As the credit crisis continues markets outside the financial sector are starting to feel its impact. Wool exporters are blaming the credit crunch for a drop in prices which is pushing many producers to the wall. Over the past few weeks, wool prices have dropped as much as 10 per cent. Some farmers are able to stockpile their wool but others are being forced to sell at uneconomic prices. The fall in price comes as many wool growers are beginning their shearing season.

The AWEX EMI fell by 75¢ (-8.9%), ending the week at 764¢/kg. This reflected falls of 88¢ (-9.9%) in the North and 64¢ (-8.0%) in the South, with their corresponding Regional Indicators finishing the week at 797¢ and 736¢ clean, respectively. The Western Indicator fell by 61¢ (-7.7%), finishing the week at 729¢.

In a three day sale in Sydney and Melbourne, the AWEX EMI fell by 62¢ on Tuesday, by 6¢ on Wednesday and by 7¢ on Thursday. The Western Indicator fell by 53¢ on Wednesday and by 8¢ on Thursday in a two day sale in Fremantle. 57,149 bales were on offer, compared with 55,911 bales last week, of which 33.3% were passed in, comprised of 29.6% in Sydney, 35.5% in Melbourne and 34.6% in Fremantle. Pass-in rates for Merino fleece and skirtings were 43.2% and 26.4%, respectively. 10,239 bales (15.2%) were withdrawn prior to sale and re-offered bales made up 9.6% of this week's offering.

The soft demand in the current financial crisis and weak competition continued this week with falls across all micron ranges and wool types. It was not helped by the announcement last Friday that the expected offering had increased by 9,600 bales during the week.

Eastern states trade lamb over the hook (OTH) rates have recently started a downward trend declining (14¢, to 357¢/kg cwt), much like prices at physical markets covered by MLA’s NLRS. However, OTH rates have been less erratic and variable than rates at physical markets. OTH trade lamb rates though have not declined to the same extent or as quickly as physical market rates. Processors are now holding off when setting their OTH rates and competition is reduced due to an abundance of new season lambs. The physical market, which is becoming cheaper, is expected to dictate the OTH for the meantime.

Further declines in rates are apparent for heavy lambs across the eastern states in both OTH and physical markets reported by MLA’s NLRS. Greater numbers of heavy new season lambs on the market and dry conditions forcing larger numbers to become availability have been the source of these declines.

The national mutton indicator at the completion of Thursday markets was 152c, which is a 13c loss from last week. The quality of mutton across the eastern states has been fair to good and mutton rates have been holding firm at physical markets, while direct to processor across the eastern states have become cheaper.

Money is still flowing out of corn which will continue to pressure prices until it slows or stops. December corn futures ended down 17 to $3.72/bu. US harvest is at least a month behind which once would have driven the market crazy but not yet/now. Yields are large but this is also the early part of the crop. US farmer is sitting on his corn and probably will do so into 2009 as cash is not a problem.

The sorghum market is as weak as we can remember basis wise. New crop basis is circa 70 c/bu under CBT May corn. This would arguably make it around 20 c/bu under FOB which is well below export parity, problem is logistically it’s hard to get it to port. Sorghum needs both exports and domestic consumption to eat current high stocks.

Globally, we have seen some pressure on the malt/feed spreads, especially in Europe where values have narrowed considerably. Some of the sting has been taken out of local malt/feed spreads too, with the southeast coming back from the $90/t highs to $70/t recently, supported by dry conditions in Vic and now, with harvest rain concerns this week in the west, spreads may steady somewhat. On the contrary, rains forecast for next week in the Eastern States (albeit it with low confidence at this stage) could provide some relief to crops in the southern and eastern areas but will likely be too late for many.

Local forward cash prices for barley were mainly higher after the weekend. A strong gain occurred at Kwinana which closed $10 higher for both malt ($300/t) and feed ($236/t). Malt barley prices were unchanged at Newcastle ($293/t), Brisbane ($310/t), Geelong ($325/t), and Port Adelaide ($300/t). Feed prices at Newcastle closed $2 higher to $203/t.

