. Another short term correction in the dollar is possible.

Crops, Oil Refineries Threatened By Mississippi River Flooding
The surging Mississippi River is flooding hundreds of thousands of acres of farmland and limiting traffic along the waterway, delaying fuel shipments.

Fields of recently planted corn, cotton and soybeans along the Mississippi Delta were inundated as the river overflowed, government officials said. Soaked soil is forcing thousands of other farmers to delay plantings this year.

"I really can't compare it to anything. This is unprecedented territory right here," said Andy Prosser, head of marketing at the Mississippi Department of Agriculture and Commerce.

The real problem for growers will be when the waters recede.

"They don't know what kind of sand or silt, debris, may have been deposited on their farmland," said Tom Womack, a spokesman for the Tennessee Department of Agriculture. He estimated that 500,000 acres are already underwater in the state.

The waters are likely to have washed away seeds and mineral-rich topsoil. The U.S. Department of Agriculture has said U.S. stockpiles of key crops such as cotton and corn are at or near historic lows, due to rising global demand.

July corn futures recently traded 1.2% higher on the Chicago Board of Trade, at $7.15 1/2 a bushel, while July delivery soybeans were up 0.7% at $13.44 a bushel. Cotton futures for July delivery were up 0.6% to $1.4631 a pound on IntercontinentalExchange.

The surging river is also threatening energy production and transport throughout the South.

Oil refineries are bracing for potential shutdowns and disruptions to fuel shipments ahead of the floodwaters now moving toward the Louisiana refining corridor. Motiva Enterprise LLC's 237,000 barrel-a-day Norco, La., refinery is preparing for supply disruptions due to the opening of flood gates, according to a spokesman for Royal Dutch Shell PLC, which is part of a joint venture operating the plant.

Fuel products such as gasoline and diesel are distributed through pipelines, rail links and tankers. The floods, which have already stalled some river traffic, could also force companies to halt pipeline flows or lead to congestion on railroads.

U.S. gasoline stockpiles have fallen for 11 straight weeks, and analysts expect further declines in data due for release by the Energy Department on Wednesday. The floods, should they curtail refining in the region, could help push average U.S. retail gasoline prices above $4 a gallon, straining the budgets of consumers and businesses and potentially weighing on the economic recovery.

The bottom line: Markets remain nervous about food and energy price runups. While they suffered a short term drop in last week's trading, the fundamentals remain bullish - but not to the extremes as espoused by some bulls. The short dollar trade is still very crowded and the currency may experience another rally that could dampen bullish commodity prices.

Source: CME News for Tomorrow

Late Spring 2011 US Agricultural Outlook

US Crop Progress: Farmers Make Huge Strides In Corn Planting
Farmers made huge strides planting corn in the western Midwest last week after cold, wet weather delayed earlier field work, according to government data.

The crop was 40% planted as of Sunday, up from 13% a week earlier, the U.S. Department of Agriculture said in a weekly crop progress report. That beat expectations that plantings would be about 30% complete but still lagged the average of 59% for that time of year.

Warmer, drier weather in the western Corn Belt allowed farmers to make significant progress. In Iowa, the country's top corn-producing state, farmers had sown 69% of the crop as of Sunday, up from 8% a week earlier and on par with the five-year average. Farmers had planted 57% of the crop in Nebraska, up from 15% a week earlier and behind the average of 62%.

"We made some historic strides in Iowa. You planted 61% of the crop in just a few days," said Don Roose, president of U.S. Commodities, an Iowa-based brokerage firm.

Yet, farmers in the eastern Midwest continued to struggle with poor weather. Indiana's crop was just 4% planted as of Sunday, below the average of 49% for that time of year, and Ohio's crop was 2% planted, below the average of 54%, according to the USDA.

The lack of progress in the eastern Midwest will likely keep the corn market on edge, as traders worry that planting delays will reduce the size of next fall's harvest, Roose said. Traders will continue to watch weather forecasts closely for signs of improving weather.

