How Chinese Buying Is Causing a Boom in Agricultural Commodities

as well. I mean that's how you know, that's sort of the big thing that everyone is talking about so far this year. Yeah, okay, so clearly we are joking, but I will say these new futures contracts were something like twenty years in the making. Um, so they took a really long time to get here. One of the reasons that so interested in starting futures contracts for pork is because they've basically had their pigs supply absolutely decimated

in recent years by African swine fever. So the whole idea is that the futures contract will come in, it will allow some standardization of pigs, and it will allow farmers to hedge and things like that, and they'll be able to rebuild their pork supply m standardization of pigs. I'm a, I'm I'm very intrigued by this. Yes, okay,

welcome to agricultural all thoughts. Um, So, we're gonna be talking about the pig futures contract, but we're gonna be talking about food price inflation more generally, because of course we've seen pork prices in China absolutely surge recently. It's starting to come down now, but but globally, as you know, Joe,

there's been a massive rise in food prices. Yeah. And I would say if I were to actually from an eco standpoint, if I were to say what is the biggest story in or in the economy right now, it would be all of the different bottlenecks price increases we're seeing at the producers side. We've talked about it with shipping, and we've talked about it with semiconductors, where we've talked about it with Jeff Curry, with industrial commodities, and of

course we're also seeing it in agriculture commodities. You know, if you look at the last year in the US soy futures up from nine hundred, I guess it's for futures contract for bushel dred corner is up by a lot, Hogs are up by a lot, cattle is up by

a lot. So there's almost you know, all these different categories we're seeing this upward price pressure issues relating to of course, uh, supply chain disruption still doing with COVID, massive recovery and demand around the world, particularly in China, but elsewhere where. And now as of the time that we're recording this, and I think we're going to talk about it too. Uh, the extraordinary scenes that we're seeing out of Texas and the freeze which is really disrupting

the economy of the entire central part of the United States. Yeah, a perfect storm of factors coming together to increased food prices. Storm might not be the right phrase there, but it is. I mean, you are starting to see actual impacts of this. So here in Hong Kong, McDonald's isn't offering hash Browns and its breakfast anymore. So you know, things are very serious. More seriously, we've seen some countries starting to talk about putting a price caps on food prices. I think Russia

is already doing it. The UAE was talking about doing it as well, So it is beginning to affect people's lives, and it is causing problems for some governments. So we're going to dive into the whole issue of food price inflation as well as the new Dallian hog futures contract. By popular request, we're gonna be speaking to Scott Irwin. He's an agricultural economist at the University of Illinois. Scott,

Welcome to the show. I'm glad to be here. So, Scott, in addition to being an agricultural economist, you're also an actual farmer from Iowa. Is that correct? Well, it's probably technically speaking. Um, I don't actually get much tractor driving and physical participation, but I it's an interesting situation. I from the landlord side of my family's farm out in Iowa. My eighty five year old mother and I provide the

management and do all the marketing of the crops. So I lived through the ups and downs of the grain markets like everybody else. Plus I get to try to work the markets with my card playing eighty five year old mother. That sounds that sounds extremely satisfying and fun. You know right now, you know sort of mentioned this rally that we're seeing. It's pretty intent across various soft commodities,

agriculture commodity. Why do you give us the sort of basic big picture of what's going on, what's driving this bid China perfect? Is that as six existent as you Yeah, it's not the only factor, of course, but in the egg markets, that's the number one driving force. We've seen a just a explosion in grain exports to China basically started about last July and has shown little signs of

cooling off. Some of that related to their Phase one trade agreement that was negotiated in the previous Trump administration. Some of it also related to rebuilding of the hug herd because of the African swine fever, and then some of it is also related to just their desire to rebuild some of their reserve stocks as well. But that's the number one fact. So one thing I always wondered about.

You see these headlines that China is building up it's grain reserves, and I don't know, I can I can kind of see why countries would do that, but I always wonder how useful those reserves are over the long term and how they actually use them. Can you give us a sort of like potted summary of what building up preserves actually means. Well. It's classic example of something that sounds good in theory and rarely works well in practice.

We have many decades of experience with different kinds of reserve schemes here in the US UM they've tried it metals, grains, and all sorts of commodities, soft commodities over the years. So they're called buffer stock ski seames. And the problem is, you know, the idea is that you build it up.