Soybean futures were carried away by the bearish din of tumbling equities and crude oil Friday, ending lower (20 cents lower at $8.63/bu for Nov 08) in a volatile trading session. However, the market does have some supportive developments, including strong export sales reported this week.

Like corn, oilseeds made fresh yearly lows last week before finding support from the general market place and positive signs in China. Dalian/China futures traded limit up on news the government will be buying domestic soybeans for their reserves. Furthermore, the recent massacre in the bulk ocean freight market has not been as evident in the bulk tanker market, meaning in comparison, it is more expensive to ship veg-oil than seeds compared to six months ago. This should encourage more imports of seeds and beans for crushing and further support the soft seeds. At current canola price levels we expect that exports to China will flourish. Numbers suggest that crop year to date China has already secured 750,000 mt. from Canada.

Local forward cash prices for Canola have rallied in the face of a falling $A over the weekend whereby prices bounced as high as $39 at Port Adelaide ($615/t). Geelong jumped by $36 to $645/t while Newcastle closed up $35 to $639/t. Kwinana rallied $27 to $597/t.

Wheat futures fail to gain positive territory
U.S. wheat futures flirted with positive territory but failed to gain traction on their own Friday and closed lower under pressure from volatile swings in bearish equities and crude oil trading. Wheat ended down 7c to $5.16/bu. Exports may be running ahead of predictions percentage-wise and U.S. product does score quality points, but their exports are facing some good competition and the market can’t really afford to have a big rally.

Local forward cash prices were higher after the weekend. The Newcastle price increased $8 to $267/t while Port Adelaide and Kwinana rose $10 to close at $282 and $305/t respectively.

The Australian dollar fell to a five year low over the weekend of US$0.6060 and is trading weakly this morning at around US$0.6162. This is approximately 2cents lower than Friday’s close. The weekend drop has been attributed to falls on the worldwide equity markets and falling commodity prices.

Most commodities were lower Friday, as liquidation continued and U.S. stocks fell sharply. Traders are anticipating depressed demand due to a worldwide recession. If US Government backed measures succeed and market turmoil settles, soft commodities will start a long grind higher. But for this to happen, financial markets will need to recognise that soft commodities are different from commodities generally.

Currently futures are trading 20c lower for Nov. Soybeans at $8.63/bu, while December corn futures ended down 17c to $3.72/bu and Wheat lost 7c to close at $5.16/bu. Forward cash prices for Canola have rallied up to $39 across Australian ports. The $A is buying US61.62c.

This was composed while flying to Sydney on a Friday night sitting next to a portly 50s gentleman who had enough red wine to think it was a good idea to start belting out some tunes – I was trapped with nowhere to go and sought solace in my laptop. I finished reading The Financial Review – no good news there.
Anyway, I spent part of the trip going through my communication looking for some positives because by week’s end, sentiment had turned very negative again, particularly on commodities. Jitters across Asia indiscriminately smashed global equities, oil and – of course – crommodities. So much for my ramblings on the $A last week. It was absolutely pulverized as Asian equity markets turned nasty and at the time of writing, it looks like the $A might spend sometime in the 50US¢ range.

Is the tide turning?
There were signs early last week that the tide was turning. Egypt preferred to buy French wheat last week – while this was negative for the US, it at least signaled Egyptian millers may have had enough of poor quality wheat out of the Black Sea. With prices and freight rates falling to levels not seen in years, millers are using some of their windfall gains on better quality grain – hopefully this is the case generally.

Also in the US, local corn and soybean cash prices continue to firm as farmers have stopped selling and processors are scampering to increase coverage. Cash prices have now appreciated to the point where it is cheaper to take delivery from the futures, making futures undervalued relative to cash, as opposed to what has recently been the case. In a normal fundamental market (which this market is not), this would be a bullish signal for futures as price needs to rally in order to attract farmer selling. I stole this from our mate Lachie Stevens who does the markets pages for me. Lachie has about 10 years of grain trading experience and brings a lot to our team.

