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Grain, livestock markets rebalancing -- economist

11/20/2013 @ 3:09pm

Until recently, the grain markets were racing. Farmland values were soaring. U.S. grain demand was rock-solid. The bulls ran the show.

But grain prices have fallen. Farmland values have mostly plateaued. Now there is speculation that the biofuels sector's corn use is going to trip and fall if EPA limits how much ethanol enters the U.S. fuel supply. Seems like the bulls are all gone and that the bears are running the show, right? Wrong, one economist says.

Why? Look at the other side of the ag marketplace: Beef prices are at record-high levels, and that's likely to stay in place for the next two years. If that holds true, things in the other sectors will snap back into a scenario where everything's on more even footing.

It adds up to more of a rebalancing of supply and demand in the intertwined crop, livestock, and fuel sectors, says Purdue University Extension ag economist Chris Hurt. And, that new balance, while possibly trimming some profit potential for crop farmers, may wind up good for everybody in the ag sector.

"It's very important for a market to send you a signal that we're not going up forever. The reality is that setbacks in markets like these are good, in how they allow people to reset expectations," Hurt says. "If something goes up for too many years -- like the housing market in the U.S. from 1991 to 2007 -- 16 years of unabated growth -- you had a whole generation of bankers who said it always goes up. Well, guess what? If the housing market could've sent a signal to the market in 2000, that industry would've never been so aggressive in lending money like they did."

That's what today's markets comprise, Hurt says: A signal to participants of the importance of the relationship between the grains and the primary industries they serve, namely the livestock sector. Without cattle and hogs, Hurt says, there'd be little reason to raise the immense crops U.S. farmers are raising. However, three years of short crops kept production closer to the demand line while farmers continued to ramp up production. The net result has been supply -- both real and potential -- that overshadows demand, with or without a massive Renewable Fuels Standard.

"Why didn't supply keep up with demand? Three short crops in a row. The 2010 crop was 10 bushels short of normal, not horrible. The 2011 crop was about 15 bushels short of the normal U.S. yield, then the big drought in 2012, we were 40 bushels short. The U.S. just had limited production. Demand wasn't growing, but supply was falling because of weather," Hurt says. "It gave us this continued illusion that demand for corn was growing so much. That's not true -- it was not growing. It was supply in those three years."

Then, along came this fall. According to the most recent data on this fall's harvest, yields are just shy of normal ("if you want to try to define 'normal,' Hurt adds). Now all of a sudden, it's that massive production capability and resulting shift in the supply/demand table -- not an expected decline in corn ethanol refining -- that's keeping a lid on corn prices. And while that's not the best news for grain farmers, it is good news for livestock farmers.

"You're going to see moderation in these feed prices. We had big production this year. It's not the yields giving us so much corn -- we're still about 2 bushels/acre short of what USDA calls normal. How did we get so much corn? It's the production base, the acreage of corn," Hurt says. "We have a huge production base -- 100 million acres. If you have normal yields, we do not have a demand base that's going to give us high prices anymore."

But, that -- like all these market dynamics in play -- isn't permanent, either. With slipping corn prices making feed more affordable, the livestock sector is taking note. So in that way, the livestock and grain markets are on more similar and less volatile paths. Cattle and hog feeders are taking advantage of lower feed costs now, and those herds are expected to grow on their natural time frames, fueling more potential grain demand -- and higher potential prices -- in the self-perpetuating process.

"These next three years will be a time when we're going to have much more moderate feed costs. This is going to be a time when the whole animal sector is going to be able to have a positive tone where they'll be able to expand production. A period of modest growth in the animal industry will be positive for the whole industry," Hurt says. The cattle business will be the slowest sector to see more herd expansion, typical of any trend shift in that business compared to other livestock like chicken, which can see higher production numbers in as little as a couple of months.

"There are big differences between chicken, turkey, pork, and cattle. The chicken industry is already pretty broadly expanding. They can just turn more meat out so quickly; even maybe by December, we will have some increase in supply. With hogs, I think expansion's underway. When we drop from $8 corn to $4 corn, the message is clear now: We've got more corn. Weights have come up a lot. Animals are less efficient at higher weights in using corn. That uses more corn."

Ultimately, what matters most to corn prices moving forward is not the future of an ethanol mandate, but a more stable livestock sector. Don't look for meteoric growth in herd numbers just yet. Instead, a slower, more deliberate increase in herd numbers, fueling more feed demand for corn, will make for a more sustainable, balanced marketplace, Hurt says.

"My perception is that we are coming into a different era vs. 2006 through 2012. That was an era of huge volatility in feed prices, and also some extreme, extreme highs: $8.50 corn is just extraordinary. Now, corn prices relative to animals is very favorable, and there's profit incentive across the board," he adds. "We've been seeing a lot of indications that when we got back to normal production, we were going to have a period of moderation. This is moderation, not a crash. It's a period of moderation. Moderation in a market is a good thing. It lets you reset your expectations."