Chart: Where we are in the commodity super-cycle

Commodity company returns reflect where we are in the cycle better than commodity prices. The last several years have been very difficult for commodity producers, indicating over-supply in many key markets after a decade of large scale capital expenditures.

Jeffery Currie, Head of Commodities Research at Goldman Sachs

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Related article: Chinese demand key to commodity prices in 2014

California drought and food prices: Salad Bowl to Dust Bowl?

California had its driest year in 2013 since the state started measuring rainfall in 1849 with some estimates suggesting it may be the driest for 500 years. Drought continues to ravage the state into 2014. California, known as the Salad Bowl produces nearly half the produce, fruits and nuts consumed in the country, according to the USDA with a value of $44.7 billion. The impact is already being felt by US consumers with retail food prices up 0.4% in the month to February, the largest monthly increase since September 2011, in part due to drought in California.

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So what are the key global commodities grown and exported from California and how vulnerable are they to the on-going drought?

Almonds are the state’s top farm export supplying more than 80% of global demand and appears to be the crop most exposed to drought conditions at least in the short term. Stress on the trees caused by water deficits is thought to potentially damage the crop for two to three years. Almond prices have already seen sharp increases due to honey bee shortages in the state and high levels of demand from China and the Middle East.

Wine is the second biggest export after almonds. According to the Wine Institute in San Francisco after two record harvests, there is currently plenty of wine to supply the market. While it’s uncertain how far this inventory will go should there be a short harvest this fall, any impacts are not thought to be immediate.

California exports about 50% of its rice production. According to Chris Crutchfield, president and CEO of American Commodity Co “even with production cutbacks, there should be enough rice in storage and in the new crop to supply the domestic market and the state’s key export markets in Japan, South Korea and Taiwan”. Many other producers like Australia and Russia have also had drought issues with output 20%-40% down although others have had record crops so any impact on prices should be limited.

There is less concern about milk supplies. Although the drought has hit organic milk production particularly hard due to poor pasture conditions and lack of available organic feed, the state’s overall milk production is up according to the CEO of Western United Dairymen. However, as producers work through their current hay inventories and look to restock, feed supplies will be very scarce and expensive limiting farmers’ ability to increase production—and may even lower it.

According to the latest forecast from the NOAA drought is likely to intensify over the next few months. Looking further out farmers have leapt on the recent forecast of an El Niño weather pattern appearing later in the year, believing that it might herald wetter conditions for the state. Forecasters currently believe there is a 50% chance of it appearing with the consensus pointing towards a minor to moderate weather pattern emerging. However analysis from FiveThirtyEight suggest even if El Niño  does make an appearance there is no guarantee of a reprieve with data since 1950 showing that minor to moderate El Niño patterns have brought California widely different outcomes.

The impact of the drought on key commodity prices appears to be limited by high stock levels and as other producers respond with increased output. However with no indication that the drought will dissipate soon price rises may start to be seen later in the year.

Related article: Higher and more volatile food prices in 2014? 47% chance of El Niño

Chinese manufacturing data to spur stimulus

China’s official measure of manufacturing activity (PMI) rose to 50.3 in March from 50.2 in February – a measure above 50 indicating an expansion. In contrast the HSBC PMI fell to an eight month low of 48 in March from 48.5 in February, the third straight month below 50. The difference between the two possibly explained by the official PMI’s tendency to be seasonally strong in March (see chart). With Premier Li Keqiang committing to a 7.5% growth target for 2014 further stimulus measures seem likely at some point, indeed he indicated as such in a speech on 28 March saying that the government “will launch relevant and forceful measures” to counter a cooling economy. Industrial metal prices have rebounded in recent weeks on stimulus speculation, however with further stimulus measures likely to be infrastructure related any increase in the manufacturing activity is unlikely to be felt until much later in the year.

Related article: Weather and China key drivers of commodity prices in 2014

Chart: Chinese manufacturing activity
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Source: ZeroHedge