Fei Zhonghai's Outlook on the Supply, Demand and Price Situation of Major Agricultural Products in 2016

This article is a transcript of the speech delivered by renowned commodity research and trading expert Fei Zhonghai on December 13 at the "2016 Global Financial Markets Outlook," jointly held by the RMB Trading and Research Forum and Tianfeng Securities.

Hello everyone! Let me briefly lay out my core views and main logic for you. As we all know, the basic pricing of commodities works at several levels. One level is currency - the currency we mainly focus on is the US dollar index, as well as the currency trends of the major producing countries of the relevant commodities. We all know that a bull market in the US dollar index corresponds to a bear market in commodities; that's the first logic. The second logic is that, as we all know, crude oil is the lifeblood of modern industry, and the price of crude oil is in fact a benchmark for the basic pricing of all kinds of commodities. We saw crude oil plummet all the way after September 2014, falling from 130 US dollars to 30 US dollars, a drop of nearly 80%. The third is the supply and demand relationship of the commodities themselves. We know that in recent years the release of commodity production capacity has kept increasing, mainly because during the previous five years, when commodities were at highs, investment was enormous, and that capacity has been released one after another over these years. At the same time, demand for commodities - especially in countries like China that have such demand for commodities - has seen a fairly large economic recession. The above factors together constitute a very obvious basic logic for a commodity bear market.

Agricultural products have their particularities compared with other commodities, but their overall price trend is consistent, and they too have gone through a relatively large decline. These are the overall views on the several commodities we want to explain today: First, we believe corn, wheat and soybeans are still in an ongoing bear market, and their core task going forward is to keep falling in order to reduce acreage and bring down inventories, so as to reach a new supply balance. Oils and sugar entered their highs ahead of time and have gone through a relatively large decline; they have now moved from oversupply to a state of balanced or tight balance between supply and demand. From a trading standpoint, we regard them as long positions. Now let me explain the main logic of these commodities for you.

Soybeans

This is the CBOT soybean chart. It was the last of the agricultural products to enter its high, which appeared on September 4, 2014, falling from 1780 US cents to the current 850 US cents, essentially "cut in half." Why did it go through such a large decline? From the global soybean balance sheet it is very clear: global soybean production increased for five consecutive years, from 240 million tons to 260 million tons, and consumption also grew, but its growth rate could not keep up with the growth rate of production, so our inventories kept rising. This is the basic situation of global soybean supply and demand.

The main factors: first, planting returns were especially good; second, thanks to technological progress, yields per unit area, even under less favorable weather conditions, still achieved very impressive and record-breaking levels; and another is that the overall weather was very good - over these five years, especially the weather in the United States in the past two years, was basically perfect. Many people previously thought that when El Nino arrived, wouldn't it be a particularly big blow of reduced production to agricultural products? In fact this is a misconception. Looking at the years when El Nino occurred, South America, North America, and the Asian continent including China all had the climate characteristic of relatively abundant rainfall, which is favorable for crop growth. Under the effect of these factors, soybean production in the United States and globally kept increasing all the way.

The focus of global soybean consumption is still China. We know that the most important use of soybeans is as feed and a protein raw material. After soybeans are crushed, soybean oil serves as a major variety of edible oil, and soybean meal as a major variety of feed. Based on our comprehensive statistics, although China's protein demand growth rate has declined somewhat in recent years, it is still increasing at a rate of about 3% per year. Here, because China's rapeseed, cotton and peanut planting have decreased, soybean meal, as the most important protein raw material, still has rising demand. We estimate that in the 2015 to 2016 season, China's protein demand will grow 3.6%, and in the next season, as China's inventories rise, soybean meal demand will increase to 6%. In other words, China's expectations for soybean imports are still very good, and consumption is still very strong.

