ALL THINGS ARE NEVER EQUAL
BY NEIL TOWNSEND
Grain and oilseed market analysis should boil down to two questions: How much did farmers produce, and how much was consumed? This leaves a residual, which is the gap between total supply and total demand. The larger the residual (ending stocks) the more pressure on prices and vice versa. A fundamentals-driven analyst would look closely at the magnitude (big/little) and direction (up/down) of ending stocks and be able to discern price direction. Unfortunately, for farmers and consumers, macroeconomics and geopolitical aspects matter and often dominate the determination of prices.
As the tragic Russian invasion of Ukraine continues, macroeconomic conditions have deteriorated. Inflation is at the root of the problem. During the height of COVID-19, western governments unleashed a massive quantity of monetary support. This largesse was necessary to stave off a larger economic cliff drop and, on a human level, provide for people who lost jobs.
Inflation has run rampant and central banks have attempted to tame it through interest rate hikes. The combination of inflation and higher interest rates has drastically affected economic conditions. Stock markets have plunged and traders are nervous, unsure which assets to purchase. So-called inflation hedges such as cryptocurrencies and agricultural products have proven unworthy, crypto because it is essentially a Ponzi scheme. The lack of interest in agricultural products is probably correlated with elevated uncertainty and potential volatility related to the war in Ukraine. The asset that has attracted the most interest is the US dollar (USD), against which, major currencies have depreciated. This includes the Canadian dollar (CAD).
Most global commerce is conducted in USD. This includes both inputs and outputs. A weaker CAD increases costs for Canadian farmers, especially imports such as certain fertilizers, machinery, chemicals and consumer products.
A weaker CAD should increase farm gate returns, but this carries a large qualifier. Ceteris paribus is a Latin term economists use in situations like this, and translates as “other things being equal.” It’s the outcome if no additional variables change. In this case, a lower CAD, ceteris paribus, would equate to higher farm gate returns.
Given heightened uncertainty and elevated volatility, anywhere the local currency has lost ground to the USD, things are more expensive and consumer demand necessarily backs off. The full extent of current demand destruction, or, at best, demand reluctance, has yet to be determined. The corollary is a weaker domestic currency, which also incentivizes the impacted country and its farmers to boost exports. They want more USD to exchange for even more of their own currency. Thus, like Canada, many of our competitors will be incentivized to export more, import less, all while consumers are likely to be cautious about consumption. Potentially, more people will be chasing a smaller demand base.
A rational expectation is that until persistent elevated inflation is tamed there will be greater uncertainty that may be amplified. In such an environment, the USD is attractive. History suggests downturns last nine months on average, but the current calamity is relatively severe and may persist between 12 and 18 months. For now, we must grin and bear it, but sometime in the future the CAD will appreciate on the USD. However, it is worth remembering that ceteris paribus is an illusion. All things are never equal and the future is unknown. As much as we hope fundamentals will be the focus of grain analysis, macroeconomic, geopolitical and environmental realities are unpredictable. Hope for stability and growth, prepare for anything.
Neil Townsend is chief market analyst with FarmLink Marketing Solutions.