Development of the crop also still lags behind normal. Overall, 7% of the country's corn had emerged as of Sunday, up from 5% a week earlier and below the average of 21% for that time of year, according to the USDA.

Farmers need to harvest a large crop next fall to replenish inventories that are expected to drop to a 15-year low this year. Concerns about strong demand draining supplies pushed corn futures to record highs last month.

"It truly is the eastern Corn Belt vs. the western Corn Belt," Roose said.

Farmers are less concerned about planting soybeans because that crop can be sown later in the spring without risking yield losses. Corn tends to produce lower yields in many areas if it is planted past the middle of May.

Soybeans were 7% planted as of Sunday, below the average of 17% for that time of year. In Iowa, 10% of the crop was in the ground, behind the average of 18% for that time of year. The USDA did not report nationwide data for soybeans last week.

Spring wheat planting also advanced after a slow start due to cold, wet weather in the northern Plains. Planting was 22% complete as of Sunday, up from 10% a week earlier and down from the average of 61%.

In North Dakota, the top producer of spring wheat, farmers had planted 7% of the crop, up from 1% last week and below the average of 51%. More progress was made in South Dakota, where planting was 59% complete, up from 22% a week earlier and below the average of 85%.

Spring wheat, prized for its high protein content, is milled into flour used to make bread and blended with other, lower-quality varieties of wheat. Users of the grain worry farmers will sow fewer acres of spring wheat than previously expected due to the planting delays.

The condition of winter wheat, meanwhile, continued to deteriorate due to a severe drought in the central and southern Plains. Overall, winter wheat was rated 33% good to excellent, down one percentage point from last week and from 66% a year ago. In Kansas, the country's top winter-wheat-producing state, the good-to-excellent rating dropped to 18% from 21% last week. Kansas and other Plains states grow hard red winter wheat, which is milled into flour used to make bread.

The bottom line: More progress in planting is a bearish leaning sign for corn as uncertainty about crop levels is being reduced. Selloff potential is limited by the steep losses seen yesterday and last week. But conditions for soybeans and wheat remain below normal for this time of year.

Source: CME News for Tomorrow

Friday, May 6, 2011

Could Brazil Run Out of Ethanol?

Corn is currently heading into a seasonal downtrend in summer trading where contracts reflect increased certainty about crop planting. However, longer term fundamental effects continue to add upwards pressure on prices. A lack of investment in technology and continuing high energy use are contributing to high prices.

The Brazilian-USA ethanol trade relationship is somewhat complicated. Due to tariffs, Brazilian exporters have long sent ethanol to the USA - but doing so through intermediaries in the Caribbean which benefit from sunny tax treatment by US tax authorities. The US tariff is meant to protect US corn farmers. At long last, Congressional (or should I say, lobbying) efforts have paid off. Brazil is currently about to enter a short to medium term decline in ethanol production.

Czarnikow: Brazil Could Run Out Of Bio-Ethanol
Brazil could potentially run out of ethanol supplies, needing a further 100 million tons of cane to meet peak demand in 2011, one of the U.K.'s oldest sugar trade houses said.

"As a result of ethanol output disappointing for the second season in succession, supply has been unable to match the rise in demand resulting in a chronic shortfall in availability," Czarnikow said.

In Brazil, a lack of new investment in cane production, rising sugar prices and production, and underlying weaknesses in the earnings structure resulted in ethanol production falling short of 2010/11 forecasts, reaching only 25.3 billion litres, only 3% higher than 2009/10.

In Europe, member states face supply issues given the implementation of higher blend rates as the European Union targets to source 20% of energy from renewable sources by 2020, Czarnikow said.

But Czarnikow analyst Henry Toller said despite the bio-ethanol market facing challenges to expand, the history of the market since 2003 shows growth is always achievable.

The U.S. meanwhile has swung from a net-importer to exporter over the last 18 months, to become the most reliable hub of ethanol supply for other nations.

Czarnikow estimates that U.S. exports will continue in 2011 as U.S. production now exceeds gasohol demand by 5%. "Even Brazil has had to turn to the U.S. to supply ethanol due to the temporary shortage being faced in its domestic market today."

