Response To Big Move In 'Corn Bubble'

Includes: CORN
by: Chris Ridder, CFA

Today I read a 3 part article on an expected move down in corn prices, with the author prognosticating that corn was in a "bubble". I wrote back on July 13, 2011, in an article (followed up on August 3 & August 10 ), that the Teucrium Corn ETF (NYSEARCA:CORN) was a long candidate and could potentially provide alpha, the price then was $44.61, and now currently sits around $49.50..

The most recent USDA World Agricultural Supply & Demand Estimate (WASDE) was released on August 11th, and the next release comes on September 12th. Let's begin by comparing the USDA data to some of the data reported in the article.

On August 20, 2011 Merco Press reported:

The Argentine 2011-2012 corn harvest could hit a record 30 million tons.

"Corn output will reach a historic 30 million tons," said Pablo Adreani, head of Agripac consultancy in Buenos Aires, adding the area earmarked for corn could rise to 4.65 million hectares from 4 million hectares last season.

The latest USDA data does show projected production for Argentina rising, but at 26 million tons, for the 2011/12 crop season. This is up from 22 mm tons for the 2010/11 crop season and 23.3 mm tons for the 2009/10 crop season (on pages 22 & 23). Brazil was also projected to increase production by 2 mm tons. Despite this, ending stocks world wide were still projected to have fallen by just over 1 mm tons, from 115.66 mm to 114.53 mm tons. World corn ending stocks for the 2010/11 crop year was estimated at 122.93 mm tons and 143.9 mm tons in 2009/10.

The CME Group had this commentary about corn on Friday, August 12th:

The USDA pegged corn production at 12.914 billion bushels, 168 million below trade expectations and down 556 million from last month. … This results in a stocks to usage ratio of 5.4%, which is the second lowest on record (since at least 1960). … World ending stocks were adjusted lower to 114.53 million tonnes from 115.66 million tonnes last month, which was already a 5-year low. World stocks/usage is just 13.2% which is the lowest since 1973.

One would hope that the USDA report released on August 11, 2011 would contain fair estimates of planting intentions. One can plant, but weather risk still remains and could effect yield, such as happened with this year's U.S. crop, and hence the production of supply.

One can look at this year's U.S. sorghum crop, a competitor/substitute to corn, and see it has been affected by the weather. Look at this week's crop progress report (pdf), page 8 showed 44% of this year's sorghum crop in the very poor to poor condition.

The condition of corn was rated 52% in the good/excellent condition verses 69% last year (page 4). The crop condition of corn three days before the August WASDE report was 60% good/excellent. This is why most traders are expecting another lowering of the yield estimate in next WASDE report.

The end of ethanol subsides is discussed, in part 2, but will this lower the demand for corn or just cut into the margins of ethanol producers? Just how high are the fixed costs of ethanol producers? If they are high then a business would still keep producing its product even at a lower marginal return.

There is also the talk of land prices in part 2. There is certainly new entities buying farmland, but I wonder how much is tax driven by people who sold real estate in 2008. You have three years to buy another property to avoid paying capital gains taxes. One must not confuse the price of two separate but complementary goods, and the supply/demand factors that effect them.

In part 3, there are some price charts of corn. I have some of my own:

[Click to enlarge]

This shows the nominal high of the December 1974 Corn contract as being $4, this would make $7.50 seem very "high" in nominal comparison. This is until inflation is adjusted $4 and it becomes $7.84.

Here are some charts that show China moving from a corn exporter to an importer from the USDA:

The CME morning commentary on September 6, 2011, said the following about feed demand in China,

China food industry officials believe the country will consume nearly 17 million tonnes of feedwheat this year, compared with 12.5 million tonnes last year. Feed demand in China is strong, with record high profit margins for hog producers and an expanding middle class.

Clearly, the data shows very tight world supplies for corn and other grains. The weather this year has not helped to increase supplies. Expect a premium in corn to exist until the data shows world grain stocks being rebuilt. Lower yields are expected in next Monday's report so we will have to see how much has been priced in, but any drop in corn should be looked at as an opportunity to establish a long position. I will try and update my yield model (August 10) with this week's data and see if the expectations are above, below or inline. I might adjust my position accordingly.

Weather markets make for bumpy rides, if the author's article made you nervous, then sell half of your corn position and lock in that alpha; try and limit emotions that influence your trading decisions. However, have a plan in place to reenter the corn market, on the long side, once the report is released.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CORN over the next 72 hours. I am long December Corn futures options and DBA Options