HardAssetsInvestor

Written by Julian Murdoch  |

March 05, 2009

The Obama Budget: How Will It Impact Commodities?

Details

The Obama budget is on the street, and depending on your perspective, it's either great, or terrible, for commodities.

• Agriculture effects
• Oil's pain
• Green investment

 

Last week President Obama released his proposed budget for FY 2010 and beyond. Since then, there has been much scrambling to figure out what it all means for investors.

The president's stated objective is to get the economy on the road to recovery by emphasizing green technology, health care, education and infrastructure. To do that, President Obama has proposed many changes to the status quo. While there's no convenient chapter heading in the tens of thousands of words in the budget called "Commodities," there will be huge impact on the commodity space, at least in the long term.

In a market often driven more by perception than reality, understanding what everyone else thinks about tomorrow is often at least as important as understanding what's actually happening now.

Here is your primer.

Round 1: Agriculture

Farm subsidies get headlines. In Iowa, they play well. In urban America, they're anathema. And the budget tackles them straight on, with a number of proposals that will directly affect agricultural commodities:

• A phaseout of direct payments to farmers with sales revenues over $500,000 a year. The phaseout would happen slowly over the next three years.
• A $250,000 commodity program payment limit (a cap on any kind of direct payments, no matter how big you are).
• A reduction of crop insurance subsidies.
• The elimination of cotton storage credits.
• A decrease in funding of 20% for the Market Access Programs (MAP) - the overseas agriculture marketing programs.

 

As you might expect, the various agricultural lobbying groups are up in arms about all of these, because these proposals ... while complicated ... all mean the same thing: less money for farmers (especially BIG farmers).

On the subject of direct payments, the National Association of Wheat Growers points out that while only 5% of the farms counted by the USDA have sales over $500,000, they are responsible for 74% of all agricultural sales. They also argue that the direct payments help farmers qualify for the financing they need for operations – equipment, seed and fertilizer. Reuters put it this way:

 

"Farmers say the direct payments help them maintain credit with local banks as a form of dependable cash flow, and help farmers who lose crops to drought or disease. They are considered trade friendly, non-distorting to price or production, and so small in sum in comparison to other budget items that farmers and their advocates say there is little upside to eliminating them."

 

For the ag investor, of course, the real question is how this actually hits supply and demand, and thus prices, should all of this get finalized in the 2010 budget.

If direct payments are truly "non-distorting to price or production," then the elimination of the payments should have no impact on commodity prices. Of course, if the programs actually have zero impact on price or production, it bears the question: What they heck good are they doing anyway?

Regardless, if in the long run farmers are unable to get credit for the purchases they need, then inevitably some level of production will suffer, either through smaller harvests of starved crops or due to lower crop plantings. Of course, if that happens, commodity prices will rise and farmers will once again have incentive to plant larger crops.

It comes down to just how pointless you think the subsidies were in the first place. Totally pointless? No impact. Actually relevant? This makes prices go up, long term.

Net-net: Possibly bad for farmers and consumers; good for commodity investors.

Cotton - A Special Case?

As a nonperishable commodity, cotton is a little different from other ags. Like oil, it can be stashed away for a rainy day. Right now, farmers have the ability to store it in a government-approved facility and borrow money against it. Until now, the government has been footing the bill for this storage by giving farmers "cotton storage credits." The budget proposes to eliminate these credits. If approved, it will suddenly be less profitable to stash a year's cotton crop. The implication is that more cotton could come to the market seasonally (with theoretically less supply off-harvest). This means volatility.

Right now, cotton doesn't trade with any real seasonality. Of course, if cotton prices are already low, farmers may bite the bullet and continue to store their product, borrowing money until it makes financial sense to sell the crop. While the cotton industry may not support this move, it may serve to make the cotton market more transparent, and ultimately, transparency is always good for investors.