Macroeconomics of Agriculture in an Over-leveraged Global Economy

Macroeconomics of Agriculture in an Over-leveraged Global Economy Erik Norland, Senior Economist & Executive Director Strategic Intelligence & Analytics Strategy & Execution April 2016 1

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The Greatest & Least Growth Potential Total calories consumed = per capita calorie consumption x total population. The greatest potential for growth is in places with low current levels of per capita calorie consumption and high population growth rates (Africa and India). The least potential for growth is in places with declining populations (China, Germany, and Japan) and relatively high levels of per capita calorie (Brazil, Germany, and USA). The commodity super-cycle is on the down-swing: growth is shifting from emerging to developed economies. Africa is a difficult place to evaluate because it involves 55-57 countries; the near-term economic outlook is mixed-to-negative. Longer term, Africa has significant developmental challenges. China, the most important source of demand growth during the past 25 years, is pretty much tapped out as a growth market. India holds promise, but near-term demand growth may be hindered. Growth is shifting to developed economies but this will, at best, lead to a modest increase in vegetable oil demand. 4

Africa Might Continue to Experience the Fastest Population Growth and Could Represent the Biggest Opportunity for Food Producers Worldwide

A Doubling of the World Population and Rising Calorie Counts Hasn t Pushed up Food Prices in Real Terms

A Doubling of the World Population and Rising Calorie Counts Hasn t Pushed Up Food Prices in Real Terms

Changing State of Agricultural Markets Corn, wheat, and soy prices are currently trading at fairly depressed prices and exhibit usually low realized and implied volatility. El Niño and La Niña have the potential to break grains out of a low volatility environment. Macroeconomic factors could also move grain prices: 1) Excessively high levels of debt (private + public) could create fragility in a variety of economies worldwide, most importantly China, where debt now totals approximately 250% of GDP, close to levels that triggered crises in Japan (1990), the U.S. and Europe (2007-2009). 2) Volatility in currency markets could surge if China devalues the RMB. 3) The U.S., Europe and Japan have not deleveraged and will likely remain stuck in a slow growth economy. 4) The best hope for strong economic growth and increased import demand is India. 5) Africa also holds great promise but its potential is long-term. 6) Energy markets are likely to remain unsettled with wide trading ranges.

Corn, Wheat, and Soy Have Been in an Exceptionally Low Volatility Environment: That May Change Soon

Japanese, European, and U.S. Crises Began When Total Debt (Public + Private) Reached 250% of GDP

China and a Number of Other Nations Have Joined the 250% Total-Debt-to-GDP Club

U.S. Federal Reserve Dreams of Raising Rates Further Following the U.S. Federal Reserve s (Fed) December rate hike, the first since June 2006, Federal Open Market Committee (FOMC) members said that they expect to hike rates an additional four times over the course of 2016; once every other meeting. At the March meeting, the FOMC said it now planned to raise rates just twice this year. At the time of the Fed s December rate hike, Fed Funds Futures priced two moves in 2016, one (mostly likely) in June and another (most likely) in December. After a turbulent beginning to the year, the market now anticipates only one further rate hike, most likely to come in late 2016 or even possibly in early 2017. The U.S. economy s strong point: employment growth. Employers are hiring at a steady pace. This is what gave the Fed the confidence to hike in the first place. The U.S. economy s weak point: inflation is too low. The Fed targets 2% inflation but core inflation (excluding food and energy) hasn t been at or above the Fed s target since April 2012 and is currently much too low. There are some inflationary pressures in the service sector but none whatsoever in the tradable goods sector or, for the moment, in food and energy. Inflation being too low will make it hard to raise rates again. This in turn might limit the upside of the U.S. Dollar.

The Fed Dreams of Hiking to the Core Rate of Inflation 27

Total Labor Income is Growing at 4% YoY 28

Fed Funds Futures & Diminishing Expectations 29

Europe: Growth Getting Set to Rebound Europe s major bout of financial volatility is now behind it. The European Central Bank s (ECB) aggressive monetary easing combined with lower oil prices and a weaker currency is likely to generate a strong recovery in certain countries, notably Spain and to a lesser extent France and Italy. Growth in Germany remains solid. Greece continues to experience extremely severe problems but it won t impact the overall European picture very much. Greece s GDP is less than 2% of the euro zone total. Strengthening growth might help the Euro but the ECB probably doesn t want a stronger currency and might accelerate its quantitative easing program. The British referendum on Europe has the potential to create a great deal of volatility in the Pound and to the lesser extent in the Euro.