You know, it's kind of the seven fat years in the seven lean years biblical example put in practice, and so that all sounds good in theory, but it all becomes very political, and governments have a tendency to not want to release the buffer stocks when they really ought to to uh you know, maybe calm markets down, because then farmers are mad because you're driving the price down. And so it's just it's a deeply political and it

rarely works as well as it sounds in theory. So why did they do it and when do they do it? So if these if this is a scheme or this idea of building up huge reserves is not even really particularly sound and doesn't working well in practice, as maybe they think what why do they occasionally do this? Because I think I was just looking at a chart. I think like in eleven, didn't they like buy a crazy

amount of cotton, sending the cotton prices soaring? What catalyzes them at one moment or another to say, Okay, we're really just going to go out in the market and buy fear. It's just driven. You'll see that those kinds of big build ups and reserves typically follow price spikes. I think of the US Strategic Petroleum Reserve. When is their intense pressure to build that up started in oh six, oh seven o eight when crude oil prices were spiking,

And that's the typical pattern. And you know, the other thing is is with China, they have huge stocks, which I'm not even sure that the Chinese government really knows the size of their stocks of basic commodities. We know that their statistics are way off. I mean the U s d A and other international organizations try to track these, and grains will occasionally just go through these massive revisions. You wake up and China has you know, a hundred million less tons of feet grains on hand then you

thought they did yesterday based on the official statistics. So On top of I think the difficulty of making those work really well in practice in China, you have the extra problem of trying to figure out what the real number is. So one thing I've always wondered, you know, when we talk about food prices being at a six

year high, do farmers actually benefit from that? Well, I think when you uh see something like that headline of food prices at a six year high, we have to be really careful because that's reflecting various indices of the cost of what I call farm level prices. So it's like the price of corn and soybeans in central Illinois that farmers here can sell their corn and soybeans for, or hogs or or anything. At the farm level. There's a vast difference between that price and the price you

pay in your local growth try store. And a rough rule of thumb is that about only of what you come home with from the grocery store that's food, is represented by the farm level share of the cost. So you can have a six year high in the raw price of most foods and it doesn't budge the grocery or retail level price all that much. Now, that's not

strictly true for all Uh. Commodities, things like milk, meat, and eggs are most directly related to the price at the farm level because they're obviously very perishable and consumed close to the raw form. The more processing you have, the more that that distance from retail price or grocery

store price to the farm price gets. And I'm going to ask another very remedial question about commodity economic and into this, which is that when people talk about the existence of the futures market, and I quoted some soy futures and con future prices in the intro, it's like they're like, well, the farmer has to hedge their production because they don't know what the weather is going to be like, and the buyer wants to hedge, etcetera because

they don't know this, and that's why the future market exists and so on. Does the futures market actually work as such in practice such that farmers who are out there on the land and some level or another use it to actually um manage risks. Great question. That's the classic textbook example that everyone uh from the exchanges on used to motivate futures markets and white people hedge, and it actually isn't a very good picture of how those

markets actually work. Most producers here in the US, been the most sophisticated ones, don't use the futures markets directly themselves very much. They do it indirectly through something called forward contracting with the books, say their local grain elevator. But even then they might maybe at most um sell forward of their production. So the vast majority of the trading volume on what we would call the commercial or hedging side is actually done by what I like to

call grain merchants. These are the big and the small companies that are involved in the basic transformation of a commodity in time, form, and space. Those are the people that really use the futures markets. That's that's the core community. So this is something that I actually wanted to ask you about, which is we have all these different futures contracts out there. So you know, the CM famously had its physically delivered contract for live hogs and then that

got converted into cash settlement. What actually makes a successful futures contract and how do you judge success? Well, you can look at it the way an economist looks at it, but the simplest way to look at it from exchange and traders at a futures exchange is simple volume. That's their measure of success. It's easy. Uh, do people want to trade it? And are there rising and large volumes

of contracts exchanged? Very simple objective function. From their perspective, An economist looks at a little bit more broadly and asked, does the contract fulfill an important role in helping to discover prices for that commodity? Uh? And is it a good vehicle that a broad swath of people in that commodity sector can use to manage their risks? So those are the two economic functions that we look at as

an economist, but exchange looks at it very simply. You don't I really like about this podcast is like ostensibly we're like, oh, what's going on in grains and food and everything? But I love that we just get to use this as a time to ask really basic questions that like, we would probably never ask in any other form, like how does the futures market work? And who actually trades it? Because I can't think of any other opportunity where I would like get to ask that question except

this podcast. So I just want to say, is one reason I really enjoyed doing it, so Tracy, Uh, I know, it's really great, and I'm just like, when else would I get to do this? Like if I said this on air on TV, I would be laughed at and I wouldn't have the time. Okay, so let's get to the big question, which is why should we care about, say, the introduction of China's new live hog futures, which have

