The worst US drought in 50 years has sent commodity prices in grain and livestock to record highs, and in spite of a drop-back in prices, traders say volatility is to be expected for as much as another year. As of September 4, the soya bean price was up 32% and that for corn up 45% since the end of May.
The effects are not only being felt in ethanol production and livestock feed.
According to farmers in the western states, large numbers of horses are dying as pastures are completely dry and ranchers cannot afford to buy hay at present prices. "People dont realize how bad it is because horses are not part of the food chain, but the drought has resulted in a lot of animals just starving to death," says one farmer. "We will end this year in the lowest stocks-to-use ratio in grain for many years."
Blu Putnam, chief economist at CME Group, says: "In the US, food and energy prices are likely to tick up, although the interconnectedness of the world now means that the impact will be felt globally. In China, for example, feed-price increases will be felt in a shortage of pork."
Scott Shellady, a trader on CME, says he thinks that corn prices are still at risk of moving higher. "Its been a lackadaisical few weeks, the August report was fairly unsurprising and traders have been on holiday. Its a contrarian opinion but I think we could be setting up for a move higher. And if we go over the all-time high of $8.40 [per bushel] then it could take off."
Sudakshina Unnikrishnan, a commodities analyst at Barclays, says this drought differs from that of 2007 in that it is more focused around the US. Oil prices are also lower now than during the last drought and inventory levels in China are higher.
Unnikrishnan says the market has priced in the big drop in global supply, but the question is how demand will respond to the price increases. She expects an elevated degree of prices continuing into early 2013 because of tightened supply, but that the focus will be on south Americas harvest in April.
One trader says the south America harvest needs to be a bumper one. "There is no wiggle room on crops now. South America has to be a bumper crop as does the crop in the northern hemisphere next year." He says the lack of leeway makes for extremely volatile markets. "The first weather forecast that seems slightly negative will cause explosive moves in prices. It might therefore be good value to buy options in the 2013 crop and sit on them for six months."