ECB QE Has Led European Rates to Extremes 31

ECB QE Has Led European Rates to Extremes 32

Germany, the Only Country in Europe with Low Debt Level, Lent Money to Everyone 33

Ireland, Portugal and Spain are De-Levering 34

Ireland, Portugal, and Spain are De-Levering 35

Ireland, Portugal, and Spain are De-Levering 36

Greece Can t De-Lever Until Nominal GDP Expands 37

Greece Can t De-Lever Until Nominal GDP Expands 38

Every Other European Country is Increasing Debt 39

Every Other European Country is Increasing Debt 40

China: The Consequences of High Private Sector Debt China s private sector is highly indebted relative to its emerging market peers. China s private sector debt levels resemble those in Western Europe, Japan, and U.S., where interest rates are much lower. High levels of debt are sustainable so long as the economy continues to grow rapidly or so long as interest rates are extremely low. As China s economy slows, this will put additional downward pressure on Chinese interest rates. China s currency is overvalued versus many of its peers, and export growth is stagnating. Imports are collapsing, mostly as a price effect from lower costs for commodities (energy and metals). Lower rates are putting downward pressure on the Renminbi (RMB). China is still trying to defend RMB, but is burning through currency reserves. This can continue for a while but not forever. Letting the currency depreciate could accentuate capital flight and cause problems for real estate/banking system. China s choice is either to keep banks/real estate afloat by defending the currency and sacrificing manufacturing and export growth OR letting the banking system and real estate implode while supporting manufacturing with a weaker RMB.

China s Economy is 5x the Size of Other BRICs 42

Chinese Demographics Look Like Japan Circa 1990

This is How China Could Look in 2035 or 2040

A Window Into China s Future: Japan s Per Capita Calorie Consumption Fell by 8% as its Population Aged

China s Per Capita Consumption has Risen in Every Category Except Grains and Sugar

China s Real GDP Growth Rate Decelerating, Probably Into The 4% to 6% Range Over The 2015-2018 Period

Nominal & Real GDP Continue to Slow. Slower Nominal Growth Might Increase Defaults. 49

China Will Probably Need to Cut Rates Further 50

Chinese Exports Have Stalled 51

Renminbi is Strong Versus BRIC Currencies 52

Renminbi is Also Strong Versus Euro & Yen 53

China Burns Through Reserves Defending RMB 54

India: Growing But No Replacement for China Indian economy continues to grow strongly. The good news for farmers outside of India is that India s agricultural sector is fairly stagnant, opening the possibility that the country will need to import more and more food as its population grows. The bad news is that strong growth in India will only offset a small portion of the decline in China s growth rate. China s economy is five times larger than India s. As such, if China slows by 1%, India s growth rate would have to pick up by 5% in order to make up the loss. India s economy has been growing more quickly but not fast enough to make up for slackening demand in China. The Indian Rupee looks to be close to fair value. It has risen versus the weakest currencies like the Russian Roble and Brazilian Real but has fallen versus the Renminbi, Euro, and Yen. The Reserve Bank of India will probably stop easing policy and may tighten sometime later in 2016 or in 2017.

