A Wise Man Does Not Wander Away From Where His Corn Is Roasting
Recent corn price momentum stemmed from the news that farmers had planted fewer acres, of floods in China and Russian drought. This implied tight grain supplies for the rest of the year. Grain markets across the globe are highly interrelated, and world corn supply felt hit by expected wheat shortage in August, when drought-burdened Russia halted all grain exports for the rest of the year. Russia may extend the grain export ban even longer (on crop estimates). Corn prices were further helped along by news of too much rain too early, as well as heat waves in the Midwest US. We believe that structural factors that will drive corn prices higher over short term / medium term are in place.
Corn prices may hover between US$7 -8 / bushel and Soya Bean price may stay in a range of $10.50 to $11.50 (if price sensitivity to year end stocks is in line with our estimates). Near term Corn and soybean prices will depend upon expectations about the November USDA production and consumption forecasts as well as winter wheat planting (January 2011). Any speculation about 2011 acreage is premature. Besides, South American crops & acreage will impact the prices in 2011. A possibility from history and based on our price outlook is that corn acres will increase in 2011. The larger picture suggests continuous high corn prices as corn inventories are at extremely tight levels due to strong demand. The strong demand level is likely to keep a strong floor under corn prices. In addition, there is a risk for a big corn price spike if there are any growing season problems during the upcoming South American corn season or next summer’s US corn season.
Investors should look for a buying opportunity in case there is a correction as short contracts bottom out (double derivative) (short managed money contracts & % of open interest are at historic lows). Any weakness in the price may be temporary.
We are of the opinion that not only US corn yields will be further downgraded, but in coming months South American crop yields will also be downgraded (IFA – September Report).
It is likely that estimates of China corn / wheat imports in 2010 / 11 will be revised upwards. The world is likely to face export deficit (estimated at -25% - FAO) because of the Russian export ban and Pakistan will be an importer of grains (October 14, 2010 announcement to cancel wheat exports). A combination of increase in demand with a decline in supply will tighten corn market more than market expectations.
The last few weekly EIA reports showed that ethanol inventories increased (17.735 million barrels) but that was still below the July high at a relatively tight level. Production is estimated to rise further (estimated at 875,000 barrels per day) (EPA’s E15 decision).
In a foretaste of things to come, on October 8, the USDA (Crop Production Report) lowered its September 30 projection of corn production for 2010 (12.66 billion bushels, 496 million bushels smaller than September 30, 2010 forecast & 446 million bushels less than 2009 forecast), lowering year end stock estimates to 902 million bushels (6.7 percent 2010/11 consumption). Spot corn prices soared 9% on the next trading day and December contracts were trading at US$5.73 /bushel. The December 2010 contract earlier fell to the low of US $4.56 / bushel from a September 27, 2010 high of US$ 5.235 / bushel. Fall had been generally attributed to September 30, 2010 crop yield estimates (162 bushels / acre, new estimates at 155.8 bushels per acre although acreage estimates increased by 258,000 acres) (Soya bean crop estimates were also lowered). The November 2010 soybean futures contract traded to a high of $11.89 on October 11. For soybeans, estimated crush for 2010/ 11 was increased by 15 million bushels and the estimated of exports rose by 35 million bushels. At 1.52 billion bushels, US exports are expected to be 22 million bushels larger than in the previous year. Brazilian 2011 harvest was increased by 73 million bushels, (Overall, South American production estimate stays at 276 million bushels less than 2010). Chinese import is estimated at 2.02 billion bushels, up from 1.855 billion in 2009/10. Year end stocks of U.S. soybeans were estimated at 265 million bushels (-85 million bushels compared to September 30, 2010).
Short & Medium Term Price Drivers Outlook
Feed & Residual Use: The USDA, in another report, increased the forecast of feed and residual use by 150 million bushels, to a total of 5.4 billion (up from September 30, 2010 estimate of feed and residual use of corn during the 2009-10). The USDA may have to revise feed & residual estimates upwards in its November report as demand for feedstock is estimated to be strong. Some indication of feed use will be revealed in the monthly cattle on feed reports and the weekly reports of agriculture statistics.
E15 Waiver & Fuel Use: On October 13, 2010, the Environmental Protection Agency granted Growth Energy’s waiver request which will allow fuel and fuel additive manufacturers to blend 10% -15% ethanol (E15) in gasoline. December CBOT Ethanol futures prices last week traded at a (11-week rally to a total of 36%) a new 2-year high at $1.97 per gallon. Current demand for ethanol is strong and ethanol prices have followed corn prices higher. However, a 39% rally in corn prices increases the risk for ethanol producers if ethanol prices come down as winter demand is lower. A bullish factor for gasoline includes an improvement in economic outlook and some short covering.
