Outlook 2016: Commodity Price Slump to Continue Through 2017

Jim Budzynski

Jim Budzynski, MacroGain Partners

In the Great Recession that began in late 2007, the global economy sputtered on weak performance from advanced economies while China, India and emerging economies generally continued to expand and prosper. Today, the opposite is true. Developed economies are finally gaining some traction while emerging economies are faltering. One major factor is China. China’s volatile stock markets, real-estate bubble, and reduced stockpiling of everything from iron ore for steel production to agriculture commodities has sent ripples through world economies. As emerging economies contract, overproduction, developed countries are unable to soak up the overproduction of just about everything.

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As part of our January 2016 Outlook issue, we talked to economists to get some perspective on how interrelated these macroeconomic factors are for agriculture, crop inputs, and farm incomes going forward.

“People need to realize that the downturn we are getting caught in is a global commodity downturn. Agriculture commodities are just one of the categories. If you take a look at the iron ore guys, they are in free fall,” says Jim Budzynski, Managing Principal with MacroGain Partners.

AgriBusiness Global talked to Budzynski and other economists to get a feel for forward-looking economic indicators for agriculture. Here are some candid and insightful excerpts from the conversation from late November, well before the Dow-DuPont deal was announced, making him look like a bit of an oracle, although the Syngenta-Monsanto genie was already out of the bottle.

AgriBusiness Global: When do you think commodity prices might rebound?

Budzynski: I’m of the view now that we might be looking at four to six years of downside, and now we’re about a year and a half to two years into it.

Interestingly, a lot of the big ag producers are in emerging markets, Brazil in particular. And for many of these countries, it isn’t about managing the market. It’s about generating revenue for GDP, social programs, etc. So even in the face of the downturn and declining demand from China, we have people cranking out volume to try to make up the difference.

The same thing is going on in the oil business. There is a play going on right now where big commodity players are trying to hold the people under the water and take advantage of the crisis by putting competitors out of business.

There will be a lot of ancillary damage from that. I think we are going to go through a period of extremely weak commodity prices. Normally in ag we have relatively stable demand and we have supply disruptions caused usually by weather, or we have a tremendous yield year and we oversupply the market.

Now we are entering into a market, partly because all of the emerging markets are in or on the cusp of recession, where we are having a slump in demand in those countries. When you combine long supply with weakening demand, those are more than cyclical downturns; those are secular downturns.

So it’s going to be another two to four years of really ugly climate driven by declining and weak global demand, commodity overcapacity, etc. Look at how many tons of potash came online (notably in Canada, Russia and India). People were racing to put capacity in place, and the problem with mining is that it has an extremely long tail. You set a course four to five years ahead of time and you keep finishing the project no matter what happens in the market.

We are going to go through this wrenching process where people will be forced to shut down, and it will be the smallest and weakest players. The big guys will continue to crank and be at efficient as possible, and then the market will bottom at the top players’ marginal cost, and at that point we would have efficiency of supply. Then prices will bottom out, and I think we are at least 18 months away from that.

I also think we are in the middle of a big reset on production. it was pedal to the metal for several years, looking at ethanol in the U.S., people were moving very fast to put a lot of ground into production and partly because of all the money being printed around the world by central banks, we had a feeding frenzy around the world on agriculture real estate.

What’s going on right now is a very painful reset because the value that we had 12-18 months ago for ag real estate are out of line with the value of commodities, and that is the biggest cost for farmers. That is going to have to reset.

I read an interesting quote from a senior energy executive a few weeks ago: ‘It’s starting to rain … it’s going to rain for a long time … we’re all going to get wet … and some of us are going to drown.’

AgriBusiness Global: How will lower prices affect crop inputs and input companies?

Budzynski: The first things big crop chemical companies do is announce reductions in force to get their cost structures in line. And then secondly and predictably, we enter into the mating frenzy. The rule of three means that we won’t have six big crop protection companies, and in the next six to 18 months, we are going to go from six to three or four big players in that business, and there will be some smaller businesses disappear as well. So there is going to be a lot of activity.

Crop chemical prices drifted upward along with the general economics of the farmer, and they are sticky and don’t come down immediately. But eventually they will come down and we are entering into a situation where the farmer is financially strained and they are just not going to be able to extract the kinds of premiums that they’ve extracted during the past three to four years over the next three to four years.

Seed is different because it tends to determine the potential of their crop, and farmers are hesitant to mess with that if they think a particular variety can get them a yield potential. However I have talked to farmers increasingly in a tough environment that are considering non-GMO seeds and traditional chemicals, so I think we are going to see some new models tried in this downturn.

AgriBusiness Global: You really think farmers will be making drastically different decisions?

Budzynski: For farmers, in the first six to 12 months that things are bumpy, they take notice but they don’t really react. Now that we are 18 to 24 months into this, then they are starting to think strategically and will change their operations.

The equipment guys can teach us a lot here; they are the first guys to get skewered because spending on equipment is the most discretionary for farm operations. One of the big unknowns is what this does for the whole precision Ag space. Precision Ag has tremendous promise to make farming more efficient. That being said, the sales proposition must be pretty crisp because in the current environment, if you have some really cool bells and whistles that a farmer can’t relate to bottom-line profitability, then it will be a tough sell. It is going to force a lot of our precision Ag technology players to mature pretty quickly and think long and hard about the value proposition to the farmer and communicate that aggressively … If not, they are going to go away. We have probably seen the high-water mark. There are a lot of companies with similar business models, and in a storm, it is going to be hard for all of them to survive.

AgriBusiness Global: Does the average farmer pay that much attention to globalization? Should they?

Budzynski: People that are growing high-value crops, particularly ones that are growing produce for Asia, are keenly tuned into global situations, especially out West, where everyone is talking about the strength of the dollar right now. But some farmers are going to get dragged kicking and screaming into this global game. We’ve built such a massive food machine in the U.S., but it requires global consumers for it to work, and i think we for a long time have built infrastructure and expanded production. I think we are going to have a pause. Yes emerging markets have hungry people, but their currencies are in free fall, economies are in recession, and they are going to be unable for a period of time to purchase food from the U.S. like they once did. So all of us in the U.S. are going to get a lesson in global economics in the next few years.

In my view, this commodity downturn and the Chinese economic downturn are driven by a whole range of things including banking problems, stock bubble, pollution and public policy. In China, no country in the history of the world has grown as fast and added so much capacity and debt in such a short period of time. There is always a hangover. There is always going to be a period of retrenchment. If you think you can go from $2 trillion in debt to $28 trillion in debt without picking up some bad debt in there, then you are nuts. When a bubble gets going, at some point standards drop and some people get loans who shouldn’t, and a lot of barnacles build up on the ship and the reason you have a recession to clean off all the barnacles. We are going to have some barnacles scraped off this boat whether people are ready for them or not. It is painful for the people involved but it is healthy for the economy.

Our biggest frustration (as an investment firm) is that we are in suspended animation. Eventually we will be better served as humans to take our lumps and clean up our balance sheets and get our houses in order, then a new era of growth and prosperity can start. But it’s not going to start with three-times GDP worth of global debt. That isn’t the beginning of a bull market; that is the end of a growth market. The party is about over.

Editor’s note: See the January issue of AgriBusiness Global for 2016 Outlook stories, including more on macroeconomics, crop protection, biopesticides, plant health, planting intentions, and supply trends from China and India.