India s Diet is Remarkable for Two Reasons: It Has a Great Deal Less Meat & 15% Fewer Calories Than China s

India s Economic Growth has Been Improving 57

India: Debt Levels Remain Reasonable 58

India s Agricultural Sector has Been Lagging 59

India s Mining Sector has Been Lagging 60

India s Manufacturing Sector Remains Robust 61

India s Construction Sector Remains Robust 62

India s Banking Sector is Driving Growth 63

Indian Transport/Communications Growing Fast 64

India Rupee Strong vs RUB & BRL But Not RMB 65

India Rupee Strong vs RUB & BRL But Not RMB 66

Energy Outlook & Oilseeds & Financial Assets Crude oil has been a major driver of financial markets and might have found a bottom. Here are the key things to watch: Inventories: Do inventories keep growing or does the market begin to clear? Inventories are highly seasonal. Typically, they rise in the early months of the year and come down during the summer driving season. So far this year, they have not been rising as much as normal. This might be an early sign that the market is beginning to clear. Supply: U.S. oil production may have peaked; Saudi Arabia and OPEC might eventually step in to curtail production, but output declines in 2016 could be modest. Demand: Will likely continue to grow in the U.S., Europe, and Japan but might be partially offset by slower growth in China and emerging markets, including oil suppliers domestic demand. Instability: Default and chaos in Venezuela, strikes in Russia, reduced spending in Saudi Arabia, a delicate leadership transition in Algeria the risks of upside surprises to energy prices (and downside risks to energy supplies) are growing by the day.

Energy Stocks Have Been Responsible for a Great Deal of the Equity Markets Recent Volatility

Soaring U.S. Production the Catalyst for Oil Price Collapse but U.S. Output Probably Peaked in 2015

Soybean Oil Has Often Anticipated the Path of Crude Oil and Might Suggest That Crude is Hitting Bottom

Palm Oil Has Often Anticipated the Movement of Crude Oil and Might Suggest that Crude is Hitting Bottom

U.S. Crude Oil Inventories Close to Record Levels After Smaller-Than-Usual 2015 Summer Seasonal Decline

U.S. Production May Have Peaked in April 2015

Investments Made 3-5 Years Ago Benefit N. Sea Production

Lower Oil Prices Mean Acute Pain for Oil Producers

Most Immediate Consequences of Lower Oil Prices Will Be Felt in Nations with Slim Financial Reserves

As of Early April, Futures Curve Shows Oil Prices To Remain Low for a Long Time. Will It Be Proven Right?

El Niño and La Niña El Niño and La Niña, the warming and cooling of central and east-central Pacific Ocean sea surface temperatures, respectively, have well documented impacts on climate and harvests worldwide. This study examines their impact on the spot and futures returns of ten agricultural markets: corn, wheat, soybeans / oil / meal, rough rice, live / feeder cattle, lean hogs, and dairy. For spot prices, it examines how they move in real terms (spot price / CPI index). For futures returns, the contract rolls 5 days before expiry. Using data from the National Oceanic and Atmospheric Administration s (NOAA) National Weather Service, we look at agricultural spot and rolled (reinvested) futures markets returns in the 12 months and 24 months after temperatures rose by 1 degree above normal (in the case of El Niño) or fell by more than 1 degree below average (in the case of La Niña), using data from 1959 to present. El Niño is supportive for ag prices whereas La Niña is usually bearish. There can be significant variation in market impact from one El Niño / La Niña episode to another. The stronger the El Niño or La Niña episode, the greater the volatility.

The Strongest El Niños (+2 Degrees C or Higher) Have Flipped into La Niñas Within 12 Months 80

On Average, El Niños Have Boosted Spot Prices For Ags While La Niñas Have Depressed Them 81

Not Every El Niño Boosted Spot Prices But Some El Niños Sent Spot Prices Soaring 82

La Niña Most Times Depressed Spot Prices for Most Agricultural Goods, But Not in 2010 83

Corn Volatility, El Niño, La Niña and Neutral Periods

Corn Volatility Under El Niño

More Intense the El Niño, More Likely For High Volatility

Corn Volatility Under La Niña

More Intense the La Niña, More Likely For High Volatility

Soy Volatility, El Niño, La Niña, and Neutral Periods

Soy Volatility Under El Niño

More Intense the El Niño, More Likely For High Volatility

Soy Volatility Under La Niña

More Intense the La Niña, More Likely For High Volatility

Wheat Volatility, El Niño, La Niña, and Neutral Periods

Wheat Volatility Under El Niño

More Intense the El Niño, More Likely For High Volatility

Wheat Volatility Under La Niña

More Intense the La Niña, More Likely For High Volatility

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