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According to most economic outlooks, what is happening in commodities shouldn’t be happening. What looks, smells and acts like inflation is starting to build into a number of commodity markets, but that doesn’t exactly jibe with conventional wisdom. Certainly a definitive downtrend pattern in the US Dollar has fostered an inflationary psychology that seems to be spilling out in gold, silver, platinum, copper, crude, corn, soybeans and sugar. Yet while the magnitude of gains in various commodity index measures today smacks of inflation, it might also the result of tightening supply. Some might suggest that some of this is the result of ramped up investor interest in commodities, but in many cases (soybeans, corn, cotton, copper and platinum) there is also evidence of robust physical demand.
Some of the markets seem to think that the economy is moving forward and that “much more” easing as requested from the Chicago Fed President this week will set us up for hyper-inflation. Ongoing dryness in South America has already resulted in a resumption of speculative buying in soybeans, sugar and coffee, and therefore there is certainly the potential to extend the tightening into upcoming crop cycles. With the added benefit of very sharp gains in US equity prices and nearly perpetual declines in the Dollar, the outside market forces are also presenting the commodities trade with a perfect storm. One has to wonder what the reaction in the markets will be if the US monthly non farm payroll report on Friday, October 8th (after this writing) ends up showing a minimal jobs gain or a nondescript decline. Could that be enough for the Fed to not invoke QE2?
The agricultural markets are responding quickly to signals from the Fed and the financial markets that inflation is coming. The sharp break in the US dollar only adds to the bullish tone for commodity markets, as it will make US commodities appear cheaper on the world market. A good example is in the wheat market, where the disastrous drought in Russia and the Black Sea region resulted in the loss of millions of tonnes of potential exports from that part of the world. The USDA adjusted the US export forecast up from last year in the wake of the drought, but we have yet to see much of a pick-up in weekly export sales. Cumulative export shipments are lagging behind the average pace for this point in the season, standing at just 30.3% of the USDA’s projection for the marketing year versus a 5-year average of 37.2%. Cumulative export sales (wheat shipped plus wheat sold but not shipped) have reached 50.3% of the forecast for the season as compared with 53.8% as the 5-year average.
The 6% drop in the value of the US dollar since September will likely have an impact on wheat export sales, and they should pick up soon. Traders in Europe already believe that European wheat exportable surplus will be nearly zero by the end of the calendar year, and this will leave the US as the primary supplier on the world market. Canada and Australia may also be in a position to boost wheat exports, but this will depend on the currency trends. In this environment, commodity currencies like the Australian and Canadian dollars are likely to outperform the US dollar.
Commodity markets with the potential for a tightening supply outlook could especially benefit from the lower dollar. If corn yield is adjusted down as much as we believe possible in the USDA production report on October 8th (after this writing), the US may be looking at one of the tightest years on record. Unlike for soybeans and wheat, the US is the world’s biggest corn exporter by far. The December 2011 contract will have the added benefit of having to battle for acres.
The lower US dollar could also support livestock prices into 2011, as tightening supplies will also be an issue. We already export 20% or more of our monthly pork production, and beef exports have also been picking up the pace this year. Cumulative beef sales for 2010 have reached 504,300 metric tonnes, up 27.3% from last year’s pace. A continued decline in the US dollar could only help support even stronger exports during a period when US meat production is already on the decline.
