La Nina Threat Returns

Brazilian Corn Production in Focus

Jake Hanley, Managing Director/Portfolio Manager                                   September 1, 2021

A recent report from NOAA, dated 08/30/2021 reveals a 70% chance that a La Nina will re-emerge in November and last throughout the winter.[1] 

Weather can have a significant impact on agricultural production. Over the past 24 months, adverse weather, spurred in part by La Nina conditions, has stifled crop production leading to a drawdown of global food inventories. As a result, grain prices have risen to multi-year highs as market participants factor in lower supplies.

Higher prices can mean larger profits for farmers. At current prices, farmers have all the incentive they need to plant as much as possible. This is certainly the case in Brazil where farmers are beginning to plant next season’s corn crop.[2]

Brazil is the second-largest corn exporter in the world (behind the US) and the USDA is estimating that Brazilian farmers will plant a record amount of corn for the 2021-2022 marketing year.[3] Record plantings in Brazil would create the potential for record production, providing much-needed support for global corn supplies. Production, however, largely depends on the weather. 

The graphic below shows the typical weather patterns associated with La Nina conditions. 

La Nina’s Toll on Brazilian Corn

As you can see, depending on the timing of the La Nina, conditions typically range from wet and cool in northern and Southeastern Brazil, to dry in the south.  

The most recent La Nina, which only just ended in June of 2021, took a toll on Brazilian corn production. In fact, USDA estimates for Brazilian corn production in ’20-‘21 reached a then-record high of 110 million metric tons (mmt). That estimate has since been revised all the down to 87mmt, which represents a 20% year-over-year production decline. 

An Uncertain Outcome

The impact of La Nina on Brazilian corn production will likely depend on both the strength and timing of La Nina.[4] Looking back in recent history it would appear that a stronger La Nina coincides with increasingly adverse weather.

The recent La Nina which began in September of 2020 and lasted into the summer of 2021 was moderately strong.

In 2017-2018 there was a weak La Nina which developed in September 2017 and lasted through May 2018. In that year Brazilian yields declined by 12% year over year. 

However, during a very weak La Nina between July 2016 and January 2017, Brazilian corn yields increased some 34%.

According to NOAA, most models are currently indicating a “borderline or weak La Nina,” emerging in the fall and lasting into winter 2021-2022. This would suggest that it is unlikely that Brazilian corn farmers will see a repeat of last year’s woes. However, as was seen over the ’17-18 crop year, a weak La Nina can potentially have a negative impact on production.

The Global Balance Sheet

Globally, corn supplies are now estimated to be as low as they have been since the 2015-2016 crop year.[5] Furthermore, the USDA is estimating record global corn demand in the coming year. Therefore, even if production meets expectations, supplies are still likely to tighten relative to demand. 

This can be seen in the stocks/use[6] ratio which compares Ending Stocks[7] to Total Use. The resulting number provides an indication as to the size of the surplus inventory (i.e. all the corn that is left over at the end of the year). Higher numbers indicate a flush balance sheet with ample supply. Lower numbers suggest a tighter balance sheet given smaller supplies relative to demand. 

The potential for a decrease in the global stocks/use ratio further supports our belief that corn prices are likely to remain at relatively higher levels for some time. 

Investment Considerations

US corn prices rose to 8-year highs in May and have since come down. However, at around $5.15 per bushel, prices are considerably higher versus the trailing 5-year average of approximately $3.97. 

Recall the concept of the “Golden Grain Cycle,” whereby prices tend to trade at or near the cost of production before heading higher amid supply concerns. Prices eventually come back down amid higher supplies due to farmers producing as much as possible in order to capture higher prices. When prices settle back toward the cost of production, the cycle is complete (read more about the Golden Grain Cycle Here).[8]

Corn markets are somewhat on edge right now. Global supplies are tight relative to demand, and farmers are racing to produce as much as they can. However, grain production is weather dependent and there is no guarantee that farmers can deliver (hence the concerns about the threat of La Nina). Should additional production concerns arise in the coming year, it is possible that prices head higher once again.

A similar scenario occurred between 2011 – 2012. As you can see on the chart below, corn prices initially spiked in 2011 before drifting lower through winter 2011-2012. However, prices made higher highs in 2012 amid ongoing production concerns. 

This chart is for illustrative purposes only and not indicative of any investment. Past performance does not guarantee future results.

 For this purpose, corn commodity values are representative of the futures (generic first corn futures contract - <C 1 Comdty>) spot continuation chart as defined by and sourced on Bloomberg: Generic contracts, such as C 1, C 2, C 3, ..., are constructed by pasting together "rolling" contracts, according to the pre-selected roll types on the commodity default page. The generic contract uses the value of a particular contract month until it "rolls" to the next month in the series. You can access a generic contract by replacing the month/year code with the number 1, i.e. C 1<CMDTY>. Replacing the month/year code with the number 1 will yield the spot contract.”

Still, if production does meet expectations next season, prices are likely to continue heading lower toward the cost of production. In that case, the chart may end up looking more like the 2008-2009 period.

A Note on Volatility

The uncertainty around corn supply/demand will contribute to additional price volatility. 

Price volatility presents both risk and opportunity. Note that options are available on the CORN ETF. Please consult your financial advisor or broker. 

[1] ENSO: Recent Evolution, Current Status and Predictions https://www.cpc.ncep.noaa.gov/products/analysis_monitoring/lanina/enso_evolution-status-fcsts-web.pdf

[2] Note that there are two corn harvests in Brazil each year. The first crop is planted between September and November and harvest begins in February. The second crop, also known as safrinha, is planted on the heels of the soybean harvest between February and March, and harvest largely begins in June. 

[3] USDA – Foreign Agricultural Service - https://apps.fas.usda.gov/psdonline/app/index.html#/app/advQuery

[4] The strength of a La Nina depends on the deviation from average sea surface temperatures in the Pacific Ocean. A strong La Nina occurs when sea surface temperatures are much cooler than normal. 

[5] USDA World Agricultural Supply and Demand Estimates (WASDE) August 12, 2021

[6] Stocks/Use Ratio: Ending Stocks divided by total usage

[7] Ending Stocks (also called carry-out): The amount of corn that will be available at the end of the crop year, given the estimated or actual beginning stocks, production and usage. 

[8] The Golden Grain Cycle -> https://teucrium.com/news-insights/294