I have written about the weather potentially affecting the yield of this year's corn crop and how to trade it via futures or the new CORN ETF. On Thursday morning, the USDA will release its "World Agriculture Supply and Demand Estimate", which will offer a projection of this year's crop yield.
The USDA has five categories in its Crop Progress Report for rating the condition of the nation's corn crop: very poor, poor, fair, good, and excellent. The greater the percentage of the corn crop that is in the good and excellent category, the higher the estimated yield.
I created a custom crop condition index by adding together the percentage of corn rated good to excellent. The USDA releases figures for 18 states but I took the top 10 corn producing states, which together produce 85% of the US corn crop. Here is a comparison of last year to this for the top 10 states' percentage of the crop falling into the good to excellent category:
|State||% of condition index weights |
Source: USDA Crop Progress Report, own calculations.
I then used a spreadsheet to calculate all the values into a single index by taking the weight of the state and multiplying by the percentage of the crop condition in the good/excellent category. Illinois would be:
- weight .20 x crop condition 50 = 10
The the figures for all 10 states would then be added together.
Here is the data for week 31 of the growing season or the week of August 8, 2011:
Though 2005 had the worst value, the weather improved so much during the rest of the year that the final yield estimate improved to 147.9 Bu/Acre, from an initial estimate in August 2005 of 139.2 Bu/Acre. Clearly, by no means is a bull market guaranteed. However, with world corn supplies at their lowest since the 1970s, as mentioned in the previous article, a sharp move up is very probable for the US crop or anywhere else in the world.
Currently the USDA has a yield estimate of 158.7 Bu/Acre. I took the week 31 state condition index and regressed it against the August WASDE yield estimate released each year from 2005-2010. The computer spit out the following statistically significant results with an 85% adjusted R^2 ! "Ex" stands for the good and excellent crop condition state index. Click to enlarge:
It is then simple to get a point estimate of the upcoming release:
(Ex 2011) * (coefficient) = 1st calculation
62.42 * .908226 = 56.69
1st calculation + constant = yield point estimate
59.69 + 97.218= 153.909
So, there we have a point estimate of 153.9 Bu/Acre. Now of course this is not a guarantee of a yield estimate coming out at this figure. As with all statistics there is a margin of error. However, this does show a higher likelyhood of available supply being lower in the upcoming report. I do not have any opinion on the demand side.
Conservative investors should just stay out of the report and weather markets. More risk-tolerant traders and investors can wait for the report to be released and see how much the market moves in response. High risk traders can get long vertical call spreads. Or for those more agnostic about direction: buy straddles and strangle; but watch out since implied volatility usually drops some after a report, unless there is a limit move. Speculators who don't believe the report will move the market can sell implied volatility if they understand the high risks and potential losses.
The CFTC's commitment of traders report still showed small speculators net short almost 97,000 contracts as of last week. Yet in spite of this, the corn market held up fairly well in relation to the carnage in the stock market. Click to enlarge:
I preferred to use futures but for those without a futures account, or constraints, they can trade the CORN ETF.
Disclosure: I have positions in corn futures options and may initiate a long position in CORN over the next 72 hours.