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China reforms a 'substantial' threat to ag prices

Deutsche Bank warned of "substantial" threat to agricultural commodity prices from a potential change to China's farm support policy, which could reduce the stockpiling which has supported world prices of many crops.

China is reconsidering its agricultural support programme which offers minimum state procurement values for the likes of corn, pork and wheat, but which has, thanks to disconnects with international values, provoked market dislocations and unintended knock-on effects.

In cotton, for instance, China has built up stockpiles equivalent to about one-and-a-half year's use as farmers exploit generous state prices, which have in turn left domestic mills paying over-the-odds for cotton, and turning abroad for cheaper supplies when they can.

"It appears that appears China's agricultural stockpiling policy may be poised to change," Deutsche Bank said, flagging reports that the country may switch from price setting to alternative agriculture support mechanisms such as insurance incentives or direct payments to farmers.

'Adds to the bear case'

The bank said that the "implications for a shift in China's policy to price determination by the market are substantial, notwithstanding the country's desire for the change to be gradual owing to concern over food security".

A switch to direct support to farmers, for instance, would, in allowing domestic prices to fall closer to international ones, ensure "less of an incentive for imports".

China is the top importer of agricultural commodities including cotton, rubber and soybeans, and a growing buyer of corn and, this season, wheat too.

When world stocks of many crops, such as corn and soybeans, are rebuilding and so putting pressure on prices, "this adds to the bear case in the agriculture market", Deutsche said.

"The possibility that the Chinese government will move away from stockpiling and towards direct farm subsidies will discourage agricultural imports, in our view.

"This raises the possibility that agricultural prices have further downside heading into next year."

Price gaps

The premium of Chinese cotton prices over international ones is famously high in cotton at the equivalent of about 150 cents a pound, more than 80% above New York futures, the world benchmark.

However, for corn too, the support price, of more than $9 a bushel for this year's harvest, is more than twice that of Chicago futures, with wheat's differential not far behind and the support price for sugar also generous by international standards.

Support prices in oilseeds are closer to international values, Deutsche said, implying that these markets appear less at risk from a change in policy.

Gradual process

The chances of Chinese reforms to agricultural support increased last month when Fang Yan, head of the rural department of the National Development and Reform Commission, said that "grain prices have come to the stage to be decided by the market", according to the China Economic Times.

However, any change would be gradual, and likely to be trialled on one crop, she said, while failing to specify which one.

Meanwhile, Deutsche Bank last week revealed it was hacking back its commodities business, cutting about 200 jobs, thanks to lower profits in the sector, and the regulatory and capital costs of maintaining a business which can have a large balance sheet impact.

The group is also moderately downbeat sentiment on price prospects for many commodities, even after a year when they look set "to be the worst performing asset class on an excess returns basis".

"This might imply a more constructive outlook for returns heading into next year. However, ongoing hazards across the major commodity sectors remain," the bank said in a report last week.

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