been trade for just over a month. It looks like, well, there you get to the real basic question of you know, what's the purpose in the largest sense, what's the value of commodity futures markets to an economy and to a society, And if it's doing its job right, it basically makes the marketing system more efficient. In other words, producers will

get higher prices and consumers will pay lower prices. That margin between the farm price and the ultimate consumer price gets a little bit more efficient, a little more competitive and cost efficient. That's the core value of a futures market that's working well. So one thing I wanted to ask you about is how the Dalian contract actually works. So I think the size is for sixteen tons of pork, which is about sixteen tons of pigs, I should say,

which apparently is equal to one truck full of hogs. Um. So again, like this kind of gets to the standardization element, but how are they actually taking delivery of actual hogs? And do you think it will help standardize China's pork market? Again, you know, I'm not an expert on that particular future contract, and what I've read is it seems like the size is comparable to what the CME Lane hog contract is

in terms of the number of hogs it represents. Roughly a truckload is kind of a common size, so that that makes sense. I think China's challenge will be is that there pork sector is far less industrialized than stay here in the US, in that they have millions upon millions of very very small pork producers and they're not

going to use the futures market. A futures market will be used by the very large industrialized pork operations China, which are growing rapidly, but there's still a relatively small share of that country's total pork production. And you'll see slaughtering plants and you know what I'd like to call that, those middle operators or what I call merchants, those will almost every futures market tend to be the biggest users, and so that's the community I would look to to

see if it's going to be successful. So I'm really fascinated by this point about the sort of uh, the inconsistency of the I guess diversity, the inconsistency of the domestic pork operations, and how that fits into I guess, you know, a standardized futures contract. You buy a uh, you know, however, many tons of hogs, and you expect

a certain like quality and consistency. But I guess that's that must be an issue across all futures always, whether it's corn or soy, you buy a certain amount, you expect a certain grade, a certain quality, and every ear of corn I guess it could theoretically be slightly different. How do commodity future or commodity traders across the futures

markets and sort of commercial buyers of them? How does that get worked out over time such that the deliveries of the actual goods become predictable and standard, And how does the futures contract except self is Tracy alluded to in the intro sort of accelerate that predictable news, right, Well, the first thing to remember is that the vast majority

of futures contracts are never fulfilled by physical delivery. Like in the grains, maybe one or two percent of all the contracts that are traded actually end up resulting in physical delivery, and that's by design. That doesn't mean there's something wrong with the contract, because the futures market is, in simplest terms, designed to be a parallel market organization or vehicle where you can play side bets if you're a producer or a middle operator, and those side bets

allow you to in essence, manage your price risk. So you're here in the futures markets taking long and short positions to manage the price risk of whatever is your underlying cash position. And what you really are interested in then is do my cash prices and my futures prices go roughly in parallel, so that if I'm long in the cash and I go short in the futures, then the price movements roughly offset one another. And that's all you care about. You're not using it as a merchandising

vehicle to actually get the physical commodity. But at the same time, why the terms of the contracts, the things you were talking about are critical because if you're going to manage your risk over here in the cash market side with the futures contract, you need a futures contract that has terms and reflects the prices as closely as you can get to what you're doing over here in the cash market. M I wanted to widen out the conversation once and talk more about agricultural prices generally. So

we are seeing lots of talk about agflation. I guess my question is what could be done at this moment in time, in your opinion, to bring food prices down. Well, I don't think that there's probably a lot that governments can do around the world because there aren't large excess stocks laying around, you know, in these kind of buffer stock schemes, except maybe inside China. I'm not myself very concerned at this point about I love the term you

had inflation. We have seen large increases in prices, but let's just kind of wait, and you know, coming on the other side of this is going to be a monstrous supply response around the world, and things like born ands a beans and then the livestock, and you just

kind of gotta give the system a little time. I mean, it's very important to remember, like, standing around mid August, we thought here in Illinois we were going to have one of the worst years we've had for a long long time on income, and it wasn't very long ago. And then corn and soybean prices started shooting up, and we're gonna see a big excrease in acreage. Farmers are going to pour the inputs in, and if we get any kind of decent weather here in the US, we're

gonna have a big crop. And it looks like for you know, the first cut at the big price high prices was in South America, and other than maybe some problems in Argentina, they look like they're going to have pretty good crops. So I don't see anything in this yet that that really deeply concerns me about long term inflation. So is there a way to sort of anticipate the how long the stocking cycle goes? So obviously you will get this and hopefully we get a robust supply response

to the demand. What about the demand side itself? Can economists? Can you anticipate how much more China has left to buy before it will be satisfied with its attempts to sort of build up a buffer or is that inherently