This is China's soybean balance sheet. China now consumes nearly 100 million tons of soybeans, but the vast majority relies on imports. Domestic soybeans have fallen from 14 million tons previously to 9 million tons, which can only sustain normal food use, for making soy products and soy milk. From the data we now have, about 20% to 30% of genetically modified soybeans have been mixed into soy products, with a price gap of about five or six hundred yuan. Don't think that the soy products and soy milk we eat now are all non-GMO - in fact that's not the case; illegal manufacturers have already mixed in a lot of genetically modified soybeans. So our dependence on soybean imports is very high. Soybeans are the largest commodity in China-US trade - one is soybeans, the other is aircraft; it is also China's largest imported agricultural product, with imports of about 80 million tons each year. This season's imports are expected to be 81 million tons, and next season to reach 84 million tons. So for the single variety of soybeans, China's demand is still in a relatively strong state, and China is also the focus of global soybean demand. Global soybean demand grew 50 million tons over these five years, and China accounted for about 27 million tons of that.

There are mainly three major soybean supplying countries: in North America it is the United States, with annual production of about 100 million tons; in South America it is Brazil and Argentina. Argentina's production is expected to be about 100 million tons this season; Argentina is about 58 million tons. What is Brazil's current state? First, Brazil's planting this season is now basically finished, with a planting rate of 92%, roughly on par with the five-year average, meaning planting is normal. Second, Brazil's acreage this year increased by about 4%. Why did Brazil's acreage increase? Because everyone saw that the Brazilian real depreciated by a total of 80% in 2015, which caused Brazil's planting costs to fall rapidly, so Brazilian farmers' returns from growing soybeans are very good, hence a 4% increase in acreage. From the current state, Brazil's weather conditions are very good overall and relatively ideal. The southern region has somewhat more rainfall, and the northeastern region has slightly less rainfall than usual, which may be a hidden concern, but overall the weather is good.

There is another issue: we note that this year in Brazil, because domestic gasoline and diesel prices rose a great deal, and soybean prices fell, fertilizer inputs were very low, down nearly 7% from previous years. This may be a problem for Brazilian soybeans in the future, but no matter what, at the current price level, Brazilian enthusiasm for planting soybeans is still very high, and it is hard to reduce acreage.

This is Argentina's data. The current planting return has already fallen below cost, but Argentina is a very peculiar country: the official exchange rate is 1 US dollar to 9.5 pesos, but the unofficial rate is 12.5, and the actual unofficial rate is about 40% lower than the official level, so Argentine farmers treat soybeans as a gold reserve, as hard currency. So Argentine farmers have never sold their soybeans, and a cumulative 1500 million tons of soybeans have still not been sold over these years - this is a barrier lake in the global soybean export market. Recently an opposition party in Argentina came to power. First, it wants to cancel the export quotas for corn and wheat; second, it wants to cut the export tariffs on soybeans, corn and wheat from 35% to 25%, and it is not ruled out that they will be gradually and completely eliminated. This, together with the depreciation of Argentina's currency and the policy changes, has formed a huge impact on the global export market. So this year Argentina will export 8 million tons more than in previous years, forming huge competition for US soybeans, while US soybeans this year exported 6 million tons less than in previous years. In other words, Argentine and Brazilian soybeans have a very large competitive advantage over the United States in the global soybean market. Because Argentine farmers growing soybeans are now operating at a loss, and if the transport channels are not very smooth, returns will also be greatly affected. It is expected that Argentina's soybean acreage will decline next year, meaning that the current Argentine price and policy have already begun to play a role in reducing acreage.

This is the US data. At the current price - the CBOT price of 850 US cents - US farmers are starting to lose money. Based on this year's yield per unit area and harvest conditions, their cost is basically 10 US dollars, that is, around 1000 US cents.

We estimate that, given the current state, if prices do not rebound, US acreage next year may decline by about 2%, that is, 1.5 million acres. Let us look at the current US export situation. As I just said, in the FOB market, US soybeans are 20 to 30 US dollars more expensive than South American soybeans, so US soybeans are in a very bad situation this year, and exports are rather mediocre.

