Most of us learned back when we were only 7 or 8 years old that no matter how badly we thought that some other kid in the school playground deserved to be punched in the nose, that if we actually went ahead and hit him, he would most certainly hit back. Over the past few weeks, we’ve seen the same sort of squabble over international trade. No matter how confident the U.S. administration is that China deserves to be sanctioned over trade practices, it’s equally certain that Bejing will turn around and hit them back.
When the United States first imposed steel and aluminum tariffs (along with an enthusiastic amount of trade rhetoric), it was only a matter of time until China responded. On March 23, China did just that, imposing $3 billion in retaliatory tariffs. One of the key items in the Chinese sanctions is a significant tariff on U.S. pork, but the package also includes duties on steel and aluminum from the U.S. The trade action in pork also has implications for the corn market since corn is the biggest ingredient in the manufacturing of hogs. With China being the largest importer of soybeans in the world, and the United States being one of the world’s largest exporters of soybeans, market watchers have a significant degree of anxiety that the oilseed could be the subject of future trade sanctions if the stakes get raised moving forward.
If you look at a map of the United States electoral college from the 2016 election, the Republican party won the majority of the states in the U.S. heartland, and the Democrats carried the east and west coasts. Personally I don’t think that it’s accidental that the Chinese governments chose to focus their retaliatory tariffs on agricultural products that are primarily produced in the core region of the current administration’s voter base. Obviously, I have no insider knowledge of how the Chinese administration chose which product classes to impose sanctions on, but looking at a map, it appears to be deliberate.
There’s a rational argument to be made that Chinese consumers aren’t about to become vegetarians. China will source pork from other regions in the world and as those shippers move more of their pork inventory into China, the American exporters will slide in behind to backfill the needs of those markets. There will be no shortage of confusion in the marketplace, but no one is going to lose its access to bacon. The big problem that these trade disputes cause for agricultural commodity markets is that the lack of certainty causes the investment funds to avoid getting tangled in uncertain futures contracts.
The majority of the equity in the agricultural commodity futures market comes from investment funds. The volume of money that the spec funds bring to the futures market is important because it provides both buoyance and liquidity to the exchange. The critical difference for farmers is that the fund managers have extremely little loyalty to any particular commodity group. Spec funds are simply tasked with providing a targeted rate of return on the money which they are managing and could just as easily be investing in orange juice or pork bellies.
This is where the issue with U.S. trade sanctions comes home for Canadian agriculture. Investment funds don’t need the anxiety of being entangled in commodities that are subject to a trade war. As long as China and the United States are implementing sanctions on these products, there’s no need to have funds invested in lean hogs, pork bellies, corn (since it’s a key ingredient in producing pork) and soybeans where it’s widely held that an escalation in trade actions will have an impact. The commodity funds manage money and that money is much safer deployed in commodity futures like coffee, cocoa, and sugar, where trade actions against the U.S. have very little capacity to impact the market. Due to this ongoing trade confrontation between the United States and China, the spec funds are clearly reticent to become too deeply invested in the two most important crops for Ontario grain producers, corn and soybeans.
We’re now in the stage where both participants are trying to figure out how to bring the confrontation to an end without looking like they lost. Although the spec funds have allowed grain prices to fall when they stepped back from the confrontation, they’re an observant group of business people and when they have a clear sense that the tensions are wrapping up, the funds will be the first ones back buying up the lows and fueling the future’s market recovery.
The strategy for Ontario grain producers is to avoid participating in the chaos. Back in grade school, we all learned to stand back when a scrap broke out. This world trade situation isn’t much different.
Steve Kell operates a crop farm in Simcoe County and is a grain merchant for Parrish and Heimbecker Ltd. in Toronto.