Source: CME News for Tomorrow

The Bottom Line: Brazil, long a chief exporter of ethanol, is running short on production due to a lack of investment in technology. At the same time, US corn farmers are benefiting from high prices and the tariff imposed by tax authorities. In fact, Brazil may have to turn to the USA to import additional supplies.

Thursday, May 5, 2011

Mexico Buys 100 Tons of Gold in First 4 Months of 2011

Here's another story on Mexico.

In 1521, Hernán Cortés, the Spanish conquistador, conquered the Aztec empire which encompasses modern day Mexico. Over the ensuing centuries, the Spanish crown systematically looted the land of its gold and silver reserves.

Fast forward to today. In a surprise announcement, the Mexican government revealed on Wednesday that they had been slowly acquiring a substantial horde of gold bullion. The sheer amount of gold bars is enough to rival the Aztec treasures of old - more than 100 tons of gold w/an estimated market value of $4 billion.

While the number of gold bars is enough to raise eyebrows, of more importance is Mexico's proximity to the USA. Mexico is America's second largest trade partner w/an economy highly linked to the dollar. As a developing nation largely dependent on exports and tourism to support its economy, Mexican authorities had built a substantial foreign reserve horde that enabled them to systematically sell the peso against the dollar.

Nor is Mexico the only country to do so. China, India, Russia, Kuwait, Saudi Arabia, and (to a lesser extent) Brazil, have been incorporating more gold into their central reserves.

However, there is an important distinction to note. The above countries are all DEVELOPING states, which is a broad term and somewhat politically loaded; but for purposes of this discussion mean their primary source of GDP growth is centered on exports. Central banks in such countries acquire foreign reserves to manipulate exchange rates thereby keeping exports cheap for Western consumers. Authorities have generally refused to comment on the official reasons behind their purchases but are widely believed to have done so for diversification away from the dollar and the inevitable debasement into inflation being wrought by America's uncontrollable spending spree.

Other countries, particularly DEVELOPED states such as the UK or more tellingly, Japan, have smaller gold reserves. But they are not necessarily buying gold either. Instead, these states tend to have well established links w/the Federal Reserve in the form of dollar swaps. These swaps are there not for currency manipulation but to pursue Keynesian monetary policy, aka money printing to support capital markets and failed bankers. This is not a specious charge. Major swap partners include Japan w/its notoriously underwater real estate market that has still not recovered from its 1980s highs. Another notable example is the EU w/its plethora of PIIGS peripheral (impending) sovereign bond defaults.

The bottom line: Developing countries such as Mexico have been acquiring gold bullion as a diversification against the dollar and inflation. But developed states have no reason to do so, instead relying on dollar swaps w/the US Federal Reserve to achieve their Keynesian goals of propping up underwater loans and mortgages.

Sugar Faces Potential Extra Supply

Mexico is not exactly the first place that comes to mind among sugar traders. America (sugar beets and corn), Brazil (sugar cane), and India (sugar cane) are all more known sources. But when prices surge high enough, as they have been over the past 2 years, farmers around the world start paying attention.

Of greater import is the significance behind the dollar's role as the preferred carry instrument of choice. More will be said on this topic in future posts.

Mexican Sugarcane Growers Upbeat On Next Harvest
The leader of Mexico's sugarcane growers says he's optimistic the 2011-2012 harvest will yield more sugar that the current one if the weather holds up.

"If the upcoming season is a normal one with tropical storms and a few freezes, but less aggressive than this year, without a doubt we're going to surpass the current harvest," Carlos Blackaller, president of the National Union of Sugarcane Producers, said in an interview.

High sugar prices have been luring Mexican farmers of other products into the sugar business, he said. Also, productivity has been increasing as well-financed producers use profits from high prices to hire more labor and to invest in improved agricultural practices.

This should contribute to better production next season in Mexico, the world's sixth-largest sugar producer, Blackaller said.

Mexico's sugar harvest usually begins in November and runs to July of the following year. This season, Mexico is on track to produce about 5.2 million tons of sugar, up from 4.8 million tons during the 2009-2010 season, according to sugar officials.

