Baring’s Govan sees trend towards rising soft commodities prices

James Govan, Investment manager on the Baring Global Agriculture Fund, sees rising soft commodity prices as summer weather in the US forces the market to rethink forward contracts prices.

While the UK and much of Northern Europe has endured a summer of relatively cool and damp weather, this is a complete contrast with the key growing region in the US Midwest ‘corn belt’ which has been suffering very hot, very dry weather. Temperatures have been as high as the low 100s in Fahrenheit (or over 37 Celsius) in some parts of the region and, from the perspective of global agriculture, very hot temperatures reduce the potential yield of crops, such as corn and soybean, and hence total production. We believe the potential for a lower US crop is a serious issue because inventories remain low when compared to consumption in corn and soybean from a historical perspective.

The recent heat wave has reduced market expectations about US corn and soybean production, resulting in a sharp upward movement in the grain and soybean prices. Chicago December Corn Futures have rallied by 46.5% during May 11th-July 13th 2012, while Chicago September Wheat Futures have rallied 38.6% in the same period*. We believe the scale and rapid advance of grain and soybean prices has been due to the very large change in market expectations, which had actually been for a bumper harvest as the planting conditions in April and May had been very strong. (In fact, the US Department of Agriculture had forecast a very high corn yield on the basis farmers had planted the most corn acres in the country since the late 1930s).

Instead, corn yield estimates have been reduced from 166 bushels per acre in the June WASDE (World Agricultural Supply and Demand Estimates) report to around 146 bushels per acre in July**. While market expectations are still for a large crop in the US, the bumper crop scenario may have been averted by the current weather conditions.

In recent weeks, agricultural companies involved in the ‘upstream’ such as fertiliser, machinery, seed and crop protection have performed strongly, supported by the rally in grain and soybean prices. Asian-based crude palm oil equities have also begun to perform well, because the deterioration in the US soybean crop improves palm oil fundamentals as market expectations on the overall vegetable oil inventories are typically revised lower.

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