US Export of Corn: The USDA (October 8, 2010) forecasted a decrease in corn exports by 100 million bushels, because of price impact supply and increased competition from South America. The forecasted size of the 2011 Argentine harvest was increased by 157 million bushels which is likely to be revised down (FAO August report). There were no changes in the projected corn balance sheet for China. However, China's Ministry of Commerce (MoC) on October 14, 2010 raised its estimate of China's corn imports by 500, 000 tonnes and soybean imports in October to 4.15 million metric tonnes, up 830,000 tonnes from an earlier prediction of 3.32 million tonnes. The expected imports were higher than 2.5 million tonnes of imports in October 2009. 2011 estimates are also likely to be revised further upwards.
Corn stock to use ratio & yields: Global corn yield in 2011 may be one of the lowest in history because of the lower use of agricultural chemicals and inclement weather. Corn stock to use ratio (6.7%) is one of the lowest in history. Corn inventory to use ratio moves in a two yearly cycle as high prices one year helps to increase corn acreage and use of yield enhancing farm implements, which results in an increase in crop production in the subsequent year – thus reducing stock to use ratio. However, there are some secular factors which may keep pulling the corn stocks lower and increase the use, thus pulling down the ratio – which means that there should be a consistent secular decline in this ratio’s biennial cycle and hence an increase in corn prices. The key question for 2010 / 11 to consider is whether a 5 percent stock to use ratio, as experienced in 1995-96, can act as a minimum carryover level.
Speculative Positions & Total Contracts: Current long contracts are just short of the spike observed in June 2008 and the CFTC reported that managed money short contracts are very low. However, short contracts seem to be in the bottoming process as double derivatives of decline of short contracts has neared zero and the short contracts are likely to bottom out. The only spoiler in this picture could be total open interest, which still keeps increasing and corn may follow the total open interest rather than long contracts and inverse to short contracts.
Population Growth: According to United Nations estimates, by 2050, the world population will grow to 9.5 billion people. India is expected to represent 20% of the growth and China about 4%. It is estimated that the rise in population will lead to the consumption of an additional 1 billion tons of soft grain, directly as food or as animal feed. It is estimated that just one third of total in soft grains consumption between now and 2050 will be driven by demographics.
Income Growth: As per capita incomes in the developing world, calorific intake will increase too. According to data from FAO, calorific intake in China is 1/4th of the US, 1/3rd of EU and 1/3rd of Japan and Korea. Per capita meat consumption in China & India has been rising since 1980. A large part of this increase in calorie intake is driven by an increase in meat consumption with a rise in GDP / capita, the likes of which happened in Japan and Korea (12 Kg per capita against 4kg per capita in China). This will increasingly result in stresses on grain inventories and China's net agricultural import trade deficit may widen further, which will stress global grains supplies.
Knock on effect
Other grains & agricultural commodities like cotton & sugar (Price increase)
Effect on corn feedstock industries (margin squeeze)
Meat prices are already higher 15% year on year (highest level since the 1980s) and can go even higher (hog futures price increase)
Price of farm machinery, fertilizers and seeds (prices increase)
Corn futures follow a saw tooth pattern as December's corn is cheap as crops are harvested at that point and contracts tend to spike in mid summer. Current flat-to-backwardation in the corn market means the market is tight, and most of the bets are on long. It was recently observed that Corn's "normal contango" is unlikely to develop again as supplies may tighten further in 2011. Storage costs for 2011 are likely to remain in 25 to 35 cents per bushel and volatility will drop. This will be beneficial for ETFs investing in near term contracts for which roll yield will become positive, which may act as a kicker on the top of spot yield.
Focused ETFs: ETFS Corn ETF (CORN-LSE), ETFs Leveraged Corn ETF (LCOR-LSE), ETFs Leveraged Soybean Oil ETF (LSYO-LSE), ETFS Leveraged Soybeans ETF (LSOB-LSE), ETFs Leveraged Wheat ETF (LWEA-LSE) , ETFs Soybean Oil ETF (SOYO-LSE), ETFS Soybeans ETF (SOYB-LSE), ETFs Wheat ETF (WEAT-LSE)
Diversified Agriculture: Dow Jones-AIG Grains Total Return ETN (JJG) ETFS Grains ETF (AIGG-LSE), ETFS Grains Sterling ETF (AGGP-LSE), ETFS Leveraged Grains ETF (LGRA-LSE), iPath Down Jones – UBS Grains Subindex ETN (JJA): 38% Soyabeans, Corn (37%) and wheat (25%) – MER 0.75%, The Powershares DB Agriculture ETF (DBA) eleven commodities (including livestock) (Soyabean, corn & wheat -34%) – MER0.85%
Late Cycle: Market Vectors Agribusiness ETF (MOO) – 47 companies in agri business including Deere (NYSE:DE) as number one holding. Others include POT, US Equity, MON, US Equity, CF, US Equity, URKA LI Equity & MOS US Equity, SAFCO AB Equity
Drivers to watch
- EIA Weekly Petroleum Status Report (ethanol prices, inventories & crush
- EIA Monthly Ethanol Report
- USDA WASDE Crop Supply-Demand (November)