China shouldn’t get fooled by soya futures

China shouldn’t get fooled by soya futures
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First Published: Tue, Apr 22 2008. 11 57 PM IST
Updated: Tue, Apr 22 2008. 11 57 PM IST
One of the key planks in China’s strategy to deal with food inflation is to boost the supply of hogs and contain the runaway increase in pork prices.
This year’s projected increase in pig population, according to one Chinese government analyst, may represent only a 3% increase over 2007 when a disease curbed supplies. The additional supply may not be enough to tame wholesale pork prices that have risen 74% in the past year in China, pushing the annual inflation rate to 8.3%.
More animals don’t mean cheaper meat if demand continues to outstrip supply, and farmers pass on higher feed costs to consumers. But what if it becomes cheaper to raise pigs?
That possibility is suggested both by the US agriculture department’s prospective plantings report as well as the commodity futures markets. The 31 March report says farmers in all but one US state intend to plant more soya beans this year. An estimated 75 million acres will be dedicated to the crop, an 18% jump from 2007. The US is the world’s No.1 soya bean producer.
Futures contracts on both soya bean and soya meal are in “backwardation” on China’s Dalian Commodity Exchange, meaning that longer-dated futures are progressively cheaper than nearer-term contracts.
China is the world’s biggest buyer of soya beans, which are crushed to make cooking oil and soya bean meal. The latter is mostly fed to hogs, poultry and cattle.
A steeply backwardated market typically suggests that soya beans are in extremely short supply. As stocks get replenished by new harvests, the deficit will ease.
Such a view may not always be correct. One can’t rely on the futures contract for a pure estimate of the expected spot price tomorrow.
The futures price subtracts, from today’s expectation of tomorrow’s price, a risk premium that hedgers have to pay to speculators to buy insurance. When inventories are too low to absorb shocks to the demand-supply equilibrium, spot prices rise more than futures (because tomorrow’s stocks can’t be consumed today) and cause backwardation. In such instances, the risk premium also often tends to rise and makes the futures contract cheaper—in relation to today’s price—even when there’s no drop in the expected spot rate for tomorrow.
We don’t know for sure if risk premiums have gone up for Chinese investors in soya bean, though inventories are certainly low. US agriculture department statistics show global soya bean stocks at the end of March were the lowest since 2004.
Farmers in Argentina, the world’s third biggest producer of soya beans, have already pushed all the land they could into growing the legume. Even then, the crop that’s being harvested will probably not exceed last year’s record production, according to the government’s estimate.
And while US soya bean acreage is increasing this year, it would still be lower than in 2006.
Finally, China’s negative real interest rates may be playing a role by reducing the cost of hoarding.
The downward-sloping shape of the futures curves in soya beans suggests supplies are now tight; yet they don’t confirm that shortages are expected to ease. The Chinese authorities shouldn’t allow themselves to become complacent.
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First Published: Tue, Apr 22 2008. 11 57 PM IST