Commodity Markets Council Meeting Highlights—February 8-10, 2011

R.J. O’Brien Special Report

Dennis Gartman: This well know commodity newsletter writer is bearish the Euro and bullish currencies in Aust, Can, Braz, and N Zealand. He remains bullish commodities overall but bearish US wage rates. He thinks Euro, which may only survive another 2 years, will go par with dollar. He commends ICE for limiting cotton spec position size in delivery month but offered no views on subsequent price action in cotton. He is bullish wheat and corn with latter likely to post another increase in US ethanol use. His 2011 crude range is $75-$95 citing ample stocks exemplified by widening carry in crude futures. He is encouraged by actions of selec governors to reign in deficit spending.


Jennifer Duffy—Editor of Cook Political Report: House stays Republican in 2012—Senate will shift to Republican majority in 2012 although she advised RNC to avoid nominating Tea Party Senate Candidates in swing states. She thinks Obama’s prospects are good in 2012 citing his recent rise in polls, rarity of one term presidents since 30’s and responsibility for US recovery that Republicans now share as House majority. The most important variable for Obama on his 2nd run for White House will be condition of US economy Oct 2012 and ability of his campaign to bring out “surge voters” i.e. youth, blacks and Hispanics. Economists think recovery is underway but most voters do not. Cautionary note is that no one can predict upcoming “Black Swan” events over next 2 years that could either boost or worsen Obama’s prospects (Black Swains include 9/11,Katrina and Gulf Oil Spill).


Randal Quarles—former Treasury Undersecretary: 2011 recovery definitely underway although massive deleveraging, continued high unemployment and ongoing stress in financial sector are formidable headwinds. EU challenges even more daunting than US given their greater reliance on government and massive bailouts exemplified by Ireland which recently approved $85 bil package for an economy with annual GDP of $173 bil. Quaries noted that extension of Bush tax cuts will add $1 trillion to US deficit and added that US cannot operate as net borrower indefinitely. He advised US businesses to access capital markets now as cost of money won’t be this low again for decades. He expressed optimism over equities amid prospects for improved earnings fueled by higher productivity, low inflation and low interest rates. Additionally, earnings will enjoy tailwind from more stable political backdrop following 2010 elections. Challenges for US ahead include massive state budget deficits, Social Security running a deficit in 3 years, prospects for continued high unemployment and under-investment in US economy (the US spends more on potato chips than the DC spends on R & D energy development). Additionally, there are more foreign graduate students at US Universities in Engineering and Science than Americans. Meanwhile, PRC’s torrid growth fueled in part by massive investment while in long term they will need to improve labor productivity to sustain current growth which is highly resource intensive. In fact, if PRC achieved an 8% annual GDP growth rate through 2031—they would need 2/3 of global grain production, 2x as much paper, 1.1 bil cars (only 800 mil cars globally) and 99 mbd of crude oil (vs. 08 production of 84mbd). Thus just as US experienced explosive growth 1870-1930 interspersed with 5 major Economic crises, the rapid growth in the PRC portends major risks for long term investors. Quarles is most bullish on Brazil over the next 5 years. India also shows promise although economy needs less regulation and protectionism to spur wealth creation.