The US soybean balance sheet: although US soybean acreage will decrease next year, because US farmers earned very richly in the previous six or seven years, even though they are currently losing money, we do not think US soybean production will decline by a large margin. In other words, US soybean inventories will still remain at a high level next year. So from the current situation of these three major producing countries, we believe the soybean bear market is still in progress. Personally, I believe that only after more than two consecutive planting seasons of acreage reduction will we be able to see the bottom of soybeans. So our overall view on soybeans is bearish. If there are no weather problems, we believe any rebound of more than 5% should be a good shorting point.

Based on historical comparison, we believe the current supply and demand relationship is very, very similar to 1991. We see this black line is this year's; let us look at the upper red line portion, which is 1991. What are the characteristics of these years? It is the second consecutive year of rising inventories, which we believe is very similar to 1991. What were the characteristics of the 1991 trend? After entering the high in early December, it fell all the way to June of the following year. The premise is that as long as the weather in the two South American countries, Argentina and Brazil, is fine, and we expect production to materialize, we believe this will be a straight decline. But agricultural products have a very special situation: weather disturbances are too strong, so we must closely watch the weather problems in Brazil and Argentina. But no matter what, we still believe soybeans are in a bear market, and the road to finding the bottom for soybeans will be very, very long.

Oils

Soybean oil and palm oil have both the attributes of agricultural products (on the supply side), but their sales also have industrial attributes, being used both for food and for biodiesel. Soybean oil and palm oil entered their highs on February 28, 2011, basically consistent with the time when our non-ferrous and ferrous metals entered their highs. Rubber, cotton, soybean oil, palm oil - the times they entered their highs are all very, very consistent. The highs for soybean oil and palm oil were on February 28, 2011, and they fell for a total of 55 months, very much in line with a technical sequence. The worst time for soybean oil and palm oil has already passed, and the absolute low may already have been seen. The supply and demand situation is shifting from severe oversupply toward balanced supply and demand or a slight deficit. So we believe it may be a relatively good long allocation, when all commodities are viewed relatively bearishly.

Let us look at the basic supply and demand situation of oils. There are nine categories of oils in total. The largest is palm oil, over 60 million tons; the second is soybean oil, over 50 million tons; the third is rapeseed oil, 22 million tons; the fourth is sunflower oil, 15 million tons. These four are the largest.

Sunflower oil and rapeseed oil are what we call high-grade oils. From their balance sheets, that is, production, we can see that both sunflower oil and rapeseed oil saw reduced production last year, so their overall inventory and supply-demand situation is tight. We see in the FOB comparison of oils that the prices of lower-grade oils and higher-grade oils are continuously diverging, and supply is relatively tight. In other words, among the four oils, two high-grade oils have already been in a blowout state over the past two years.

This is the global soybean oil balance sheet. What is the situation with soybean oil? In recent years, as soybean products have increased and crushing levels have risen, soybean oil production has been increasing, and consumption has also been increasing, but the increase in production has been greater than that in consumption, so the staged inventory ratio has kept rising. However, in the 2015 to 2016 season, global food consumption grew by about 1.9 million tons, while global production grew by about 2 million tons. At the same time, the consumption of soybean oil for biodiesel in the three countries of the United States, Brazil and Argentina increased by 400,000 tons. For the first time we see a scissors gap in soybean oil supply and demand this season, meaning demand exceeds supply and inventories have begun to decline. Globally, including China, we believe soybean oil is relatively tight, especially since the US Energy Administration recently wants to adjust bioenergy policy to raise the proportion of soybean oil used for biodiesel, which will raise overall soybean oil consumption. Including its subsidy method, it may begin directly subsidizing producers, which would greatly stimulate US domestic soybean oil consumption. So we believe soybean oil is a relatively tight oil.

The most influential is palm oil, mainly from two producing countries: Indonesia and Malaysia. Together these two countries account for nearly 50 million tons, with Indonesia at about 33 million tons and Malaysia at over 20 million tons. For palm oil, we have seen production continuously increasing since 2011. In this whole round of oil declines, the chief culprit was palm oil, with production increasing very, very fast. Over these two years, Indonesia and Malaysia massively expanded palm tree planting, capacity has been continuously released, and food consumption has kept growing, but due to the fall in crude oil prices, the increase in palm oil [for biodiesel] has been very slow, and it even saw a brief decline last year.

