Despite being oft overlooked, agricultural commodities have stormed back into the news amid the global trade tensions that have been stoked by President Trump’s protectionist policies. After Trump announced plans to implement tariffs on Chinese imports, China announced retaliatory tariffs on US imports that included almost all of the agricultural commodities. This, together with a strong US dollar, has pressured prices and drove the Bloomberg Agricultural Index to record lows on 11 July.
Historically, prices have been driven by weather conditions, the supply/demand balance, economic growth, and government policies. But tit-for-tat tariffs and dollar strength has created a unique situation – one where the current prices do not reflect the fundamentals for many commodities. Soybeans and corn have been particularly affected.
Tariffs – What’s going on?
On 15 June, China announced that it would impose a 25% tax on corn and soybean imports from the US. As one might expect, the market’s response was negative. Both commodities fell in price by a fifth in the US on the news. Conversely, local prices in Brazil and Argentina surged on the expectation of increased demand from China. China is responsible for 65% of global soybean imports, and has been a huge driver of demand growth over the past 20 years. China imported $14 billion worth of US soybeans in 2017, which is 39% of the country’s soybean imports. Chinese customers reacted to the announcement by “panic buying” before the tariffs took effect, and as a result, soybean imports rocketed in volume in June by 27% year-on-year. China also removed corn and wheat subsidies for its farmers while increasing soybean subsidies, in a bid to encourage domestic production.
China will have no choice but to import [soybeans] from the US over the coming months.
But this action won’t solve China’s problems in the short term. China currently imports 90% of the soybeans it consumes, and without US production, there are not enough beans to go around.
China is projected to import 94 million metric tons (mt) of soybeans for the 2018/19 marketing year. The three largest exporters of soybeans are Brazil (67 million mt), the US (62 million mt), and Argentina (7.3 million mt). If China chooses to keep the tariffs in place, it will be unable to avoid US soybeans altogether - there is insufficient alternative supply on the market to meet its needs.
We have already begun seeing signs of triangulation in the market. Brazil and Argentina are importing soybeans from the US at discounted prices for onward sale to China.
Both US and Chinese governments are stepping in to aid both suppliers and buyers, with the hopes of minimizing changes to the supply/demand outlook. President Trump announced a $12 billion emergency aid stimulus for US farmers to help ease the pain of lower market prices. China has also pledged that it will subsidize buyers to insulate them from higher post-tariff prices.
Given that both US farmers and Chinese consumers are being shielded by their respective governments from bearing the brunt of the announced tariffs, it appears that they are being used more as a negotiating tactic, rather than something that disrupts the overall fundamental picture for these commodities.
One more key factor suggesting that the tariffs will have less of an impact than markets are pricing in is geography. The US and Brazil/Argentina are in different hemispheres. When it is summer in the US, it is winter in South America. For this reason, China imports a vast amount of soybeans from the US in the months between September and March, while primarily importing from South America between April and August (see graph). China will have no choice but to import from the US over the coming months.
Chinese Soybean Imports
If trade tensions resolve and tariffs are removed, China’s demand for US soybeans will likely return to previous levels. TIf the tariffs are not removed, there is likely to be a slight pullback in Chinese demand for US agricultural products, but - crucially - not to the extent that the market is currently pricing in.
Either outcome appears to reflect that US soybeans will see more robust demand than what current prices are reflecting.
Chinese government policies
The selloff in corn prices in the wake of the tariff announcement appears to be an overreaction, as China imports an insignificant amount of US corn, making it the US’s 23rd largest customer.
But the effect that China has on the agricultural market goes beyond the tariff headlines. In an attempt to curb air pollution as well as draw down corn inventories, China announced a nationwide mandate that requires gasoline to contain 10% ethanol. China is the largest vehicle market in the world, meaning the new policy could lead to an incremental 3.6 billion gallons in ethanol demand. Given that corn is the primary biomass in ethanol production, we think corn demand may increase by up to 45 million mt as a result of this policy. As previously mentioned, China has cut corn subsidies to its farmers in order to limit future productions and draw down current inventories, and to encourage domestic production of soybeans. Both the increased demand and the constraints on supply should provide tailwinds for corn prices.
Global weather conditions
Weather is a major factor when analyzing agricultural commodities. For the current growing season there have been favorable growing conditions in the US contributing to record crop yields. However, there were unfavorable drought conditions that plagued Brazil and Argentina’s corn and soybean crops at the start of the growing season. Adverse global weather conditions are another positive for US producers as international supply is likely to be adversely affected.
Where do we go from here?
Corn possesses an attractive risk/reward profile at current prices after being grouped into the tariff-driven selloff. Chinese farmers are curbing production in favor of soybeans, while South American farmers are following suit due to tariffs leading to increased demand for their soybeans. The Chinese ethanol mandate is driving long-term demand, creating a favorable supply/demand environment for corn. Although the future of soybeans is facing some uncertainty, foreign weather disruptions and government support should sustain demand for US soybeans. An expectation of a thaw in trade tensions is not necessary to see opportunities in agricultural products, since the largest consumer will have no choice but to trade with the largest producer.
The fundamental picture for agricultural commodities has improved vastly, while increased investor pessimism has led to a disconnect in prices that is unsustainable and will soon reconnect. We believe prices will go up from here, given the favorable prospects for the two commodities that the market has seemed to have pushed aside.
The tariff-driven selloff appears to be a market overreaction. The impact of the tariffs on corn should be muted and the overall supply/demand outlook is very favorable. China’s ethanol mandate will drive demand growth and supply growth should be restrained as China, Brazil, and Argentina farmers switch to a crop balance that favors soybean growth over corn. We expect this to drive prices higher as current prices are not reflecting this fundamental shift.
Although soybeans will see a more significant effect from these tariffs, China will be unable to completely avoid trade with the US since there is not enough supply in the world elsewhere. Even if China avoids direct trade with the US as a political tactic, they are likely to end up with US soybeans through triangulation since the US is the primary supplier for soybeans during the winter months. The market is anticipating a steep drop-off in demand; we think this is unlikely to occur. The futures market is showing a high amount of short positions for both commodities, so any positive fundamental developments would be likely to lead to a short squeeze that results in upside from the current prices.