Let's first take a look at the last several years of data so you can see the overall trend.  I use the numbers back to when the USDA added China numbers in for the 1999-2000 years.  Because of the massive change in ending stocks on this addition there is little reason to go back to 1994; however, if I did and then adjusted for China, the trends would be the same.

These numbers are World Wide Ending Stocks by crop years.  Please, take your time and look at the numbers carefully:

The trends are un-mistakable.  Only wheat has not had dramatic cuts in inventory world wide and still it's down 21% in 5 years.  If we started in 2002 with 198 Million MT, we are down close to 40% in just 3 years but I will stay consistent.  There is little doubt that world inventories are dropping and in some cases plummeting, so the question begs to be asked.  Is the drop in inventories because of an increase in demand or a decrease in production?  Let's see.

Below are the numbers for production world wide in these same categories.  Before looking at them, understand that the USDA raised these number in almost every category for the July report as it factors in China's acreage and assumes a trend-line yield or better.  That is a big assumption, but we will go with it as it's the numbers we are given to work with and that means the market will follow them.  Here are the new World Wide production numbers from USDA:

In all cases but rice, production this year will be higher than 5 years ago but as can be seen, production has not increased that much and in many years, it has dropped and is not keeping up with demand.  What should really grab your attention is the coarse grain category which is mostly corn.  Steady increases in production can be seen but the demand is far out stripping supply and it is only going to get worse.  We are up 7% over 5 years in production and down 46% in ending inventories.  At this rate, we will flat run out of corn in the next 4 years which can't happen.  That means it will take higher prices to cut off this demand.

So where is the demand coming from and how long will it last?  This was what we wrote about last September when we talked about the new demand factor in the world and her name is China. 

Let's start this by looking at their ending stocks for the past three years.  This is amount of grain in their tanks at the end of the year.

All inventories except soybeans are declining rapidly and in the beans, I'm not concerned with the increase back to 4.4 million metric tons for this coming year.  This is the USDA minimum number.  China is now only producing 50% of the soybeans it consumes on a yearly basis.  It appears China decided to buy grain when they need it and they do not have to store large amounts any longer.  This has caused them to liquidate huge inventories but what it also has done is put the whole world on notice, there is no longer any inventory in the world that can offset major weather problems in large producing countries. 

Rice is where the USDA found some acres for China and increase production by 5.25 MMT.  This is about the total US long grain crop.  They raised the carry-over for them by 4.5 MMT.  This assumes a good crop in China.  What if the USDA is wrong?  There is no room for error that's for sure.

While all of this is well and good, there is another problem.  To get the whole picture, look at the table below, which shows China's production against usage.  This includes the additions in the July 12th report.

Every year a negative.  China may indeed be selling inventory and that is why their carry-over numbers are falling but there is no denying they are using up most of that inventory themselves and when it's gone...it's gone!!!  Think of it this way, China is filling its high demand from surplus they have held for many years.  Their consumption is at record levels and when they have no surplus to draw from, they will be forced into the market.  A market that already is seeing huge declines in supply and world increases in demand that include other countries, not just China.

Lets loom at the current rate a little closer.  Divide the balance decline by the ending stocks and you will see how many years before China is out of inventory in each category.

Notice that once the number drops below 1 then China is in a must import situation as they are in Soybeans.  Also notice rice, the number flipped back up once it got closer to 1.  This is due to heavy emphasis on China producers to plant more rice.  Still the decline in ending inventories will have a multiplier effect on the years left.  For instance, if the USDA is wrong in their July report but right in their June report and China has an ending inventory of 29 MMT, then the Deficit number grows by 5.3 MMT to 15 which drops the years to Zero number to 2.3.  That is a dramatic impact when you change their production by less 6%. 

Now please don't use this analysis as a reason to believe China will ever run completely out of inventory.  The USDA is probably correct that the markets will ration themselves out at a certain price level, but that price level is no where near the current price levels for the 2004 crop year of the commodities mentioned above. 

China's government is seeing the same thing we are and they are putting the incentives out there to buy acres.  Long-term China can produce the heck out of crops but near term, they are in a spiral that cannot be turned so easily.  Also, the Chinese government may have a propensity to say things are better than they are and we all know the USDA wants to believe them. 

The bottom line is that we are two to three years from seeing China buying  grain in unprecedented levels.  Just as now they are taking more and more crude oil to fuel their country, they are going to be in the market for more and more agricultural commodities and very soon. 

I might add right here, they are not in nearly this bad of a situation when it comes to cotton but they are still using more cotton then they produce.  China is expected to import 6 million bales this next year. 

Now for a little 'I told you so'...look at the next paragraph.  This is a direct quote from last Septembers World report and forecast we wrote.

Look for Corn prices to once again move into the $3.50 level.  Look for Rice to head back to $9.00 and Soybeans, well maybe $7.00 until Brazil gets their act together.  In other words, I'll make the prediction now, Ag commodities will go from a buyers market to a sellers market over the next two years.  All these things certainly happened. 

July 2004 Conclusion and Outlook:

So far, there is no sign that we are putting enough grain into production to trim the current decline in inventory.  China is not keeping up with demand and will need the World market place to feed their nation.  The US Dollar is heading lower which will head buyers into the US market in waves like we haven't seen in 40 years.  Will we run out of food?  Not likely unless we have two years of drought starting in 2005; however, we need more production and that will take higher prices to buy the acres. 

Position yourself to profit from the next 24 months and look for the market to head higher starting with the demand cycle the end of this year.  Currently, the market is trading lower in anticipation that the world picture wasn't as bad as it was in June.  The assumption is correct; however, where would we be if the USDA had put these numbers out in May and held to them?  What is occurring right now is the market saying, "that was close" when it should be saying, "we have a reprieve for about 6 months." 

As for the upcoming farm bill debate.  Based on these numbers, the government is trying to out wait the market.  Higher prices and a huge demand increase will have a tendency to solve some WTO and US Farm Bill debate problems.  The next farm bill may be trying to hold prices down, not support farm producers.  Besides, isn't that what the farm bill is really about, a cheap - safe food supply with the emphasis on CHEAP!!!    

What about the current prices?  They sure are in a down trend.  Yes they are but then that is what you would expect from a market that is so focused on supply.  A record crop this year?  More than likely.  A record carry-over?  NOT EVEN CLOSE.  Even with a massive record corn crop in the United States, we will barely raise carryover levels at all, and I will go out on a limb and say that in corn, carry-over will still be below 900 million bushels and prices will again be over $3.00 by the end of the year.  Why?  Remember, lower prices only increase demand.  It's the law of economics.  I don't think the USDA has that factored into the equation just yet.  Look at the average farm price...it was dropped by 25 cents or 10% and how much did they increase exports?  They didn't!!  Look for exports to be higher and the carry-over number to be lower. 

We will check our progress next month.

Dennis DeLaughter, CEO