Commodities Roundup: Corn
July 21, 2008
On May 2nd, our Optionsellers.com client newsletter advised selling put options in corn based on the outlook for investor jitters over a delayed spring planting. (See: Delayed Spring Planting is Opportunity for Corn Bulls, 5/2/08.)
In it, we outlined the solid fundamentals supporting corn prices and speculated that the delay in Spring Plantings would cause speculators to drive up the price of corn. Corn prices did react, rallying almost 33% within a month.
Eventually, however, the crop did get planted albeit a bit late. It appears as though investors are just now realizing this over the last two weeks. Corn prices have plummeted since making new all time highs over $7.50 per bushel in late June. Now the bears are coming out asking “how low can it go?”
Despite what their trading systems are telling them, corn is a market that adheres primarily to old fashioned fundamentals. We had a market with bullish underlying fundamentals that experienced a scare that US farmers would not get the crop planted in time. Speculators came in and drove the price up. Then the crop got planted after all. The scare went way.
The bullish underlying fundamentals did not.
If one looks at a corn chart, the picture becomes fairly obvious. The market is taking the fear premium out of prices and gravitating back down towards the price levels we were before the scare. And once again, we feel these should be good value levels to begin writing puts.
In addition to on time plantings corn has had to deal with other bearish factors over the last few weeks. Favorable growing weather, outside influences such as falling oil prices, and a general outlook for slowing global growth are pressuring corn prices at this time. Corn’s rapid accent in June was spurred on, in part, by unrelenting rains in the US Midwest growing regions. However, now that the rains have subsided, it has left corn fields in almost ideal growing conditions with sunny weather and warm, wet soil.
All of this points to a healthy crop which has led to the recent round of liquidation. A crop endangered is extremely bullish – a crop not endangered is less bullish. The price pullback is justified. Corn prices were ahead of themselves above $7.00 and needed to come back to fair values (See OptionSellers.com’s James Cordier recommendation to sell calls on surging corn prices, LIVE on CNBC from June 9, 2008 – watch at the end of this article).
Meanwhile, the bigger picture fundamentals for corn remain favorable. Plantings and weather are bringing us back down to where we where before the planting scare – Corn near $6.00 per bushel in a year of tightening stocks.
The latest USDA supply demand report for corn from July 11 shows a fairly sizable US crop projection of 11.715 billion bushels (bb), down 20 million bushels from last month. Combined with beginning stocks and a nominal amount of imports, total supply is pegged at 13.328 bb.
Yet, projected demand for ethanol has fallen little and projected feed demand has risen since last month’s report, resulting in total demand of 12.495 bb. This leaves ending stocks at a precarious 833 million bushels for the 08/09 crop year. If realized this would be the second lowest ending stocks in over 25 years.
As we have explained in past articles, ending stocks are the amount of product left over at the end of the crop year after all demand has been met and is a key figure in price discovery. The stocks to usage ratio is the ending stocks vs. total projected demand for the year. Pegged at 6.7%, the 2008/09 stocks to usage ratio would be second lowest in over 25 years. World corn stocks to usage ratio at 13.3% would be the lowest stocks to usage seen since the 1970s.
The bigger picture in corn then, is a market with increasingly tightening stocks. As we stated in past articles, demand for corn as both animal and human food as well as demand from the biofuel sector has and will continue to grow. World populations continue to expand and emerging economies continue to develop in Asia and South America. It is interesting to note that total demand is pegged to outpace total production in the US this year (12.495 bb total demand vs. 11.715 bb total production) meaning a hefty portion of 07 carry over stocks will be used to meet this year’s demand.
Corn prices are falling now as funds liquidate long positions built up on the weather scare in June. But corn’s fundamentals should allow it to find solid support in the $5.75 -$6.00 area as the trade will most likely be unwilling to drive prices much lower than that, given the supply situation. Look for further weakness next week as an opportunity to sell puts beneath the $5.00 strike basis December contract.
Remember, as a seller of puts, one only needs the market price to remain anywhere above his strike to eventually be profitable. Thus, prices do not necessarily need to move higher for a successful trade.
Figure 1: December corn, 7-21-08
See James Cordier’s live interview on CNBC, June 9, 2008, advising investors to sell calls on the corn weather rally. Watch Now: http://www.libertytradinggroup.com/news.html
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
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