Corn: Have record prices finally rationed demand?

Recessionary fears abound, and the bull markets in many commodities are unraveling. Corn has been an exception, even among U.S. agricultural products, by exceeding the 2008 highs.

It’s not a mystery. No other commodity has had to deal with sharing a new and growing source of demand: Ethanol. U.S. farmers responded to high prices by planting 92.3 million acres of corn, 4.1 million acres more than in 2010-11, but poor weather compromised their efforts.

The much anticipated September USDA crop report is now behind us, and the supply-side estimates showed mixed results. The USDA slashed the yield estimate from the August estimate by a staggering 4.7 bushels per acre (bpa), to 148.1 2 bpa. A downward revision was in the market, but the estimate was below the average analysts’ guesstimate of 149.086 bpa. The crop estimate fell to 12.497 billion bushels, a scant 50 million bushels larger than the 2010-11 crop, which was planted on much smaller acreage.

On the other hand, the USDA maintained the August estimate for the harvested-to-planted ratio at 91.4%. Analysts were expecting to see the ratio lowered as well and were surprised that it was not. There is talk that once all the data are in, it will be reflected in the October estimate and that the cut could be as large as one million acres. That would bring the ratio down to 90.4%. Aside from the two disastrous crops in 2002-03 and 1993-94, that would be near the low end of the range of the past 20 years. Were that to happen, the crop would be 12.351 billion bushels – actually smaller than last year’s crop!

The demand side of the report, however, mitigated the bullish implications of the shrinking crop. The USDA cut its forecast for all major demand categories from the August estimate. Domestic feed was lowered by 200 million bushels, and ethanol usage and exports were revised downwards by 100 million bushels each. The 400-million-bushel drop in demand was equal roughly to the decrease in the crop estimate. The estimate for ending stocks fell from 5.4% of consumption in August, to 5.2%, the lowest level since 1995-96.

The report was deemed bearish by analysts in the pre-market of the trading session following the report and opened lower. However, reports that dropping temperatures had put crops in some areas at risk of frost rallied the market. December corn closed up 9¢ per bushel.

Despite the overwhelmingly disappointing crop, we have tempered our bullishness.

First, although the bpa yield was lower than expected, it was widely expected to be much worse than the August estimate, and in fact, it was in the middle of the range of expectations. Some guesstimates were as low as 143 bpa. So it was not really news at all and probably was already built into the market. The real surprise in the report was not the supply side, but rather the bearish demand side.

The USDA is forecasting a 10% drop in U.S. exports for 2011-12, but commitments to date are 13.5% behind last year’s pace. It’s very early in the marketing year, but the rationing process may be working, and it’s entirely possible that we won’t see sales pick up at these prices.

Then, the U.S. is still by far the world’s largest corn producer and will be for years to come. But its position of supplier of last resort will not be quite as prominent as it has always been. South American corn-producing nations are expanding their corn acreage. The USDA raised its estimates for Brazilian and Argentinean crops to be harvested early in 2012. The Brazilian crop is forecast at a record 61 million tonnes, up from 57.5 million tonnes in 2010-11, while Argentinean output will increase from 22 million tonnes in 2010-11, to 27.5 million tonnes. Still dwarfed by U.S. production of 317.44 million tonnes, but enough to tip the global balance sheet and add to the pool of supplies available for world trade.

Global ending stocks were revised upwards in the September crop report, to 13.6% of usage, from the August estimate of 13.2%. That’s still near historic lows. But with the outlook for soft global demand, we can see that number inch higher to represent a comfortable global inventory level.

We remain sidelined for now to see how the frost scare will play out. However, once the harvest is well underway, we envision trading this market from the short side. Stay tuned.

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