The average yield of sugarcane per hectare has been about 67 tons this season, and it could reach 70 tons next season, Blackaller said. He added that about 37% of plantations are using irrigation systems rather than relying on rainfall, and that percentage is expected to keep growing. Four years ago, about 30% of sugar plantations were irrigated. "There's a better use of water," Blackaller said.

Rene Martinez, director of the national sugar chamber, which represents the country's sugar mills, was less optimistic about the 2011-2012 harvest, saying it didn't rain when it should have in January and February during planting for the next harvest.

"It's an indicator that the 2010-2011 season will be a hard one, with production probably lower than this season's," Martinez said. "Normally when you plant, you cross your fingers and hope for rain, and since it didn't rain we're expecting bad yields."

Blackaller said industrial productivity has increased roughly 6%, and that many of Mexico's 54 sugar mills have been renovated and improved as their owners seek to take advantage of the bullish market.

Migration has been a problem in the sugar industry in the past, with growers abandoning their plantations to find work in the U.S. or in Mexican cities. But this year, Blackaller said high prices have kept producers "rooted to their plantations."

Mexico is expecting to export a record 1.3 million tons of sugar this year amid rising U.S. demand and the displacement of domestic sugar consumption with high fructose corn syrup.

Source: CME News for Tomorrow

The bottom line: Extra sugar supplies are adding bearish pressure to world markets from unexpected corners. The dollar's role as a funding currency in carry on risk trades also plays a critical role in commodity trades.

Tuesday, May 3, 2011

Update on Silver: SLV Fund Sells 7.59 Tons of Silver

Remember my earlier post about backwardation and contango? Here's an update.

As to why the SLV fund is liquidating its physical holdings, look to the fund prospectus which basically states that if SLV has more shares short than long, then it will trade to the downside. In this situation its custodians must buy back SLV shares to absorb the excessive supply to get back to its tradable NAV. To do so, fund managers must sell some of their physical silver bullion thereby equalizing SLV selling into silver itself. This activity is magnified in levered funds such as AGQ.

Silver holdings in the iShares Silver Trust (SLV), the biggest exchange-traded fund backed by silver, decreased 7.59 metric tons to 11,013.75 metric tons as of May 2, according to figures on the company’s website.

The bottom line: Read the fund prospectus before investing any funds into levered ETFs. There is a lot of money to be made on both the long and short sides but be sure to have a SOLID understanding of how they work. I cut my teeth on the 2008-2009short etfs and paid my dues then. I can see the same thing happening in other instruments now.

Opinion: Russian & Indian Wheat Exports Unlikely to Lower Prices

Wheat prices have remained at elevated prices ever since the dramatic runup in late summer 2010. Prices have remained high due to not only Federal Reserve money printing but also fundamental conditions. While North and South America remain affected by La Nina dry weather conditions, buyers have also been hopefully waiting for Russian and Indian exports to open since both countries banned exports (Russia last fall and India 3 years ago). Recent speculation that the two countries would relax controls have not done much to dampen the mood among some bullish speculators.

Of more importance to grain market speculators are the results of moisture conditions in the US midwest region (namely Kansas where hard red wheat is grown). Preliminary reports from scouts indicate that the region has received some rainfall but not as much as expected.

Russia, India Wheat Exports Won't Calm World Markets - Analysts
Deteriorating prospects for U.S. and European wheat crops mean even the return of exports from Russia and India to world markets this year would be unlikely to lower prices, analysts said.

Futures markets for the world's second-most consumed grain have soared to within sight of record highs this year after a succession of natural disasters, including a historic drought in Russia, spurred fears of a shortage of supplies.

But now even hopes that India will ship its first wheat abroad in five years and speculation that the Kremlin will lift a ban on Russia's exports as early as this summer look unlikely to calm nervous markets.

"We don't expect that the Black Sea region will be able to come into the market in the way it did after the 2008 price rally to supply the world with a significant amount of cheap exports," said London-based Rabobank analyst Erin FitzPatrick.