unpredictable due to how political it is. With China in particular, that is wildly hard to predict because you're purely predicting, you know, inside the Chinese Communist Party, what are going to be their political decisions on these key kinds of variables, And the data is just so poor at least in the public domain. Give you an idea of how hard

this thing is to assess in China. I have some colleagues that working hedge funds, and when the African swine fever started taking off, you know, there's a huge hedge fund. They had no idea, so they started having regular calls with veterinarians they could get ahold of insight China directly, and they just try to build up a network and start talking to people. So it's very hard. You know, it's very volatile and uncertain situation when the world's largest

consumer is this kind of opaque. There's one other big thing going on at the moment where that has the potential to actually happen um and impact food prices and the farming community, and that's the new US President Biden coming in presumably with some sort of new agricultural policy. He definitely seems to have a focus on climate change UM, which would impact things like story beans. How do you

see that playing out? Well, I think that's going to be very interesting, UM and it's going to be layered on top of and our ongoing what I call RFS swars here in the US politically over the renewable fuels mandates that we already have UH here in the US by law. So we have that that's ongoing, and then you have layered on top of that things like the California Low Carbon Fuel Standard, some talk of that being

expanded going forward. You have something called renewable diesel plants being built at a wild pace right now in responding to these policy incentives. So this is definitely an area that I'm paying really close attention to and I think has the potential to be probably the biggest demand game changer, both negatively and positively for egg in the next few years. Can you can you actually explain that a little bit further one could change policy wise that's on the horizon,

making it making either agg demand go sharply higher or lower. Well, probably the first thing I'd come up is, you know, what's the Biden administration going to do with ethanol you know? Um, I hear chatter that there's certainly the groups are going to really be pushing moving from a de facto ten standard on gasoline. Would a Biden administration for climate change reasons and domestic political reasons go along with that? That

could be huge. Secondly, what is the new Biden administration's position going to be in terms of how we implement our renewable fuel mandates? Under the Trump administration, who was very closely allied with the crude oil refiners, basically their entire strategy was to give it as big a haircut as possible, you know, reduce it. We're still kind of trying to find out where the Biden administration is going

to fall on all of these. Plus we have a big case in front of the Supreme Court on the rentable field standards, so there's a lot of moving pieces on that right now. So one of the few things I know about the farming community is that they seem to be uh, how do I how do I put this? Like, for the past few years, they seem to be um. They seem to feel bad. What will would it take to get um? I guess the sort of like happy days, uh,

sentiment back into the farming community in the US. Oh. Now, there's always a lot of things that contribute to farmers grumpiness, having grown up and being kind of technically one myself. So that's that's a complicated question on a personal level. But more seriously, high prices. That always takes care of it, doesn't it high prices, So you know, I can give you some round numbers that would help here in Illinois.

If you could assure Illinois farmers of four dollar corn and eleven or twelfth dollar soybeans, there'd be a lot of smiles. And what do we at right now? We're actually above those levels right now. Uh, in terms of the cash prices um there. Look, you know, quite a bit higher than that. We're looking at over five dollar corn and uh what I just check. I think right around thirteen dollars for beads. So farmers are very happy

with those prices right now. So the other thing that's going on, obviously this sort of horrific arctic blast that's really affecting the entire central part of the United States, actually a huge swath of the country, particularly brutally in Texas.

All kinds of spillovers. Recording this may very seventeenth. Did an hour or two ago I saw the Texas Governor declaring no natural gas exports would be allowed from the stage, so it's gonna spill over into other states, and so other issues with getting the feedstock to the ethanol ethanol plants due to the freeze. What are some of the implications that you're already seeing as a result of this, and how long could we be sort of dealing with the aftermath even if it warms up in the next

couple of days. I don't think that the natural gas related disruptions that we've seen will last very long, simply because it's gonna warm up stretch in a week. It's just that's not going to last too long. Probably in an egg side the I would say that would be two main impacts that will have to be assessed to see how long lasting. First off, I mean, this was a absolutely brutally cold event that went right straight down

the middle of the Great Plains. So what kind of losses are we looking at in cattle feed yards and uh literally death and freezing or calf operations and slow down in rates of game things like that. Those those are gonna play out for a while. Hogs are almost entirely in confinement buildings, so there's not gonna be chickens the same way. Not not much. One that's really only now I think, you know, the futures market has been

thinking about it. But one of the ones that might have a long the longest lasting impacts is what did this do to the winter wheat production here in the US. You know, normally it's extremely hardy crops, Like a friend of mine says, you know, you can kill the wheat crops seven times a year with bad weather. But this was a length of low temperatures that was extraordinarily long, even by Greats standards. And you know, dormant wheat is

supposed to be very hardy. You know, it's literally dormant, but it can still be killed if the temperatures are low enough long enough, and so there's a lot of debate about that. That's that's the one I would really be looking for long run, is to see, you know, how much what they call winter killed did we really get with the U S winter wheak. Carl, I think that was fantastic. I learned a lot from that. Well, hopefully I'm not too worthy that professors tend to do that.