What is happening now? We see the impact of the strongest El Nino years in recent years on palm oil production. In the two strongest El Nino events in history, in the year after El Nino, Malaysia's palm oil production generally saw a reduction of more than 10%. This year is a very strong El Nino year, very close to 1997, and even exceeding the level of 1997.

Whether El Nino has a relatively large impact on production in Nigeria and Indonesia - this is the rainfall we have compiled for Malaysia and Indonesia. We see that in Indonesia, starting from March, in the central region - that is, the Java island area, which accounts for about 50% of Indonesia's palm oil producing areas - rainfall declined markedly, especially entering July, when compared with the historical minimum it fell by 60%. In Malaysia, starting from February, a relatively large deviation from the mean has already appeared. The production characteristic of palm oil is that after a drought, the impact of rainfall on production gradually shows up six months later. We see that in November, Malaysia's production compared with the same period last year had already fallen 19%. But after November it is often also the off-season for production, yet the average decline should be about 10%, while our current decline has reached 19%. For Indonesia, starting from the first quarter onward, we need to gradually observe the impact of the drought on it. From current market estimates, this year production in the two countries may fall by more than 3 million tons. Over the past five years, palm oil production on average increased by about 5 million tons each year, and this year's increase will be greatly cut. This is the reduction in supply.

At the same time, Indonesia has adopted a new bioenergy policy: an export tariff of about 50 US dollars is levied on crude palm oil and 30 US dollars on refined palm oil, and this tariff is used to subsidize the losses of bioenergy production. The state energy company plans to start in September to force tenders to increase bioenergy consumption. We estimate that for the full year this will increase by about 1.7 million tons.

The current focus of oil speculation is, first, the impact of US bioenergy policy on soybean oil, and second and most importantly, whether the production cuts in Malaysia and Indonesia after entering the first quarter will be a process of confirmation or a process of falsification. But no matter what, I personally believe the worst time for oils has passed and they can be allocated as longs. But no matter what, oils on the whole are still in a bear market, and in terms of cycle they can only be treated as a rebound rather than as a reversal or the start of a bull market. The operational characteristics of these two definitions are completely different.

Corn

Corn entered its high around August 2012, with a peak of 820 US cents, and has now fallen to the level of 330 US cents. Corn has also fallen all the way, entering a bear market two years earlier than soybeans. Like soybeans, corn has had five consecutive years of bumper harvests, production has kept accumulating, and global production is basically 1 billion tons. Global staged inventories have also kept rising, because while production keeps rising, global consumption basically has no highlights. Feed consumption has performed mediocrely; China's feed consumption this season increased by 1000 tons. Industrial consumption is mainly in the United States, where half of the 360 million tons of corn produced is used to make alcohol, but alcohol usage has already reached the ceiling set by the government, meaning that bioenergy demand for corn has also entered a bottleneck period, and there can be no more highlights. Under these circumstances, global corn staged inventories, and inventory corn, have also kept rising, so corn prices have slid all the way down. The core of global corn is the United States. US corn production, US corn exports, and US corn consumption all play a crucial role in global corn prices. But because the US dollar keeps appreciating, US corn this year has been squeezed badly in the export market by Brazil and the EU, so the pressure on the US domestic market is very great.

From the current expectations for next year, first, we believe that based on the current soybean-to-corn ratio, the probability of an increase in US corn acreage next year is high, and Argentina's corn is also increasing. In other words, we still cannot see a state of acreage reduction in the major corn supplying countries, so corn is still in a bear market, a long, long bear path. US corn has lost money for three consecutive years, but the degree of loss is relatively small, and US farmers' returns are very rich, so they will probably still plant corn.

Wheat is very similar to corn, that is, continuous bumper harvests, very mediocre consumption, staged wheat inventories continuously rising, and no country reducing acreage, so it is still bearish. The current price is 480 US cents, and there is even a possibility of breaking below 400 US cents - a bear market. China's wheat on the whole is relatively tight in supply, because our wheat acreage has not increased, staged inventories are not increasing but slightly decreasing, and we import about 3 million tons each year to maintain domestic balance.

