James Cordier & Michael Gross, Optionetics.com
May 5, 2008

High demand, reduced supply. It should mean higher prices, right? For corn bulls, the story goes something like that.  But the full story has a few more wrinkles.

Earlier this spring, it did look like it would be that simple.  While corn, wheat and soybeans were all enjoying bull markets, soybeans had outperformed the complex and were reaching new highs right about the time US farmers were figuring out how much corn, wheat and soybeans to plant in US growing regions. As many of the available acreage can be planted with either crop, farmers will tend to plant more of what is bringing the highest price. It made sense then that farmers would opt to plant more soybeans.  April’s Prospective planting report confirmed this view.

The report showed US soybean plantings up over 18% from 2007, while corn plantings would fall by over 8% from 2007. As a result of the report, corn prices surged while soybean prices collapsed.  We advised selling put options on the break in beans as put premium had become overinflated on the break. (See Soybeans Back to Value Levels – 4/7/08 on the Market Commentary page of the website). The premise was that farmers still had time to change what they actually planted and would shift more acreage back to corn as a result of higher corn prices.  This indeed seemed to be the case as private analysts had as much as 4 million acres of soybeans being shifted back to corn.  Corn and bean prices began to adjust to another shift in acreage as corn prices slowed and soybean prices rallied.

And then it rained.

And it kept raining. While rain is beneficial to the freshly planted grain, it makes it difficult to for farmers to get into the fields and plant. As a result, corn planting has fallen substantially behind schedule.  As of the April 27^th planting progress report, US farmers have 10% of the corn crop planted at a time of year when about 29% is usually already in the ground (based on the 10-year average ).

Corn is planted earlier in the year than soybeans. Farmers generally like to have the corn crop in the ground by May 15^th as corn planted after mid-May tends to produce lower yields. After mid-May, it becomes more beneficial to plant soybeans instead.

Technology makes it possible to plant corn very quickly and farmers could still get the majority of the crop planted by mid May.  And they have a substantial incentive to do so.  According to Purdue University, returns for planting corn are now about $135 per acre more than soybeans on average quality land and about $200 per acre more on high quality land. 
In the meantime, even if US corn producers are able to plant the USDA estimate of 86 million acres, world corn demand will keep the supply/demand ratio historically tight.

In the US, domestic usage is at an all time high as American monthly ethanol production reached 518,000 barrels per day in February of 2008 and continues to climb. This is a 23% increase over year ago levels.  US domestic corn usage is expected to reach an all time high in 2008 at 10.87 billion bushels.  Exports are pegged at 2.15 billion bushels but this number could grow as China has already suspended corn exports in order to meet higher than expected domestic demand.

If we assume the USDA’s acreage figure of 86 million acres and assume an average yield of 154.9 bushels per acre (3.8 bushel yield higher than last year), total US production should reach 12.203 billion bushels. If we adjust 08 beginning stocks to account for increased demand in the first quarter, US ending stocks should come in near 596 million bushels – according to the usage numbers provided above by the USDA.

As we at Liberty Trading have stated in past articles, ending stocks tell the whole story of a grain market. It is the left over supply at the end of a crop year after all demand has been met.  596 million bushels would be the second lowest US ending stocks on record.  This would put the corn market in a precarious situation in 2009 with global demand continuing to surge.

With the new avenue of demand (fuel usage) causing food shortages in different parts of the world, corn demand will continue to grow in the coming years and its economics will continue to reflect a commodity of increasing scarcity.

While corn supply is never certain until it is “in the barn” demand is not going away. Corn prices will be extremely sensitive to the slightest weather disruption or planting challenges.

We at Liberty Trading will be looking for pullbacks in corn (possibly caused by strength in the US dollar) as opportunities for selling put premium far beneath the corn market in our managed portfolios. A steady to higher trade in corn will make these puts profitable. As a put seller, one does not necessarily need the price of the underlying commodity to rally. It only needs to remain above the put option’s strike price.  Whether adverse weather takes the market higher or new strength in the US dollar pressures prices, soaring global demand should keep a solid floor under prices. Put sellers should do well in such an environment.

Figure 1: July 08 Cron (CBOT)

Note: The opinions presented here are that of Liberty Trading and not necessarily shared by Optionetics and/or its instructors.

James Cordier & Michael Gross
Contributing Writers, Liberty Trading Group
Optionetics.com ~ Your Options Education Site
Questions for James and Michael? Visit the Optionetics.com Discussion Board