Weekly Grain Market Review (KSU Ag Econ) for July 6, 2018
Question of the Hour in World Grain Markets:
How Will the “Law of One Price” Work Out for Grain Markets in the U.S.-China Trade Dispute?
By definition, “The law of one price is the economic theory that the price of a given security, commodity or asset has the same price when exchange rates are taken into consideration. The law of one price is another way of stating the concept of purchasing power parity. The law of one price exists due to arbitrage opportunities.” (Source: Investopedia, https://www.investopedia.com/terms/l/law-one-price.aspFeedback)
In regards to grain markets, here is more explanation: “In case the two markets both produce and can trade a commodity in either direction the law of one price states that the price difference should be smaller or equal to transport and transaction costs.”
There are a number of studies in the grain markets within the last 10-20 years that appear to indicate that the Law of One price DOES hold in the grain markets in the long run, but that there may be short term (from several weeks to a month or so) during which prices may be “out of line” or “not aligned economically” in a manner that would otherwise be dictated by differences in transportation costs, exchange rates, or I would add, time, storage, or possibly even quality.
So, how do these definitions of the Law of One Price relate to the current situation in U.S., Chinese and World grain markets? It seems that with 1) flexibility in the directional flow of grain, 2) the inflexible needs of domestic users of grain in terms of timing of usage and location of processing plants and/or livestock feeders, 3) the risks associated with point #2 and varying risk averse attitudes and approaches of domestic U.S. and foreign users, 4) the short term inflexibility of supplies coupled to the long term seasonal ability to adjust production plans, and other factors, that in the short term, grain markets may tend to be reactive, if not possibly over reactive to such an issue as tariffs on grain imports placed on U.S. soybeans, grain sorghum and other commodities by China.
However, past the initial reactions of the markets – to a degree rationally driven by short term needs of grain users, but to another degree perhaps driven by fear of the unknown in a risk averse environment, if not a herd mentality – there will be volatility in the grain markets. In other words, it could be a challenge to figure out to what degree grain price volatility in the midst of a major trade dispute such as this between China and the U.S. should rationally affect grain prices.
There is a fair amount of confidence that grain markets will eventually readjust to changes in the directional flow of grain in international trade, and that livestock that has to be fed and processing plants that have to run will eventually receive their supplies. But the period of adjustment could “try the mettle” and “test the courage, patience, and managerial ability” of both producers and users of grain, both in the U.S. and in China.
Finally, the reverberations from this event will likely persist and force themselves upon the grain markets over the next 1-2 years at least, as high soybean prices for export in South America may pull more Brazilian and Argentine acres into production for export to China, competing for corn acres in those countries, and affecting the decisions of U.S. corn producers in 2019. And these speculations on future cropping patterns in response to the current U.S. – China trade dispute are only beginning.
Likely this trade dispute will eventually be settled – possibly by fall 2018 as China will need U.S. soybean supplies after South American supplies have run short. If the trade dispute is settled by the U.S. 2018 soybean harvest, then the U.S. will likely ship soybeans to China directly. If it is NOT settled by that time, then China will still need soybeans, but some form of trans shipments or substitution of inventories on an in and out basis via other countries may occur. These and other questions will likely “roil up” the grain markets for months to come.
Grain market summary notes, charts and comments supporting the Weekly Grain Market Review presented in the KSU Agriculture Today radio program to be played on Friday, July 6, 2018 are available on the Kansas State University www.AgManager.info website at the following KSU web address:
The recorded radio program will be aired at 10:03 a.m. central time, Friday, July 6, 2018 on the K-State Radio Network (KSU Agriculture Today Radio) – web player available. A copy of the July 6th recording will be available afterwards at the KSU Agriculture Today website.
Following are sections of the Working notes for this week’s radio program up on the KSU AgManager.info website…