Grain dealers in Russia are starting to move stocks to ports in the hope that the government will allow exports as early as July. Forecasts for Russia's 2011-12 exports range from around 3 million tons to as high as 10 million tons.

Dmitry Rylko, of Russian forecaster Institute for Agricultural Market Studies, said dealers are hoping to free up storage space for the upcoming harvest. But Russian traders said companies are positioning grain in a bid to ship supplies quickly as soon as the ban is lifted.

"I would assume the Russians want money quickly so, if they can sell, they will sell as soon as they can," said analyst James Dunsterville of Switzerland-based Agrimoney.

In Asia, the U.S. Department of Agriculture's attache predicts that a record wheat crop of 84.2 million tons may prompt New Delhi to allow up to 2 million tons of exports, the first time in five years India would export grain.

Still, with food security concerns high on the political agenda in both countries, a sudden surge in shipments looks unlikely.

Both Russia and India are struggling with near double-digit inflation despite holding excess government grain supplies in some areas. And with polls already under way in India and an election set for next year in Moscow, observers say domestic politics is likely to come ahead of international markets.

Even exports from these producers are unlikely to make up for a fall in output in the U.S. and Europe. Wheat prices have rallied more than 20% since April 16 due to concerns for harvests in the world's two largest exporters as dryness has stressed crops in the ground and excessive rainfall has hindered planting.

Source: CME News for Tomorrow

The Bottom Line: Wheat prices are likely to remain elevated despite the possible re-introduction of Russian and Indian exports due to fundamentally bullish conditions.

How Low Can the Dollar Go?

So, just how low can the dollar go? Above are some technical charts detailing potential price movements. If you are a subscriber to Point and Figure chartology, there is even a price target.

On the fundamentals, the prospects for the dollar remain decidedly weak. In fact, there is a strong consensus in Washington D.C. - both among the Federal Reserve and elected officials in Congress to keep the dollar low. Their thinking is based on the premise that so long as the dollar continues to slide there will be great benefits to large American firms increasingly doing business on foreign shores, with particularly strong growth for those moving product in emerging markets. Additionally, interest rates must be kept low for borrowers to keep on making their payments - or more correctly, for the owners of MBS assets to keep on receiving their income streams. The all time lows were established in the pre-crash environment of summer 2008.

Discerning readers may note that the mention of 2008 mean that the market is set to crash again. This is not entirely untrue. However, the main difference between 2008 and 2011 is the level of government involvement in the market. The Fed is basically acting as a giant backstop to all risk on trades w/giant liquidity pumps. While markets may certainly experience corrections, they are unlikely to test the volatility swings seen in 2008.

The US Treasury Department noted this week that it is taking some steps towards responsible FISCAL policy. But this does nothing to alter the Federal Reserve's MONETARY policy. Quick summary - US finances are divided between monetary and fiscal policy. Monetary policy is controlled by the "Treserve" (Treasury + Federal Reserve). Fiscal policy is controlled by Congress (the power to tax and spend). Usually. This line of demarcation has been gradually blurred ever since 2008 and the alphabet soup of bailout programs. The latest announcement by the Treasury is aimed at cutting off subsidies towards state and local governments, hence the fiscal aspect. In contrast, talk of deficit limits are aimed at reigning in Fiscal policy among Congress which decides each year's budget. All of which are going nowhere fast and does nothing to alter the basic preserve of US politics - that in a pork barrel political world, politicians get voted into power based on how much they spend - not how much they cut.

Throw in the addition of Japanese monetary policy (estimated at $250-275 billion last month alone) and the world is easily awash in liquidity several times over. All of this excess cash seems set to continue raising all risk assets several times over - even in spite of the pain dealt to savers and consumers in developing nations.

So, how to profit from this type of environment? Well, precious metals and commodities will continue to climb but will deliver diminishing returns given the current rate of run-up. Another more conservative option is to buy equity index funds when they are trading below NAV and just buy and hold. Don't even open the newspaper but just sit tight and wait for inflation to take effect.