Oil World: Thomas Mielke believes soybeans are at high end of winter trading range.  He underscored importance of looking “outside the US” for key drivers of oilseed prices.  Palm oil alone represents 57% of global edible oil exports and accounts for the vast majority of growth in global edible oil trade since the mid 90’s.  Global palm oil production in 2010 grew by only 0.5 mmt vs. more typical 1.5-3 mmt annual growth rates since 2000. Long term, global palm prod growth is slowing with Indonesia overtaking Malaysia as world’s largest producer.  PRC veg oil use alone is growing 1.4 mmt/year.  India veg oil use increasing 0.6 mmt annually.  Mielke estimates 5 mmt gain in 2011/12 PRC soy imports vs. prior 2 year gains of 8 mmt/year although he notes than China (and India) are now wealthy enough to build up reserves of both soybean and edible oils. Low global oilseed stocks (its very unusual that both rape and sun seed posted low global production as they did in 2010) sets the stage for extremely volatile 2011 price action that will serve as incentive for importers to extend forward coverage on price breaks.  Mielke’s 4 mmt decline in 2011 S American soy production contrasts against a 16-17 mmt gain in 2010/11 global soy crush led by surging PRC demand.  Food vs. Fuel debate ignited in oilseeds with about 13% of edible oils globally going into bio-diesel which is only 0.3% of diesel use globally.  Bearish warning flags include evidence that current high prices are constraining use including indications that 2010/11 Arg soy oil use for bio-diesel may be 0.4-0.5 mmt below expectations.  EU use of bio-diesel also falling short of expectations. Additionally, 2011 global palm prod is poised to rebound nearly 3.5 mmt from 2010 output.  Miellke cannot rule out new highs if 2011 US crop is threatened but in the short term believes market has had ample time to discount all the bullish inputs outlined above.


Brazil Update: Founder and head of Agroconsult believes 2011 Brazil soy production heading to 72-73 mmt based on high early season yields and much above average crop conditions observed on crop tours.  He pegs 2016 soy production at 85.6 mmt—an annual gain of 3 mmt/year—well short of the rapid expansion in global soy crushing over the last decade and the 16-17 mmt gain in 2010/11 global oilseed crush alone forecasted by Oil World.  Meanwhile, strong growth in domestic Brazilian soy product use will limit gains in Brazil soy exports which are expected to be 38 mmt in 2015/16 vs. 33 mmt today—an annual gain of only 1 mmt.  Domestic soy product use driven by both income driven boost in meat/poultry consumption and burgeoning meat exports with Brazil now ranked as largest poultry exporter and 4th largest pork exporter.  Large domestic livestock growth will also serve to cap corn exports in 9 mmt area (Brazil is 3rd largest corn exporter) vs. 6.5 mmt-11 mmt annual corn exports since 2005/06.  Brazil corn yields only ½ of US with increasing portion of domestic corn production coming from D-Crop corn which now represents over ½ of total corn area. Constraints to bring more land on line (it takes 18-24 months to receive permits to open new land) include increasing environment demands to up farm set asides.  Additional constraints to production growth include high transportation costs ($2.72/bu from internal M.G. to port) driven by inadequate infrastructure and high fuel costs.  Nonetheless, large farm operations are seeking IPO’s to access capital markets to achieve gains in productivity and economies of scale.  This analyst estimates untapped Brazil acreage available for cropping at only 20 mil HA—well below other projections.   Bottom line here is that capacity of Brazil to meet burgeoning global soy demand is limited suggesting continued tight global soy stocks over the next decade.


Dodd/Frank Blue Ribbon Panel: Setting the table, panelists noted that D/F will have far greater impact on previously unregulated OTC markets than regulated futures markets with OTC market trade valued at $584 trillion in 2010 vs. $24 trillion in exchange traded futures.  Additionally, most OTC transactions occur in interest rate and currency markets.  Nonetheless, panelists echoed industry concerns that D/F deadlines for rule making are too aggressive which has increased uncertainty, promised a “messy” series of revisions and exceptions that will likely have “lethal” consequences for select market participants.  IT specialist noted that electronic systems do not exist to audit real-time reporting of OTC trades to regulators.  Furthermore, existing exchanges are reportedly shying away from listing complex OTC trades.  In the short term, however, the trade is still awaiting how CFTC will define a swap, who will be granted end user exemptions and how aggregation will be monitored which collectively suggests that D/F implementation will be lengthy and expensive.  Additionally, the CFTC’s legal pool is woefully short of experienced traders that understand swaps. Meanwhile, D/F skeptics believe that Swap Market Participants will be taking on greater liquidity risk than pre/D/F counterparty risk.  Additionally, banking sources note that D/F will launch banks active in OTC trade into a “slow death roll to utility status” amid higher compliance costs and lower revenues prompting shift in trade to foreign financial centers with less onerous regulatory oversight and costs.  Panel concluded by underscoring need all OTC participants to register their concerns with regulators during critical rule making stage.