What we may need to focus on is China's corn. In fact, one of the most important factors in the global agricultural bear market of recent years is China's price-support purchasing policy, and the largest variety involved is corn. In other words, China's corn price has had a huge impact on global agricultural prices. Why do I say this? We know China now imports 80 million tons of soybeans and 45 million tons of cereal feed each year, but we produce so much corn that we cannot use it all ourselves - it all piles up in warehouses - while at the same time we go and import large quantities of foreign grain, creating a very wrong state of affairs. This is the result of China's price-support policy.

Last year China's corn production was about 230 million tons. On the whole, the annual surplus was an oversupply, with 50 million tons of corn overproduced. This is the current corn situation. But what is the state of China's corn inventories? Let me tell you. China began price-support purchasing of corn in 2008: 35 million tons in 2008, 610,000 tons in 2009, 8 million tons in 2010, 1.02 million tons in 2011, 30.83 million tons purchased in 2012, 69 million tons purchased in 2013, and 84 million tons purchased in 2014. This year, although the price was lowered to 200 yuan, based on the current pace, after the end on April 30 next year, the government may purchase 80 million tons of corn. In other words, apart from what is auctioned off, how much corn will be in the warehouses? Previously the state reserve held 15 million tons of corn. In 2012 we purchased 30 million tons and auctioned it down to 10 million tons remaining - that is 25 million tons. In 2013 we purchased 69 million tons and auctioned 8 million tons, leaving a surplus of 60 million tons, which added together makes 95 million tons. In 2014 we purchased 83 million tons, which added together makes about 177 million tons. This year, at the most conservative estimate, if we purchase 50 million tons, our staged inventory will also reach 230 million tons. In other words, even if China does not plant corn for a year, we would still be fine now. Moreover, the earliest corn we purchased - the corn from 2012 and 2013 - can no longer be stored by now. That is to say, for corn alone, counting storage fees, bank interest and price-difference losses, the loss comes to roughly 300 billion yuan. If you add the sugar, cotton, oils and corn purchased under price support over these years, the central finance estimate is that these items together over these three years will lose 700 billion yuan.

How can this problem be solved? I believe that next year the government will definitely make up its mind to change this price-support policy. Now there is to be a separation of price and subsidy, that is, returning the price to the market. First, safeguard farmers' income from growing grain; second, ensure that after farmers sell their grain, someone buys it. What method will be adopted? For example, if a farmer plants 1 mu of corn, I give you a subsidy of 200 yuan, and when the corn price falls to the cost line, the government starts buying. We calculated that China's two main corn producing areas - one is the Huang-Huai-Hai region, with about 50 million tons a year, and the most important is the three northeastern provinces plus Inner Mongolia, with an annual output of 70 million tons. From current statistics, Jilin's corn is at 1500, Liaoning at 1500, and Heilongjiang and Inner Mongolia basically at a price of 1150. So you can imagine, if the government subsidizes 200 yuan per mu, corn prices in Jilin and Liaoning will fall to the level of 1300 or 1400. At present, the trading price of corn on the Dalian futures market is 1900 for May and around 1800 for September, and in the spot market Dalian port is about 2050. In other words, with the enormous corn inventory, China's most core task for corn is, first, to cut production, and second, to destock. The time needed to cut production and destock, I personally believe, will be very, very long. In other words, China's corn is in a slow bear market. If China's corn price is lowered, it will have an even more severe impact on the pricing of global agricultural products. We can put it this way: China's corn can serve as an anchor for the prices of the entire soybean complex and cereals. It is precisely because a lot of China's land has been used to plant corn that China has gone to the international market to import other grain and oil varieties. Now the government is determined to adjust this structure, so we believe that a lower Chinese corn price will have a very large impact on lowering global agricultural prices.