Land title rights in China
Lachie was also rambling on about some policy shifts in China: 1) the resumption of domestic accumulation of grains for the state reserves; and 2) the initiation of an official transfer scheme for production rights (land title). The Chinese Government’s decision to step into local markets puts a short-term floor in prices and provides support to the local farmers and certainty to processors (who are largely unhedged), in that their feedstock and product prices won’t continue to crash leading to defaults and negative margins.

However, the big one is the potential change in land title rights. With nearly 75% of the population still living in rural areas, the move to increase land holdings, and compensate those who have reduced land holdings, has a number of impacts. Firstly, it designed to increase rural incomes 10-fold (a massive % increase in wealth across a large % of the population); secondly, it gives the rural people an asset; and lastly, with more land per person, more people will be required to move to the city. This will further stimulate urbanization in China and investment in the infrastructure that is needed to support it. This makes it more than just an Ag reform and could help stimulate global economic demand.

In our $A comment last week we alluded to the potential for China to make such moves. China is also acting aggressively to shore up its property market by slashing interest rates.

Our forecasts for corn prices have not been that good. We did not anticipate the worst flooding in parts of the US Midwest in over 100 years – which drove corn prices to an early seasonal high – and since then, the near faultless weather that has taken pressure off prices. For the record, our price projection with the actual is below.

Corn has run the weather gauntlet well. While there are some strong differences of opinion regarding the final US yield, the USDA currently pegs yield at 155bu/ac. At 155bu/ac, the yield would be the second largest on record and would suggest genetics are going to be a yield kicker for the next few years. Still, a number of analysts argue that given the late sowing and flooding problems, the final yield will be closer to 150bu/ac. The difference is large (400 million bushels, or 10.1mmt).

A better idea of the final number will not be known until October – the September USDA report will likely use a number around 155bu/ac. The current USDA numbers lift recent stocks estimates for 2008/09 over 1 billion bushels and hence, stocks do not appear as tight as initially expected. But should yields disappoint, prices will need to move into rationing mode again. The chart below displays the current stocks to use ratio.

Floods and late planting early in the season did not get corn off to a good start; however, weather during pollination has been mild, thus the question is – does one trump the other?

The demand side
The current futures price is very close to the bottom end displayed on the above chart. The market does not feel it needs to ration demand. The two major demand elements are ethanol and stockfeed. Stockfeed is currently expected to decline significantly year on year due to the recent high prices. The graph below displays US domestic use of corn for feed.
The other major factor is ethanol (see previous chart). This year, one-third of US corn produced will go into producing ethanol. The main issue with ethanol is – if serious demand rationing is to occur, it must be at a level that slows use for ethanol. Currently, with the drop in crude oil and process products, ethanol margins have not been so good but use and growth in supply is still strong.

Other influences
In our last forecast, we talk about speculative capital being a major driver of corn prices in Feb/Mar and again in June. The chart below tracks investment (speculative flows into corn).

Following the worst month in recent memory for commodity investments during July, the attractiveness of corn is now waning and positions are getting smaller. Should index funds begin to significantly shed their bought positions, there will be additional downward pressure on corn prices. Further long liquidation is a factor to watch.

The index funds have consistently maintained a large long position in corn, now standing at 51mmt, or 20.5% of all open interest. Speculative and fund interest is currently waning. Other funds / large speculators have recently lowered their large net long position in corn – currently 7.8mmt, or 3.1% of open interest.

Other factors to watch are crude oil prices and the $US. Sustained strength in the $US is not a positive for the commodity bull market and hence, corn. We should also watch US exports. Currently, Black Sea origin wheat is competitive into Asia and at times, cheaper than US corn. A large drop in exports is factored in for this year but further falls in export estimates could occur.

