For agriculture commodities, droughts mean no water, no crops, and price increases driven by scarcity. That was the scenario in 2012 in the US with drought-ravaged corn production. 2013 was another story. The Wall Street Journal reported that thanks to good weather conditions, “production in the US, the world’s biggest grower and exporter of the grain, surged to a record of 13.989 billion bushels” (the year before, due to droughts, US production was 30% below this level).
What was the result of this “bumper crop” of corn? Chicago Board of Trade corn futures fell by 40% in 2013, making corn the worst performer of the S&P GSCI index of 24 commodities due to lower prices.
In Asia, rain was abundant in the first half of 2013 as well, and rice prices fell. Thailand 5% rice, for instance, ended the first week of January at around $420 per ton, down about $130 per ton from a year ago (during that period, the Thai baht was stable at around 32.75 baht per U.S. dollar).
Two similar stories – an excess of supply in an agricultural commodity in 2013 creates a drop in prices. But in Thailand, the impact of one fundamental rice price driver (weather) was followed by another: political policy. The Wall Street Journal revealed that in June 2013 Thailand’s National Rice Policy Committee decided to boost “the price at which the government buys rice from local producers” by 25% to “help farmers and drive up rural incomes.”
The government thought it would increase not only local but global rice prices by stockpiling grains of rice. Instead, the article highlights, “other exporters such as India and Vietnam stepped in to fill the gap in the market. India knocked Thailand off its perch as the world’s biggest seller of the grain.”
And what was financial market participants’ role in all of this? Their participation in commodity derivatives played a positive role in the first scenario ‒ they enabled corn producers to hedge against price declines that are normally associated with abundant crop production. Unfortunately, though, in Thailand producers can’t access an effective rice derivatives market, and that limited their ability to hedge against the price decline.