But the current state of corn trading is very troublesome, because every contract is at a discount, and the September contract has already fallen to a very low level. So from a trading standpoint, corn is very difficult to trade. But I believe there is one variety that can be continuously shorted on rallies, and that is starch. As corn prices decline, I believe starch prices will keep falling. Moreover, starting this season China will strictly restrict cassava imports, which will deal a very large blow to Southeast Asian cassava and also very heavily suppress cassava starch.

Sugar

Finally, let me talk about sugar. Sugar, like oils, showed a supply-demand gap for the first time this year. On an annual basis, this year's gap is about 4.5 million tons, the first time this has happened in nearly 4 years. Why has such a large supply-demand gap appeared? The most important is Brazil. First, Brazil's sugarcane crushing period had continuous rain, causing the sugar yield from sugarcane to fall nearly 3% from last year. Second, Brazil also uses sugarcane to make fuel ethanol. Because sugar prices kept falling, the price of fuel ethanol, that is, alcohol, also fell a great deal. When this ratio is below 0.7, overall alcohol consumption increases substantially, by about 30% to 40%, and about 60% of sugarcane is used to produce alcohol. Thus sugar production falls - originally expected at 32 million tons, now estimated at around 29.5 million tons.

The second is India's production. India's production last year was 28.3 million tons. Now various institutions have different estimates, with an overall reduction estimated at around 2 million tons. These two countries are the main sugar producing countries. So we feel that the low for sugar may also have been seen. Sugar fell after August this year, from 13 US cents to 10 US cents, and this final 20% decline was mainly caused by the depreciation of the real. As the real stabilized and rebounded, sugar also saw its low. From August 28 to now, international sugar has rebounded 50%, with some retracement recently. But we believe the absolute low for sugar has been seen, and after this retracement, I personally believe it is still a buying opportunity.

China's sugar has also shown the same situation as Brazil and India. This year's Chinese sugar production, on the most pessimistic estimate - looking at the balance sheet, last year our sugar production was 10.58 million tons, and we have had three consecutive years of declining sugar production. This year it is expected to be about 9.3 million tons. From the current crushing situation, Guangxi and Yunnan entered the crushing period in November, and the sugar yield is very poor. The most pessimistic market estimate now is sugar production of around 9 million tons. This is the supply situation. Second, because of our annual consumption - last year we put it at 15.3 million tons, and this year we put it at 15.2 million tons. Why was it reduced by 100,000 tons? Mainly because corn starch prices have fallen, and people have begun to use corn starch to produce starch sugar. So now we see that Pepsi and Coca-Cola have already switched from cane sugar to high-fructose corn syrup, that is, using sugar produced from corn starch to replace white sugar. This has reduced demand for white sugar. Our production is 9.3 million tons, and our consumption is 15.2 million tons. We now import in two ways: one is within-quota imports, about 2.1 million tons, and above-quota also adopts a managed approach, with this year's above-quota quota at 1.9 million tons. Thus for the whole year, adding imports and our own domestic production, we still have a gap of 2 million tons for the year, and the state may need to release reserves. There are 7.7 million tons in government reserves, and in the end the government will release them to close the gap. China's overall sugar supply and demand relationship can be defined as a state of tight balance. A tight balance basically makes it hard to fall below cost, or a fall below cost should not exceed 10% for a very long time. So China's bottom price for sugar, we believe, is basically in the 5200 area, meaning there is support below. At the current sugarcane purchase price, the general cost of sugar is about 5300 yuan. But there is also the problem of smuggling; smuggled sugar in Yunnan is at 4700 to 4800, which may be the extreme value we see going down. Overall, we believe that authentic domestic sugar entering a seasonal low is a very good buying opportunity. But because we are now entering the crushing stage, a period of relatively ample supply, and at the same time because old sugar or imported sugar prices are relatively low, there will be a drag. We believe a large rise in the short term is unlikely, but after May, domestic sugar supply will gradually tighten. As inventories are digested and the consumption peak season arrives, we believe sugar may rise relatively well. Especially for the main contracts for May and September, if they fall below 5400, we believe the margin of safety is very high. So we recommend sugar and oils as the varieties we are relatively optimistic about.