A recent report from the Agricultural Economics Department at Purdue University suggests that the same factors that drove commodity prices to record levels are helping to drive a reduction in commodity prices this year.

The three major drivers of prices that were identified by Purdue economists were trends in global production and commodity consumption, the declining U.S. dollar and the evolving link between energy and agricultural markets (biofuels).

Macro Forces

Since the peak in 2008, grain and seed prices have fallen dramatically, however they remain elevated from long term averages. Drops in market prices have also fallen quicker than farm input prices, which will likely lead to tight margins for farmers this coming year, not a surprise. Macroeconomic influence, now more than ever, has become a determinant of commodity and agricultural prices. Going forward prices will likely largely be influenced by foreign exchange rates and underlying oil prices. The recent report suggests that these broader macro forces have more influence on commodity prices than typical supply and demand relationships.

The U.S. Dollar

Commodity prices have tracked similar paths with the U.S. dollar and oil prices since early last year, again not a surprise, as a weak dollar in mid 2008 lead to inflated prices largely driven by stronger exporting activities. Since then the dollar has gained some strength against emerging countries, leading to more import activity and a reduction in prices of agricultural products. The continuance of this trend is a big question. We don’t believe the dollar will remain at this stronger level for any extended period of time.

Energy and Agriculture

Agriculture and energy markets have become inextricably intertwined since 2005, as biofuel production and demand surged. Use of corn stocks for these alternative fuels became so prevalent that a biofuel premium had been built into global pricing. Since oil hit its peak in mid 2008 ethanol prices, production and corn prices have retracted, largely due to the decrease in gas prices. Some 2 billion gallons of capacity in the ethanol industry has been idled, however there is still a biofuel premium in corn and biofuel production continues. Energy and agricultural commodities will likely continue to be directly linked going forward as new fuel mandates are implemented into American energy consumption.

All of these pressures and reversals of trends suggest a potentially tough year for farm incomes, which is tough to deny. Times are tough everywhere. However, as the global recession rolls on through this year, visibility in the agricultural markets should be improved going into 2010.

The full report from the Purdue University Economists can be read at: http://www.farmfoundation.org

-GDH