Price Volatility in Feed Input Costs - World events impact the price of crops and cost of feed


For some, the word volatility doesn't come close to describing what has happened to corn and wheat prices over the last four months. Last year, prices were on an upward slope due to supply issues such as weather factors in Russia that led to a ban on wheat exports there. The response from speculators was decisive. They wasted no time in buying wheat futures, as well as corn and soybeans. Although supply concerns weighed heavily in the decision to go "long" on grains, it was also a response to a policy adopted by the US Federal Reserve Bank known as Quantitative Easing 2 (QE2). Imbedded in this policy was a decision to purchase $600 billion of US bonds, also known as US Treasuries. As a result of the massive purchase, investment rates on bonds fell to an historic low. The US dollar was also driven down because the injection of $600 billion into the money supply diluted its value. Essentially, what happened to the US dollar is what happens to the price of corn when the supply is very high. The US Federal Reserve adopted this measure to help kick-start the US economy by providing low cost financing for businesses to grow, and prevent the US from sinking into another recession.

The result, however, was that in addition to a lacklustre performance by the equities markets (still suffering from the effects of the global downturn) was that Treasuries were also not delivering any significant returns. Speculators began to look at the commodities markets, and grains in particular, to make gains.

This year is much different. Speculators were already "long" coming into this year, meaning that they had already bought grains in the futures markets. A futures market is very similar to a stock exchange. Grain contracts are bought and sold and are settled for cash value. The contracts have a set expiration date meaning that if you bought a grain futures contract, you must sell it before the contract expiry date. The market constantly matches up buyers and sellers. The buyers may place a bid with the exchange to show that they intend to buy a certain number of contracts for a set price. A seller may place an offer with the exchange to show that they intend to sell a certain number of contracts. Buyers may also choose to "lift" the offer, or meet the price of the seller. A seller can "hit" the bid to meet the price of the buyer. A contract remains open until the buyer or seller chooses to close the contract by doing the reverse. Contracts are generally closed before the contract expiration. It is also possible to get physical settlement, meaning that grain gets exchanged for money, but this rarely happens.

Because they were already long, they needed additional reasons to add to their position. One of the reasons prices rose this year was the cold rainy spring we had in North America and Northern Europe (both prime grain exporters). Another reason was the continued devaluation of the US dollar as a result of Quantitative Easing (explained above). India also reported that it was considering banning grain exports to help stave off food inflation, which reached double digits there last year. However, perhaps the biggest reason for price increases was that demand for grain held up despite record prices.

By contrast, there were also a lot of negative pressures on grain prices: the US Federal government announced that it will not be extending quantitative easing, which is due to end June 30th. Another negative sign was the European debt crisis, largely because it caused the US dollar to increase in value. Commodities are valued in $US, so when this dollar goes up, the value of the commodity is diminished (and vice-versa). To illustrate this point, think about how willing you ere to pay the publisher's price on books when the Canadian dollar was trading above par? Prices also tumbled when the weather situation improved, and farmers worked around the clock to ensure the crop was planted.

Lately, the bears (or those who believe that grain prices are going lower) are gaining traction, especially with Russia announcing that it will begin wheat exports on July 1. Wheat trading on the July futures contract actually traded below corn, which prompted some of the large US poultry processors like Tyson's to change their feed regimens.

Volatility continues to be a concern, enough to draw the Agriculture Ministers from the G20 nations to address it in a summit. Some, like France's Sarkozy, is proposing the imposition of restrictions on speculators. Others, like the World Bank president, are proposing to beat speculators at their own game by using financial tools such as futures and options to mitigate price volatility.

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