The bottom line: The dollar's decline is both fundamentally and technically all but ensured. While brief rallies may delay the dollar's inevitable decline they do nothing to stem the vast forces moving against it.

India Defers Lifting Wheat and Rice Export Ban

India, like most of Asia, is suffering from a prolonged bout of inflation. And not just inflation. But food and energy inflation. While Americans spend about 10% of their disposable incomes on food, the percentage is much higher in countries like India. Estimates vary but run anywhere from 33%-70% of incomes. In any event, it is a much larger figure than the developed world and America in particular.

This background context is important in understanding why Indian officials are still hesitant about lifting a more than a 3 year old ban on wheat and rice exports. They are understandably nervous about the potential impacts on social stability.

It is also likely that the Reserve Bank of India, the central bank, will act to raise interest rates to cool rising prices. Unfortunately, the source of much of the world's problems are not based domestically but come from abroad in the form of Washington DC's Federal Reserve. The Fed's insistence on maintaining low interest rates has resulted in an ocean of liquidity for Western fund managers to speculate on multiple asset classes. The original intentions were to stimulate lending among US borrowers. However, returns on asset classes such as commodity trades have proven to be far more lucrative and that's where the bulk of the funds have migrated. Of course, all trades carry an element of risk but ever since QE 2 was announced in late summer 2010, the returns on commodity trades have beat any loans that financial institutions could make to cash strapped US borrowers.

India Panel Defers Lifting Of Wheat, Rice Export Ban
An Indian ministerial panel deferred a decision on lifting a ban on wheat and rice exports as it wanted to first take stock of requirement under a proposed food security law to increase subsidized grain sales, a senior government official said.

The country is facing a dilemma as there is little space left to store grains in government warehouses. That had triggered speculation the government may soon allow limited exports of wheat and rice.

India's Farm Ministry had been pushing for some exports as procurement from a bumper wheat crop is underway, but food ministry officials have opposed the move, saying that it will need to keep all the stocks bought from farmers to meet the proposed food security law.

Last month, Farm Secretary P.K Basu said India can easily export 2.0 million tons each of wheat and rice because of good stocks and a likely bumper production this crop year through June.

India, the world's second-largest producer of wheat and rice, has maintained a ban on exports of the two staples for more than three years to curb inflation, although it has allowed limited shipments under diplomatic agreements.

The country is expecting a record foodgrain output of 235.9 million tons in 2010-11 because of favorable weather and higher plantings, up from 218.1 million tons last year.

As of April 1, India's rice and wheat stocks stood at 44.18 million tons, more than double the buffer requirement.

The food ministry official, who didn't want to be identified, told Dow Jones Newswires that the ministerial panel cleared a proposal to import edible oil for subsidized sales to the poor until Sept. 30.

The move will allow the world's top edible oil importer to continue supplying cheap cooking oil beyond the previous deadline of March 31 to millions of poor families. The food ministry had proposed to import 500,000 metric tons of edible oil through various state-run agencies on behalf of provincial governments.

India's state-run trading agencies have been importing edible oil regularly since July 2008 and selling them below cost for welfare programs. The federal government later reimburses the agencies for selling edible oil below cost.

The state-run agencies imported around 650,000 tons of edible oil in the last fiscal year that ended March 31.

India meets more than half of its total edible oil requirement of about 15 million tons through imports from Indonesia, Malaysia, Argentina and Brazil.

The ministerial panel also approved a proposal to supply around 120,000 metric tons of common-grade rice and 106,234 tons of wheat flour to Maldives from April 2011 until March 2014 to honor a diplomatic request, the official said.

The panel also approved a proposal to supply a total of 5.0 million tons of wheat and rice from federal stocks to poor families over six months starting June 1, a move that will help trim stocks at overflowing warehouses.

Source: CME News for Tomorrow

The Bottom Line: Indian officials are still nervous about inflationary outlooks and are acting to build up abundant food reserves. Ultra low US interest rates are contributing to a massive ocean of liquidity that is raising commodity prices around the globe.