I know now it's perfect. Thanks so much, Scott, right, take care of Scott, Joe. I'd love talking about commodities. I think, I think, I secret we always wanted to be a commodities reporter and I never really got the chance. Do you know, Tracy, I meant to tell you speaking of being a reporter, remember a while back on one of our episodes, you said if you were starting UM as a journalist now, you would be a semiconductor reporter.

Oh yeah. Someone d m me the other day and said they heard that and they were inspired and they wanted to get into They heard you say that, and they were going to get like, start writing about semiconductor. So you you may have launched someone falling the whole generation of semiconductor reporters. Let's chill out at least one maybe one? All right, um, but commodities. So here. The thing.

The thing I like about commodities, I think is it brings a lot of these sort of market ideas and market structure theories to life, right, because you're talking about an actual product and you can think about holding up well maybe not a live pig in your hand. But you could think about holding corn or soybeans in your hand, and you can actually connect that to the way the futures market works and to the way markets generally function. Tracy, you're gonna take delivery of a live pagram, I can

see that. Yeah, I know you would. No, I'm not, but I totally would actually if I had a place to to put it. But you see what I mean, right, Like the aspect of the commodities market, Okay, totally. And I actually thought that was a really interesting point he said about the goal of a commodities market is not about taking delivery of the physical commodity itself via the end commercial buyer of the future, but about having a contract running parallel to the cash market such that the

fluctuation should be in the same direction. So you could get a delivery of pigs, and maybe they're a little bit inconsistent, but as long as sort of directionally the cost of the actual cash pigs I guess, and the pig futures are moving in the same way, then the futures market serves its purpose for the participants, which I thought was interesting. But then, of course, you know, you could see how over time the desire to I guess,

I guess you would are the cash what is? What are the cash future spread would encourage participants to start delivering pigs or any other commodity that are, you know, in line with the the specs the specification, so you can see how it serves that purpose. I was just thinking it'd be funny if you saw live hog prices or lean hog prices go negative and suddenly everyone had to take delivery of a bunch of pigs like oil.

The other thing I liked is I finally got to ask the question about whether the hedging farmer is a myth, because I've always sort of suspected that farmers don't really hedge, like doing the textbooks. And I'm glad he confirmed that. But that was a great That was great. I really I could actually could have listened to him for a lot longer. Well, we'll happen back on for sure. The next time we have a big agricultural development, we'll start

our all thoughts farming spin off. I like, I like when you're asking what would make farmers happy, and he's just like higher prices. That was good. Well, it's a look. I feel entitled to ask that question because actually My granddad in Texas was a cattle farmer. Um, and they tend to be I mean, Scott's use of the word grumpy was correct. As far as I could tell. They tend to be a pretty pessimistic bunch um. And of course we've seen them complain a lot over the years.

So I'm genuinely curious, like, what what do they want

to see? There's always a drought, right, There's always a drought, right, There's always consolidation, and probably the large industrial egg factory farmers are probably are always sort of making life miserable, and somewhere or another for the small farmer, there's probably and we could have gotten into this, but I have to imagine um and maybe we could even do another episode concentration, particularly when it comes to and I remember this was an issue this past summer in spring, but

the coronavirus, but sort of the concentrated buying power of the slaughterhouses as a form of leverage over the farmer essentially, So if you don't have, you know, if you have sort of this monopsyony buyer of of your wares, of your your cows, then that's an issue. So I think in addition to higher low prices. There's all kinds of structural things that probably um upset the sort of the

day to day farmer. Okay, look well, Episode one of All Thoughts Farming series will be why are Farmers so Grumpy? I'm into it. This has been another episode of the Thoughts podcast. I'm Racy Allowitt. You can follow me on Twitter at Tracy All the Way, and I am Joe wi isn't Thal. You could follow me on Twitter at the Stalwart. Follow our guest Scott Irwin on Twitter. He's at Scott Irwin U. I follow our producer Laura Carlson.

She's at Laura M. Carlson. Followed the Bloomberg head of podcast, Francesco Levi at Francesca Today, and check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening.