Macquarie Research: Agri-view -Inverted forward curves point to acute shortages

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Macquarie Agri-view
Inverted forward curves point to acute
shortages
Feature article
 Recent price movements across the agricultural commodity space have been
very volatile, culminating in a large sell-off last week. Open interest has
started to fall in many futures markets, as prices begin looking “toppy” amidst
renewed risk aversion following the Middle Eastern unrest. But the underlying
fundamentals across each market remain very much constructive. Indeed, the
decline in prices has been met with strong support as commercials identify a
potential buying opportunity to take physical cover before prices resume their
uptrend. Short-term supply shortages (with proper supply relief still at least 6
months away) are very much the name of the day, as evidenced by inverted
futures curves across the grains and softs complex.

Latest market update
 Ethanol: Prices for corn-based ethanol have been rising steadily in the US for
the last four weeks in a row. While more expensive corn is providing costpush
pressure, even higher gasoline prices are supporting the market
upwards. Blender economics and ethanol margins are very profitable right
now, with a strong export market keeping the domestic US ethanol market
quite tight. In Brazil an even sharper rally is now being seen for cane-based
ethanol due to a sharp decline in hydrous ethanol availability following the
bias amongst mills in producing sugar over ethanol for much of 2010, as well
as the seasonal end of the crushing season in the Centre South. Flexi-fuel
vehicles, which account for 38% of the Brazilian car fleet now, are finding it
more economical to switch to gasolina C in most states, which will help ration
domestic demand; but in the interim period ethanol exports from Brazil will
have to decline further until the new crushing season commences post April.
 Grains: Markets consolidated amidst long liquidation and a flight to less risky
assets following the Middle Eastern unrest. But the dip only served to attract
commercial buying, with new tenders being placed by countries in MENA who
are stockpiling at home to contain food inflation. Concerns over dry weather
on the US wheat crop, as well as rains affecting the Brazilian soybeans
harvest, also supported prices. With the USDA planting intentions report out
at the end of this month, there is a risk of further consolidation ahead given
the strong incentives to expand acreage. But any dip will likely be short-lived,
due to tight physical supplies and the risk premium associated with the
growing season. We continue to see prices firming into the middle of 2011.
 Softs: Some price easing was seen over the past few days in sugar, cotton
and coffee amidst profit-taking. Cotton fell sharply from its peak of US210c/lb,
but seems to be climbing back up on mill buying and strong US export sales.
Total open interest in cotton futures is at a 7-mth low, but physical shortages
could see new speculators return to this market. Cocoa prices have reached
new 32-year highs to US$2,730/t on fears that Ivory Coast may return to civil
war, raising the risks for supply disruption. The coffee rally, despite pausing
for breath last week, continues to be well supported by roaster buying, while
sugar prices remain steady in the midst of the Brazilian intercrop lull.