Longer term agri outlook seen constructive in 2012

The year 2012 has begun in an air of uncertainty on the global macroeconomic front with many imponderables currently weighing on the minds of market participants. A significant part of the current uncertainty is, of course, a spill-over from last year which was characterised by slowing economic growth, geopolitical instabilities and importantly, the European sovereign debt crisis all of which impacted most of the markets – equities, commodities and currencies.

The big question everyone is asking is if and when the weakened market sentiment will begin to improve. Global agricultural markets have not been insulated from the broad macro dynamics. After two solid seasons of strong prices driven by adverse weather and tight fundamentals, is there hope of abundant supplies and consumer-friendly prices during 2012?

Investment in crops

Going by basic economic theory, there will be strong supply response in 2012 as there is reason to believe that higher cash returns of last year (driven by elevated prices and manageable fertiliser costs) would encourage producers to invest in their crops.

Expanded acreage and increased application of nutrients and pesticide can be expected. Higher production would translate to a high probability of agricultural prices consolidating lower this year.

Fertiliser

While fertiliser prices should also ease in sympathy, the anticipated rise in global crop production this year will boost fertiliser application. It is likely that the increased demand will support prices through the first half of the year, particularly as the US farmers move towards spring planting.

According to experts, while producer restraint will push potash prices higher, balanced supply/demand fundamentals will stem losses in urea. Importantly again, there are signs the current weak La Nina is fading. Weather experts assert that two seasons of unpredictable weather (led in good part by extreme ENSO events) is unlikely to be followed by a third. If we assume a return to ‘normal' weather then yields will return to trend. In the event, with augmented output, farm commodity prices can be expected to gradually ease over the course of the next two seasons, falling sharply from the second half of the year soon after the northern hemisphere harvest.

As the next big harvest of major crops will be in the northern hemisphere in the second half of the year, the first half may continue to remain somewhat tight in terms of physical supplies simply because despite an anticipated crop rebound later, demand conditions will remain steady and most likely some inventory rebuild will take place. So a tighter H1 will give way to a comfortable second half. A factor that is less-understood and less-appreciated but seldom highlighted is the role of speculative funds. In the last few months, we have found extremely limited risk appetite among investors. Funds have stayed in the sidelines waiting for clear signals. It is reasonable to assume that the hedge fund community will be less willing to bid up agricultural prices from the current levels. A strong dollar combined with weakened risk appetite reduces the appeal of commodities. The only caveat one must enter is that weather should stay normal and no anomalies should scupper production hopes. China factor is something to watch. Though not as critical for agricultural commodities as for energy and metals, China is still a force to reckon with. In 2011, through steady credit squeeze, the country's monetary policies aimed to cool the economy seen to be overheating.

To what extent credit tightness will be eased remains to be seen, although there is reason to believe the policy stance has been reversed. Recent appreciation of the Chinese currency yuan means imports into China will be less expensive. How crude oil prices will behave in 2102 remains a matter of conjecture and debate.

crude prices

As universal intermediates, crude prices have positive bearing on agricultural crop production costs. Geopolitical instabilities can potentially lead to price spurts. High crude prices push up synthetic fertiliser prices higher and cost of mechanisation especially in the western world. According to the World Bank, prospects for decline in 2012 food prices remain favourable due to weaker consumer demand as a result of sluggish global economy, expected declines in the price of energy and crude oil and strong forecast for 2012 food supplies. As a note of caution, it has added that some upward price pressure will remain nevertheless. These include possible increase in demand for biofuels if oil prices pick up again, very low stock-to-use ratio for maize (corn), volatility in oil prices as a result of unrest in producer countries and weather changes. Experts assert that longer term agricultural outlook remains constructive.

This year's supply recovery is part and parcel of the normal cyclical pattern in agricultural commodities. Things will likely remain bearish in 2013/14 season on the back of ample stocks, beyond that prices may shift higher. Rising incomes, growing population and enhancing dietary needs, not to forget biofuel mandates, will expand demand which will have to be met through area expansion or yield improvement. Will the world rise to the challenge?

(Responses and queries relating to articles on this page are invited from readers. They may be sent to >agri-biz@thehindu.co.in)

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