How Volatile Currencies Affect Grain Prices

Every day in currency markets around the world traders measure the value of different currencies against each other. The action is heated as different economic factors come together to make one currency’s value rise and the other fall. In Canada, these currency fluctuations manifest themselves in the agricultural cash prices received by farmers. The challenge is understanding exactly how these currency fluctuations affect your local price.

Of course one of the most watched currency in Western Canada is the Canadian dollar. The value of the Canadian dollar as determined in U.S. dollars is one of the foreign currency benchmarks most of us are aware of, so it’s understandable that we fixate on market events occurring to the south. Market watching is almost ubiquitous in our agricultural culture. “What did the loonie do today?” is often the question asked in conversation as farmers discuss wheat, barley, canola, corn and soybean prices.

EXCHANGE RATES AND PRODUCTION

Foreign exchange influence on cash prices, however, is much greater than the relationship between the Canadian and U.S. dollar. For instance, it can be argued that foreign exchange relationships between specific currencies have a huge effect on world production patterns and commodity prices. Take for instance the effect of foreign exchange on world soybean production. In Brazil a two-to-one relationship between the Brazilian feal and the U.S. dollar is seen as very positive for Brazilian soybean production. Anything less than this is seen as negative, essentially depressing Brazilian cash prices and, ultimately, production levels.

The implications for western Canadian canola country are obvious. Soybeans are a very minor crop in Western Canada, but are a direct competitor to canola. Soybeans have a higher meal content than canola, and, in years when the world’s oilseed crushers are trying to meet meal demand, they prefer soybeans. When it is the opposite situation, canola is preferred. Crush margins are everything. With Brazil being the world’s No. 1 soybean producer, a higher than two-to-one relationship with the U.S. dollar versus the real means the possibility of more Brazilian soybeans on world markets. This has the effect of lowering soybean prices, and increasing their competition with canola. At the present time, (October 2010) one U.S. dollar is equivalent to 1.687 Brazilian reals, a negative for Brazilian soybean production and indirectly a positive for Canadian canola country.

Think of it this way. The U.S. dollar is the world’s default currency. There have been public musings by foreign leaders to change that, but the U.S. currency has always represented stability backed by the world’s biggest economy and the world’s biggest military establishment. It remains the currency that the world’s commodities such as gold, silver, oil and grain are priced on. How the U.S. dollar moves in relationship to currencies around the world not only affects cash prices for those commodities in various countries, but it also affects production patterns. One big difference that applies to Canadian canola is the futures contracts traded at the Winnipeg Commodity Exchange. These contracts are traded in Canadian dollars and reflect the value at various interior-pricing points. This lessens the impact of the U.S. dollar value specific to canola.

DETERMINING EXCHANGE RATES

There are many economic factors which affect a currency’s value. For instance, simple sup- ply and demand for the currency determines value. Factors, which sway that value, can be many things like interest rates, the regulated money supplies from agencies (Bank of Canada and the U.S. Federal Reserve), fiscal policy and general economic stability.

Not all of the world’s currencies are convertible. In other words, not all currencies can be easily bought and sold, such as those in Third World countries. However, for large agricultural nations, for the most part this is not the case. All countries reserve the right to manage their currencies the way they choose; China is one example of a highly regulated currency maintained at a value derived on their own China Foreign Exchange Trading System.

HOW RATES AFFECT WHEAT PRICES

That is the big picture — currencies trading in a fluid environment affected by all kinds of factors. For western Canadian farmers, the key to any marketing decision is to understand by intuition how these major currencies interact with commodity prices. To understand that it’s important to start with the world’s default currency, the U.S. dollar. As the value of the U.S. dollar goes up, it becomes more expensive in non-U. S. currencies and therefore there will be a negative effect on demand, sending futures prices in that commodity down. It is also true for the inverse, when the U.S. dollar goes down there’s a positive effect for the demand of that commodity in non-U. S. currencies, generally sending futures prices for that commodity up.

ForGrainewsreaders in Ontario, this “US dollar rule of thumb” when applied to wheat is something to watch closely. In the East, they sell wheat to whomever they want. However, the CWB does that job in Western Canada. These foreign exchange gyrations are a bit of a double-edged sword for the CWB. When the U.S. dollar goes up, generally futures prices go down, but at the same time the Canadian dollar has an inverse relationship with the U.S. dollar sending it down. As the value of the Canadian dollar goes down in concert with the rising U.S. dollar, our cash basis levels expand giving the CWB higher cash value opportunities. These cash movements can be substantial, all based on foreign exchange. The CWB works with this every day. In fact, these sharp movements in currency values have been a source of controversy between CWB supporters and critics through the years.

The foreign exchange impact on grain prices shows up in marketing opportunities that appear in different basis opportunities at country elevators, brokers or crushers across the West. For instance, sometimes “basis opportunities” caused specifically by foreign exchange changes appear simply based on the unexpected movement of grain, whether that be rail cars or truck movement. With 55 to 60 per cent of Canadian canola exported, elevators with an export adaptation would be quite attuned to this.

Much Canadian canola is exported to Japan and China, f.o.b. Vancouver. At the time as I write this, the bid in Vancouver is approximately $530 per tonne. Buyers in these countries use the U.S. dollar in purchase agreements for canola. That means the value of the Japanese yen and the Chinese yuan against the U.S. dollar are the important factors in pricing this canola. With the Bank of Japan recently attempting to weaken the Yen, it means less capacity to buy Canadian canola. On the other hand, if the Chinese ever decide to let the Chinese yuan appreciate, more Canadian canola will reach their shores.

It would be prudent to have a “rule of thumb” for foreign exchange fluctuations and western Canadian cash grain prices. At the present time in commodity markets corn is surging and at the same time pulling soybeans, canola and almost everything else up with it. Wheat did the same thing earlier in 2010. Sure there are short supply situations, especially in corn and wheat. However, throwing gas onto the bullish fire is the low U.S. dollar. With the U.S. Federal Reserve following a zero interest rate policy, it’s like a trap door under the U.S. dollar. Its weakness is like testosterone to grain markets.

At the present time, some countries are deliberately manipulating their currency to give them the best advantage for their exports. China is the obvious example but Japan is doing this, too. Of course some argue that with the zero interest rate policy of the Federal Reserve in the United States it amounts to the same thing. Simply put, foreign exchange values and currency fluctuations are becoming the new economic levers in an economic war among friends. How our agricultural commodity prices adjust to that new reality may be the question of 2011.

PhilipShawfarmsnearDresden,Ont.His agriculturaleconomic,farmmachineryand commoditycommentaryispublishedacross theUnitedStatesandCanada.Learnmoreat www.philipshaw.ca

About the author

Comments

explore

Stories from our other publications