Our projection
When we last looked at corn, we were correct to think that capital inflows into commodity index funds would slow due to uncertainty about US futures regulation. This time around, our projections take into account a slow but sustained drift lower in the size of index fund positions. Overall, we expect the US crop will fare well and the overall price regime of the past month won’t change going into September.

Implications
Strong corn prices will continue to provide a floor under coarse grains well into mid 2009. The recent drop in prices will encourage demand. Looking into 2009, the US will need to increase corn area significantly, as the ethanol industry could chew through an additional 500 million bushels (12.7mmt) in 2009/10. This means corn needs to buy acres from soybeans and wheat – this will be primarily driven by price.

Over the longer-term, it is difficult to see corn futures moving back under 400¢ or even 450¢ for some years to come. It would require either a significant and rapid advancement in yields or a sustained downturn in the ethanol industry.

In our experience, commodity markets are far more volatile than you ever expect.
When forecasting, you can be right and wrong or never right or never wrong – all at the same time (depends how you look at it).

A case in point is our June soybean price forecast of $13-17/bu for the current quarter. Already, prices have over and underperformed this range.

Similarly – the $A. Avid readers will recall we changed our minds on the direction of the $A early this year on 10 January when we wrote ‘In contrast to 2007, it appears that the $A may be supportive to Australian grain prices in 2008. A period of slower global growth seems inevitable’.

But a couple of RBA rate hikes and aggressive easing by the US Fed threw a spanner into the works and had many commentators suggesting that the $A was heading to parity.

This precipitated our heading ‘Short-term gain, but long-term pain for the $A’ and encouraged us to write the following on 21 February: ‘We feel that the US is close to recession, or entered recession at the end of last year...Around mid-2008, the US will be finished cutting rates, and the $US should start recovering into the second half of this year.

The slow-down in world economic growth poses a risk to the Australian economy and should cap any upside move in the $A. We expect the slowing in world economic growth to weigh on the Australian economy more in the second half of this year.

Continue to watch for the $A to ease into the mid to low 80s by year’s end as the $US begins to recover.’
If we wrote it today, we couldn’t have put it better! This thinking was the reason we took $US swaps for 2009/10.

No reason to change our minds
Anyway, enough gloating. The drivers of the $A retreat have been: $US strength, lower commodity prices and global growth forecasts, a weakening in the outlook for our interest rate differential, a sharply weaker domestic growth environment and some unpopular moves by our rookie federal government (carbon and wealth taxes).

China may not save us
Reading between the lines of the RBA’s latest quarterly Statement on Monetary Policy, the RBA seems less convinced that China has largely ‘de-coupled’ from the faltering US economy.

So the global economic backdrop that has been so favourable to Australia’s terms of trade in recent years may have run out of steam.

With the engine that has driven the stellar performance of the $A slowing (China’s blue-sky demand for our commodities), and other bits and pieces starting to loosen (strong interest rate differentials, and strong domestic economy), it is hard to see how the $A will mount another attack on parity.

But at the same time, don’t expect the $A to continue to fall at the same rate it has done in the last month. Our strong terms of trade (the commodities index is still well above historical averages) will support the $A at well above its longer-term average of 72US¢.

The recent slump in demand for hard commodities may be arrested when manufacturing in China resumes after the Olympics. But growth for the next couple of years will be constrained compared to the previous couple.

Markets have already factored in deep cuts in local rates and a slowing in local growth may be just what our economy needs to ‘readjust’ to a more sustainable medium-term growth path (although we would suggest there is more pain in the short-term).

The fate of the $US could well determine how far the $A falls. We suspect that the US economy will have to negotiate a few more hurdles before it finds its feet again, but it does look like they will not be game to ease rates again. A change of president later in the year is thought to assist the $US’s recovery.

ProFarmer perspective
Many of the factors that have driven the ascent in the $A are now not there. ‘Watch for the $A to ease into the mid to low 80s by year’s end as the $US begins to recover.’

