Corn Prices Set for a Historic Bull Market
Since 2010, under the powerful shadow of policy, the grain market has hardly been content to sit still, with its trading range continuously expanding. As the major grain over which China has relatively weaker control, corn has already sustained a two-year bull market since the financial crisis. But that is not the whole story: because China's domestic corn market faces prominent contradictions -- a widening supply-demand gap, inventories falling to historic lows, the potential for acreage growth essentially exhausted, and high import costs -- it is highly likely to see a historic bull market this year. At the same time, good arbitrage opportunities are likely to emerge between corn and strong wheat and early indica rice.
I. Influencing Factors
1. Subsidies Trigger a Strong Policy Model
China introduced a policy of subsidizing southern enterprises to purchase new corn in the northeast, with the subsidy halved to 35 yuan/tonne. Based on last year's experience, the subsidy model can typically bring the market an additional upside of 100—150 yuan/tonne. In addition, Sinograin may receive stronger preferential purchase policies. If Sinograin is allowed to enjoy the 35 yuan/tonne subsidy on top of following market prices, the market will form a double-subsidy model, potentially doubling its effect.
The bearish factors also mainly come from policy. In the short term, policy delays the entry of state-owned enterprises into the market, imposes restrictions on diversified purchasing entities in terms of loans, transportation and inventory, and continues high-volume auctions -- but these policies only add short-term pressure and cannot improve the annual supply-demand relationship. In the medium to long term, policies the state may implement include restricting production by deep-processing enterprises and imports. Xinhu Futures conducted a special survey of deep-processing enterprises in the northeast in late November; these enterprises are not strongly worried about regulation, because most deep-processed products supply the food industry. Reduced cassava production in Southeast Asia has created opportunities for Chinese corn alcohol; if output is strictly limited, prices of downstream products could surge. According to Xinhu's survey, some large deep-processing expansion projects will be commissioned in 2010/2011, and all of these projects were lawfully approved.
2. Supply-Demand Gap
In 2009/2010, China auctioned about 25.7 million tonnes of corn in total, while purchasing more than 600,000 tonnes of temporary reserve corn, plus two allocations of corn to disaster areas, reducing state corn inventories by 25 million—25.3 million tonnes. Non-state beginning inventories are estimated to have increased by 3 million—5 million tonnes year on year, with total social inventories falling by 20 million—22 million tonnes, i.e. a supply-demand gap of 20 million—22 million tonnes. Production in 2010/2011 is estimated to increase by 13 million—15 million tonnes, while demand increases by 3 million—5 million tonnes, reducing the supply-demand gap by about 10 million tonnes. That is, the supply-demand gap for the year will still remain at 10 million—12 million tonnes. Of course, it is necessary to revise our expectations based on actual market developments. On the production side, some large enterprises in our surveys strongly dispute the corn output of Heilongjiang, believing it may be significantly higher than estimated. In addition, on the demand side we must continuously monitor the actual operating rates and capacity of deep processing, hog inventories and new changes in the import issue.
3. Inventories Fall to a Twenty-Year Low
According to estimates, China's corn futures inventory-to-consumption ratio fell to about 15% in 2009/2010, the lowest in at least twenty years, and in 2010/2011 it may continue to drop below 10%. In 2009/2010, when the market had a huge supply-demand gap, China had enormous state reserve inventories to fill it. In 2010/2011 we will face a no-inventory situation. In the medium term, the state's delay of Sinograin's market entry and extension of the auction period may leave the state inventory level in December about 7 million tonnes lower than the same period in normal years, creating enormous medium-term restocking pressure.
4. Acreage Growth Potential Essentially Exhausted
Based on our years of on-the-ground surveys in the northeast, corn has maintained a comparative price advantage over soybeans for many consecutive years (except 2008); land that could be converted has essentially all been converted, with very little remaining convertible acreage, and it is mostly concentrated in high-latitude or medium-to-low-yield areas with lower per-unit yields. In addition, China has little potential for newly developed farmland, mostly concentrated in remote areas with high latitude, low accumulated temperature or poor soil. China's urbanization is advancing rapidly, with construction, roads and other uses consuming large amounts of existing farmland every year. In the past, a sharp price rise in a single variety could trigger inter-variety adjustment of farmland; this year many agricultural products have risen sharply together, collectively reflecting that the total supply of farmland may be facing a historic turning point. In the coming years, China's corn supply-demand gap will continue to widen.
5. Import Costs Remain High
Because global corn consumption is rising rigidly and US corn inventories have fallen to a 15-year low, international corn prices have soared from their mid-2010 lows, with the highest gain exceeding 80%. Although prices began to fall in mid-November, by the end of the year the duty-paid cost of US corn imported to China was still at a premium of more than 300 yuan/tonne over the price of Chinese domestic corn at southern ports. More critically, the current CBOT corn price is based on China not yet having launched large-scale imports. Although from November 2010 market rumors circulated that China had signed an agreement with Argentina's Ministry of Agriculture to import about 5.5 million tonnes of corn, official spokespeople later denied this. According to our exchanges with multinational companies, the biosafety testing procedures for imported corn usually take a very long time. According to Xinhu Futures' speculation, China's corn supply-demand gap will begin to be exposed after June 2011, and the import gate is likely to open from then on.