USDA’s Chief Economist: Dr. Glauber, in addition to his widely publicized remarks on difficulty in shutting down US ethanol industry and extremely tight 9/11 US corn stocks (only 18 days use-same as tight 9/96 stocks) conveyed additional insights into upcoming 2011 outlook for ag markets.  He noted that pre-plant net returns for corn as of early January 2011 of $581/acre exceeded bean returns by $113/acre vs. Feb ’08 when corn returns exceeded beans by $81/acre.  Additionally, he noted that 2010 D-Crop soy acres were unusually low vs. 2008 which posted one of the highest D crop soy acres in recent years.  Glauber noted that 2010 combined acres of corn, soy, wheat, feed grains, rice, cotton and CRP at only 277 mil acre vs. recent ’08 high of 287.7 mil acre and ’96 high of 295.3 mil acres.  The implication here is that strong returns over variable costs may illicit a larger 2011 US area gain than the trade expects.  Glauber acknowledged need for USDA to survey corn ethanol yields (WASDE uses a rather dated 2.70 gal of ethanol/bu) amid increasing share of US corn used for ethanol but noted that funding for surveys is limited. He also noted that final decision on bidding of additional acres into CRP would not be made until September.  Additionally, EPA (in consultation with USDA) has final say on any temporary suspension of ethanol mandate.  On China, he noted that trade has over-estimated extent of PRC corn import demand since the mid 90’s although he acknowledged critical need for more accurate data on PRC corn stocks.  Glauber termed grain export bans as “bad and pointless” suggesting that ethanol mandates would be rescinded well before imposing grain embargoes in the event of a 2011 US crop disaster.  Responding to question on Vilsack decision to add more land to CRP, Glauber recalled 2008 appeal by TX Governor Perry to release CRP acres as prices surged into early summer that was denied amid gradual improvement in mid/late summer weather that along with financial crash pummeled grain markets lower by late summer.  Glauber expects USDA to adjust current 2011 US food inflation forecasts higher as calendar year advances.  Meanwhile, US corn and soy stks/use ratios which have tracked well below normal for the last 2-3 years, will take several years to rebuild because of the intense competition for acreage from high priced cotton and wheat. He cautioned against using spot ethanol margins as barometer of ethanol profitability given indication of heavy forward pricing by ethanol plants.  Final note—Glauber noted extreme variability in Russian weather is not uncommon and that growth in US corn demand for ethanol over next 5 years will be much slower than last 5 years.


Dan Basse-Ag Resource: This well respected analyst painted a strongly positive tone to row crop and wheat prices saying he cannot define “how high is high” if 2011 US production is threatened.  He believes prices stay well supported until 2011 US acreage, planting dates and early summer weather are clarified May/June. AG Resource expects 39 mmt drop in 2010/11 global grain stocks to be followed by another 29 mmt decline in 2011/12 with corn clearly the price leader with global usage outpacing production.  2011/12 global corn production must advance 40 mmt (unlikely) simply to stabilize 9/12 stocks at 9/11 levels.  Major producer corn yield history shows PRC corn yields leveling out, extreme variability in Arg corn yields since 2003 and steadily rising US corn yield. The US cannot afford to sell large amounts of corn to PRC where reserve stocks are likely overstated by Beijing. 2011/12 Russian wheat exports likely restrained even with production rebound amid need to rebuild internal grain stocks.  Bull case in wheat further supported by 3rd lowest US winter wheat acreage since 1971, high correlation between low April 1 KS wheat ratings and high abandonment, heavy upper Great Plains snowpack and prospects for slower EU wheat exports.  Total 2011 US stocks of corn/soy and wheat will clock in marginally above 1996 lows of only 38 mmt leaving no room for US crop adversity in 2011.  Keep your eye on Drought Monitor across entire HRW belt which along with low HRW crop ratings represents a major risk for wheat end users. Mr. Basse concluded that current bull grain/oilseed market is likely multi year affair given high unlikelihood of rebuilding stocks to comfortable levels in a single growing season.


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