Thursday, December 26, 2013

Chinese Farm Commodities, Gold and Deflation

Despite being a relatively primitive part of the Chinese economy, the country's agricultural sector is tied in to global financial markets. An example is the surprising correlation between Chinese gold and corn prices shown in the chart below. 
Note: Cash prices from China National Bureau of Statistics, Ministry of Agriculture, and gold.org. 

Chinese gold and corn prices have generally been on the rise since 2000. The link became more clear during 2009-11 when both prices rose at a robust pace. China's gold price peaked in 2008 and fell after the onset of the global financial crisis that year. Chinese corn prices fell later in 2008, along with nearly all other farm prices. Since then, monetary authorities in China, the U.S. and elsewhere have been in expansionary mode, and from 2009 to 2011 there was a steady run-up in both gold and corn prices. The Chinese gold price rose 118 percent from its low point in December 2008 to its peak in September 2011. Chinese corn prices rose too, but about half as fast: 52 percent from November 2008 by their peak in September 2012. 

The gold price plateaued and then began sinking in 2012. By November 2013, the Chinese gold price was down more than 30 percent from its peak. Corn prices also plateaued during 2013. The average Chinese corn price hasn't fallen sharply but the upward trajectory has stopped. The average Chinese corn price is down about 5 percent from its peak value. With a few exceptions, most agricultural prices in China have stopped going up and in some cases have fallen. 

Another example is China's pork price (below). Chinese hog prices are more volatile than corn prices, as there is less government intervention and disease epidemics cause intermittent supply shocks. The peak in China's hog price in 2008 (following the "blue ear" epidemic in 2007) coincided with the peak in the Chinese gold price. The hog price fell sharply in 2009 due to excess supply but probably helped by the global financial crisis. Chinese hog prices began rising sharply during 2010--a period when nearly all commodity prices in China were rising at an alarming pace. Chinese gold prices were rising at the same time. Interestingly, China's gold and hog prices again peaked at the same time in 2011. During 2012-13, hog prices continued to fluctuate but the hog price is clearly not headed back to its 2011 peak. 
Source: China National Bureau of Statistics, Ministry of Agriculture and gold.org.

The gold-commodity link is not unique to China. U.S. corn prices have been more volatile than Chinese prices but they have also followed the general trend in the gold price. The U.S. corn price spiked in 2008 during the global commodity price boom (China banned grain exports during 2008 and thus prevented a spike in Chinese corn prices), fell sharply during the global financial crisis and rose to high levels during the droughts of 2011 and 2012. The U.S. corn price has fallen precipitously during 2013. This is mainly due to this to this year's big harvest, but it also coincides with the collapse of the gold price bubble. Chinese authorities are struggling to prevent a similar collapse of China's corn price by stockpiling the 2013 harvest, subsidizing purchases of domestic corn (and perhaps by rejecting U.S. corn imports).
Chart shows U.S. Gulf price of corn and gold price from gold.org.

Chinese officials are wringing their hands over this year's decline in farm prices. The chart below shows that corn production costs and gross income per-unit-of-land have been rising at an accelerating rate since about 2006. Increases in both price and yield have kept gross income rising fast enough to keep up with the rise in costs. Data are not available for 2013, but reports indicate that yield went up about 4 percent while prices are down about 5 percent. The chart shows that gross income per unit of land would fall under these assumptions. If production costs rise at their customary rate, net returns for farmers will shrink or vanish. This would not only slow rural income growth but also discourage farmers from planting grain in 2014.
Note: Chart shows gross income (price x yield) and costs per unit of land for corn production in China.
Costs of land and labor include imputed costs of family-owned inputs plus costs of rented land and hired labor.
Source: China National Development and Reform Commission data. Gross income for 2013 is estimated.

The chart also shows that the recent inflationary period echoes a similar euphoric inflationary period in China during 1993-95. That inflation came to a screeching halt, leaving Chinese agriculture in a deep funk during the late 1990s. Farmers had difficulty selling their grain, rural incomes were depressed, authorities tried to support prices (with "protective prices") and were burdened with huge grain inventories they couldn't sell. There are signs that we China is at a similar turning point that could bring everything grinding to a halt. 

The growth in China's agricultural commodity prices since 2009 may have partly reflected general inflation due to massive monetary stimulus all over the world. "Quantitative easing" in the United States drove U.S. interest rates to zero, sending investors scampering around the globe looking for returns. China was also boosting its money supply in 2009 when banks were ordered to ramp up lending to support gargantuan infrastructure spending to counter the recession that came with the global financial crisis. Much of that money went into real estate but some went into agricultural commodities. About that time, stories about Chinese real estate and agribusiness companies flush with cash investing in agricultural projects began showing up in news media. During 2010--the year after China's big stimulus program--there were stories about Chinese speculators with wads of cash stockpiling garlic, ginger, and chili peppers. In 2010, authorities cracked down on corn market speculation and desperately sold corn reserves into the market to tamp down prices. 

China's agricultural sector has been locked in to inflation as a fact of life since 2009. Production costs rose every year, so Chinese officials adopted a practice of raising price supports every year to cover rising costs. Ever-rising prices also meant that commodity reserve managers could always sell the grain they bought at a higher price and make a profit. China's approach to managing agriculture is predicated on the notion that production costs and prices would go on rising forever. What happens if prices fall?

The financial world is now focused on "the taper"--the U.S. Federal Reserve's roll-back of its monetary stimulus. China has had two cash crunches so far in 2013. The trends indicate that commodity price inflation has ended and a deflationary period may be about to begin.

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