Now that commodities are front and center in the national spotlight, the finger pointers, conspiracy theorists and self-serving politicians have arisen as if drawn out by a full moon. Unfortunately, what many of them are spouting is sheer lunacy. Here are the three biggest “real” drivers of commodity prices.
First and foremost, supply and demand determine prices. Powerful new demand from emerging economies was only briefly sidetracked by the global recession and has returned in full force. China is already the world’s largest buyer of soybeans, soy-oil, cotton, iron, aluminum, copper and zinc. China, the Middle East and Brazil will account for nearly all of the demand growth for crude oil in 2010 and 2011. Now, spreading unrest in the Middle East is threatening to disrupt crude oil supplies. That fear has added roughly a 25-percent premium to crude prices. Subsequently, higher diesel prices are compounding costs at each level of the supply chain.
Secondly, John Barleycorn must die. Putting 40 percent of our corn crop into ethanol production has doubled the cost of the main source of feed for cattle, hogs, poultry and dairy cows. As a result, protein and dairy producers continue to hold back expansion plans despite receiving record-high prices for their livestock.
Finally, the Federal Reserve through its recession-fighting quantitative easing, or QE, program has flooded the economy with liquidity. The biggest side effect of QE has been a sharply weaker U.S. dollar, which affects commodities in two ways. First, any commodity traded on U.S. futures exchanges and priced in U.S. dollars tends to readjust higher every time the dollar weakens. Second, U.S. exports are now cheaper and more attractive to foreign buyers — and that increased export demand also helps drive prices higher.
These three factors easily account for 85 percent to 90 percent of the run-up in commodity prices over the past year. Yes, those evil speculators are adding some premium to prices, but take away QE and ethanol, or raise interest rates, and all of those long specs will be short commodities in a hurry.
Beef — The U.S. Department of Agriculture’s April cattle report showed feedlot inventory at 11.28 million head, up 5 percent from a year ago. March new placements were up 3.3 percent. Deteriorating pasture conditions and record cattle prices continue to prompt ranchers to push calves prematurely on feedlots. As a result, feedlot numbers and slaughter rates will climb into late summer, likely triggering a slump in beef prices by August. However, once that mini-glut has passed, supplies will drop off sharply. Strong export demand will likely compound the price effects of sharply lower supplies expected later this year.
Cattle futures closed the month of April at $117.05 per hundredweight, down from the April 4 record high of $122.38, but October and December futures contracts are in the low $120s and reflect traders’ anticipation for record-high cattle prices in the fourth quarter. Seasonally, expect high beef prices with peaks ahead of the “big three” grilling holidays — Memorial Day, Father’s Day and Fourth of July — and then lower prices in July and August.
Dairy — Milk production is expected to rise by 1.6 percent in 2011 despite record-high feed prices. Slightly higher cow numbers and increased output per cow will help lift output. But strong exports will continue to support higher year-over-year dairy prices. Block cheese began May at $1.6125 per pound, 4 cents above the market bottom of early April. Milk output is peaking seasonally and cheese production is strong, but cheese exports in February were double year-ago levels and Oceania Cheddar markets remain above $2 per pound. Look for cheese prices to be choppy but remain in the $1.60s through June.
Butter prices at $2.0750 per pound continue to strengthen on tight supplies. Storage supplies are at a six-year low. The Oceania market is at $2.13, and western Europe is $2.59. U.S. prices were expected to move lower post-Easter and Passover, but supplies just haven’t recovered enough for that to happen. Expect butter to remain above $1.95 per pound through June.
Grain — The USDA threw corn markets a few curveballs in April. In its April 1 quarterly stocks report, USDA cut supplies by 178 million bushels, leading analysts to drop the stocks-to-use ratio from 5 percent to a record-low 4.2 percent. But in April’s World Supply and Demand Estimate, USDA did not lower 2010/11 ending stocks and left stocks-to-use unchanged at 5 percent. Corn used for ethanol was revised higher to 5 billion bushels, or 40.2 percent of the corn crop, but was offset by a drop in feed and residual usage. Traders remain focused on tight old-crop supplies and a wet start to the new-crop planting season. Corn planted after May 15 has historically suffered yield losses due to weaker root structure and vulnerability to summer heat. Corn futures traded in the $7.36 -to-$7.76-per-bushel range in April. December 2011 and all 2012 contracts are trading below $7 and reflect expectations for some new-crop supply relief this coming fall.
Pork — According to the USDA, lower summer farrowings are expected to be more than offset by continued gains in litter rates, resulting in a marginally higher summer pig crop. Hog production this year is expected to be 22.6 billion pounds, slightly higher than last year. But it is likely that strong domestic and foreign demand will offset any downside price effects of higher hog inventories. Strong sales are expected to South Korea, which lost 25 percent of its hog herd to foot-and-mouth disease, and China, where domestic hog prices have hit $1 per pound. China imported 157 million pounds of U.S. pork in 2010, almost triple its purchases in 2009. Chinese pork imports look to jump another 6 percent in 2011.
Lean hog futures, which peaked at a record-high $103 per hundredweight in mid-April, have fallen back to the low 90-cent-per-pound range. Post-Easter ham market prices remain strong in the upper 70-cents per pound, and will likely trade in the mid-80-cent range this summer. Pork bellies were record-high at $1.50 in April but dropped to $1.37 by month’s end. Look for belly prices to remain strong in the $1.40 range at least through mid-summer.
Poultry — The big question for producers is the outlook for profitability given sky-high corn prices. Producer margins turned negative in late 2010 and continue to decline. The April 1 hatching flock was 2 percent below a year ago, and that doesn’t account for April’s tornado damage that may have taken out another 1 percent to 3 percent of production capacity. That means that egg sets, which have been running 1 percent above a year ago, are likely to turn negative soon. USDA dropped its 2011 broiler production forecast to 37.4 billion pounds, 1.4 percent higher than in 2010. That number will likely be lowered further in their upcoming May and June reports.
Chicken parts prices are likely to strengthen due to tighter supplies and higher beef and pork prices. USDA boneless skinless breast prices closed out April in the mid-$1.30s per pound, 20 cents below a year ago. But boneless skinless breast should be above $1.60 by June and could still peak near $1.80 this summer. The USDA whole-wing market is 80 cents per pound, versus $1.20 a year ago. Wing markets could remain below $1 per pound through summer.
John T. Barone is president of Market Vision Inc. in Fairfield, N.J., and can be reached for comment at jbarone@mktvsn.com.
