Sky's the Limit for Scarce Corn

04/26/2011 3:34 pm EST

Focus: COMMODITIES

Jon Markman

Editor, Trader's Advantage

China’s growing appetite for grain-fed protein, as well as the American drive toward ethanol fuel, have driven grain supplies to a 15-year low, writes Jon Markman of Trader’s Advantage.

Corn prices recently hit a new high of $7.78 a bushel, and are now back to levels last seen at the peak of crude oil prices in mid-2008.

Inventories are reported to be at 15-year lows—and they are still declining, according to analysts. This is a surprise in a way, because higher prices should have killed demand by now.

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It’s a little hard to believe, but you know the big hubbub about physical gold hitting new heights, up 20% in the past year? It’s got nothing on physical ears of golden kernels. Yellow corn—the type fed to animals being prepared for slaughter, as well as to ethanol refineries—is up 120% in the past year.

The problem is scarcity. Weather has been bad, and not enough was planted. “Essentially, we don’t have any corn. That’s the bottom line,” said Sterling Smith of Country Hedging, a commodity broker in St Paul, Minnesota, to the Financial Times.

It’s a paradox that these higher prices haven’t yet affected core inflation enough to worry the Federal Reserve—or even make a dent in demand. Smithfield Foods (NYSE:SFD), a major pork producer, told investors that it has not seen any “consumer fatigue (due) to pricing.”

Of course, a lot of this corn is going into our cars. The Department of Agriculture estimates that 40% of last year’s US crop was turned into 900,000 barrels a day of ethanol. One reason is that rising crude oil prices have kept the cost of “corn oil” competitive.

We can expect the situation to go from serious to critical if US cornfield yields are threatened over the rest of this year. And if crude oil moves toward the $150-plus area, which I am expecting due to an acceleration of turmoil in the Middle East, then this rally in corn may be just getting started.

The exchange traded fund for corn prices is Teucrium Commodity Trust Corn Fund (CORN), and it has traded as many as 250,000 shares a day in the past few weeks, though the average is around 100,000.

Where will future demand come from? It looks like China, according to a Barclays analyst in a recent Bloomberg report.

The analyst, Sudakshina Unnikrishnan, told the wire: “The problem really is that we haven’t seen any letup in Chinese demand.”

And a Macquarie Group analyst added that risks to the US crop from snow, cooler weather, and increased global demand may help push corn to a record $10 a bushel as early as June—about 30% higher than the current quote.

Imports by China “could be as high as 2.5 million metric tons, easily double that of last year,” said Unnikrishnan, who correctly predicted in November that increased cotton purchases by China would help drive prices to an all-time high.

China is “increasingly becoming more reliant on imports because of domestic diet conditions and inventories,” she told Bloomberg.

As we have discussed, the main reason for the rise of corn demand in China has been to feed animals, as the real increase is in protein consumption. A JPMorgan analyst told the wire service: “People are getting wealthier, so they eat more meat. That’s why you need feed, soybeans and corn to feed the livestock with.”

While corn is looks very interesting from a practical point of view, the chart of the cotton fund (the iPath Dow Jones-AIG Cotton Total Return Sub-Index (BAL)) looks the most compelling to me as a trader.

It is rebounding out of the sort of consolidation that has led to tremendous runs higher in the past nine months. The seasonal pattern is also very bullish right now, with gains recorded in the next two to three weeks when prices have been set up like this.

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Plunging into commodities might not be your thing, but they are one of the main games in the marketplace this year—and a way to fight back against inflation. Looks good for at least a small position as a probe, say 2% to 3%.

[CORN has risen 3% to a new high in the two weeks since Markman’s recommendation. In contrast, BAL is down 12% over that span, and is in all likelihood no longer flashing the same bullish signals—Editor.]

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