Deeper than expected cuts to local interest rates or further shocks to world growth could act to drive the $A below 80US¢. A quick resumption in world growth, a turnaround in commodity values or further easing in US interest rates (all unlikely in our view) may be the catalysts for the $A to buck the lower trend.

Even with good yield boosting recent rain across nth NSW and sth QLD, the Australian wheat crop has back-pedalled since last month. It has stopped raining in WA and most areas are desperately needing rain to maintain yield potential.

On the east coast, it is make-or-break month for crops outside of the northern region, and we are nearly halfway through September without any rain.

In summary, it just hasn’t rained enough in Aug/Sep to be confident about yield prospects in most states. But, one thing is certain – there has been plenty of wheat planted, which may catch the market by surprise when harvesters start to roll.

So, we have dropped our production forecast from 24.5mmt to 22.7mmt, owing to a sharp decline in WA production prospects and reduced potential in SA and VIC. The boost to production from good rains in NSW is limited by the large areas in the south that are still under yield stress.

Queensland
Excellent rainfall in the nick of time throughout QLD will ensure strong wheat yields on a large planting. Conditions on parts of the Downs remain so-so, but in the large producing shires on the western Downs, a strong harvest now seems assured. We have boosted our QLD production estimate to 1.6mmt, with a 2t/ha average yield on 800,000ha planted. The strong average yield for QLD reflects the consistency of production potential across the state.

New South Wales
The first meaningful spring rain in years has saved crops from the QLD border down through to Parkes/Forbes. The rain got as far south as just north of Condobolin.

Apart from a patch west of Narrabri, the northern NSW crop now has strong potential. But the rain didn’t come before there was some crop abandonment around Bellatta and in other isolated areas throughout the north. We have dropped our harvested acres a little but boosted average yields to lift our NSW production estimate to over 7.1mmt.

South Australia
South Australia was the only state that saw crop conditions improve in August. Monthly rainfall was around average in most parts, with totals ranging from 50-100mm in the south down to 25-50mm in northern areas.

Growing season rainfall to date (April-August) remains below average over much of the western Eyre Peninsula, southern Yorke Peninsula and parts of the Mallee and south-east districts.

Our crop rankings model ranks September rainfall very important for South Australian crop conditions, and if rainfall in September falls below average, crop rankings in September will fall. For the month to date, rainfall has been virtually non-existent, although there is some forecast for this week. Unless 25-50mm is received in September, SA crop rankings will slip.

The areas most at risk are the western and northern Eyre, upper north and northern Mallee. Crops in these areas are looking good, but are surviving on regular falls and have limited subsoil moisture, so could slip quickly if it gets hot and dry.

We have decreased our production forecasts for SA to 3.5mmt, with yields of 1.6t/ha over plantings of 2.2m ha. The SA Department of Agriculture lifted its production forecast from 2.7mmt, to 3.1mmt.

Victoria
Crops in the Mallee are thinner but still have yield potential. The topsoil is wet but there is not much to draw on underneath. Good September rain will be needed to maintain yield potential.

Crops south of Hopetoun have full yield potential, but crops are heavy and susceptible to a few weeks of dry weather or a spell of hot weather. Good rain through September will help to keep crops on track for above-average yields, but crops need the rain forecast this week.

Western Australia
Apart from 10-25mm of patchy rain through the central WA wheat-belt, it virtually hasn’t rained since the excellent July. Later crops and crops on lighter soils are suffering badly, and yield potential is falling by the day.

Areas west of Lake Grace, Kulin, Wongan Hills and west of the Midlands road through to Northampton are desperate for rain. 

Some very big, early crops in the southwest are drying out fast, and later-sown crops will yield well below average if more rainfall is not received in the next week. 

A good number of crops in the central and eastern wheat-belt received good rainfall in late August; however, any late sown crops will require some follow-up rainfall within the next week or so if they are to amount to anything.

Early sown lupin and canola crops seem to be the least affected by the long dry spells experienced this season, while barley has lost a lot of potential, especially on the poorer soil types.