A conflux of factors – ranging from global warming to rich Chinese citizens eating more meat – is conspiring to drive up soybean prices long-term.
- Fundamental, long-term changes in the market
- Entire market exposed to disease, weather
- The outlook of 2008
Commodities have experienced spectacular returns over the past few years. As a result, new investment vehicles such as exchange-traded commodities have been created to provide investors for the first time ever with direct exposure to commodity prices. In this article, we focus on soybeans, a grain - which along with corn and wheat - is experiencing fundamental changes. While agricultural commodities are often known to be cyclical in nature, these changes appear to be more significant and may have implications for long-term pricing. These changes include:
- Historically low inventories for many commodities;
- New and robust demand for animal protein, requiring more soy-feed from emerging economies that represent roughly 50% of the world’s population;
- Rising input prices such as oil, which are adding inflationary pressures on production;
- New sources of demand for agricultural commodities (e.g., bio-fuels); and
- The threat of global warming, which may have a variety of impacts on future production.
Looking At Soybean Markets
Like many of the agricultural commodities, the world soybean market is currently affected by the same factors, which have helped soybean prices rise over the past 12 months.
Soybeans have little commercial use in itself, but they can be crushed to produce soybean meal and soybean oil at a ratio of 4:1. Soybean meal is almost exclusively used as a high-protein feed for livestock. Meanwhile, 90% of soybean oil is consumed in foods (e.g., in salad or cooking oil, margarine, baking frying fats and candy), and 10% is used in industrial applications (e.g., soap, inks, paints, varnishes, resins and plastics). In aggregate, soybean use can be broken down into three categories of demand:
- Feed for livestock (77%)
- Food (21%)
- Industrial applications (2%)
Four countries make up 75% of world demand for soybeans: the United States, China, Argentina, and Brazil. Consumption growth has been the greatest in China and Argentina, increasing by 9% and 11% per annum respectively since 1991, compared with 1% in the United States.
Importantly, the United States, Brazil and Argentina largely produce enough soy beans to satisfy their domestic demand, but this is not the case for China. China (which turned from net exporter to net importer in 1995) has been a major factor in supporting strong growth in world soybean demand over the past 10 years. While world imports increased by an average of 7% per year, Chinese imports have been increasing by 28% per year, driven by China’s growing appetite for soy-fed pork, poultry and beef.
Soybean for feedstock now represents more than 60% of China’s soybean consumption, up from approximately 15% in the early 1980s. As a result of this growth, China’s soybean imports now constitute almost 50% of world soybean imports.
Although soybean is native to South East Asia, approximately 86% of world production comes from South and North America. Three countries, the United States, Brazil, and Argentina, account for 80% of world production and 90% of world exports. This high level of concentration makes soybean vulnerable to supply disruptions caused by diseases, like the soybean rust that has been spreading across South America since 2001 and more recently entered the U.S., as well as adverse weather (potentially caused by global warming).
World inventory levels for grains may also affect soybean prices. Corn and wheat stock-use levels are at their lowest for more than 35 years, and while soybean inventories have risen gradually, all the grains are competing for acreage. High oil prices and growing concerns over climate change have led several countries to support the production of alternative fuels through subsidies. As a result, U.S. ethanol production – which is almost entirely processed from corn – has increased by over 20% per annum since 2002, and the share of U.S. corn used in ethanol production has doubled from 10% to 20%. Continuing this trend, the Energy Information Administration (EIA) has forecast U.S. ethanol production to double again by 2012.
Over the past decade, U.S.-grain-planted acreage has remained relatively constant and world soybean production and inventories have risen gradually. However, due to increasing ethanol production, U.S. soybean acreage declined by 15% this year as farmers rotated acreage away from soybean to corn. In part as a result, the world soybean stock-to-use ratio is expected to decrease by 20% in 2007. World inventories may continue to fall if production cannot keep up with robust world demand (led by China) or if U.S. soybean exports continue to decrease.
There are a number of ways that investors can participate in the movement in soybean prices without investing in soybean commodity futures. The two main options which are available via stock exchanges are (i) indirectly through equities and mutual funds or (ii) directly through Exchange Traded Commodities (ETCs). An indirect investment will not give real exposure to soybeans and will be subject to company specific risk. In addition, there are limited or no equities which are exposed to soybeans only, or agricultural commodities; for example, food companies have low or no correlation to agricultural commodities.
In terms of direct exposure, ETCs are a new listed investment vehicle which provide simple and safe access and have high correlation to agricultural commodity prices. Because agricultural commodities have typically been hard to access, agriculture ETCs have grown to approximately $1,000 million of investment in Europe in the first 12 months, of which over 25% has been directly into the three grains.
[Editor’s Note: Among U.S. funds, the PowerShares DB Agriculture Fund (DBA) has the most direct exposure to soybeans, with a 25% stake in soybean futures.]