The Case for Going Long Corn

04/08/2011 5:00 am EST

Focus: COMMODITIES

Andy Waldock

Founder, Commodity & Derivative Advisors

An existing supply shortage, coupled with mandated production of ethanol and exploding demand for grains around the world are just a few very good reasons why corn prices will only continue heading higher.

Corn is facing unprecedented demand on all fronts. The USDA reported that prospective corn planting for 2011 is expected to be 5% higher than last year. That would make this the second largest crop planted since 1944. The 92.5 million acres is second only to 2007’s record of 93.5 million acres.

In spite of the growing acreage in corn and higher yields driven by greater technology, corn stocks are still down 10% from this time last year. In fact, the corn on hand versus this year’s expected demand (stocks-to-usage ratio) stands at 5%. This is the lowest number since 1937. There are currently 6.5 billion bushels of corn in storage versus global demand of 123.5 billion bushels.

The government’s push towards ethanol was actually initiated by President Carter during the oil crisis of the 1970’s. It was left dormant until the post-9/11 energy independence push. Corn was trading at $2.25 per bushel in 2001. Cheap, clean-burning corn made it a political win/win for energy independence and the global warming/green energy crowd. This led to government mandates and subsidies to increase ethanol production every year through 2015.

This year, up to 40% of the corn crop, at a price above $6.50 per bushel, will be allocated to ethanol production. If we multiply the intended planting acreage times an average yield of 155 bushels per acre, we can see that the cost of the corn input of ethanol production will be more than $37 billion.

The US also exports more than 60% of the corn it produces. Our exports have continued to climb even as the price of corn has nearly doubled in the last year alone. Meat consumption has just begun to grow in Asian countries as they’ve begun to prosper and develop their own middle class. This will not only continue, but it will accelerate.

Global meat consumption is still only 20% of the US average. The demand for feed grains continues to outpace production by 1%-4% per year. China is determined to have a self-sustaining hog industry by 2013. These factors help explain the continual decline in ending stocks in the face of growing harvests.

The demands on the corn market from ethanol and food production leave absolutely no room for weather-related issues. This year’s crop is crucial to restoring our reserves. Based on the current ethanol policies, it would have to rally another 50 cents per gallon just to catch up with the current price of gasoline. Corn would have to reach $8.82 per bushel for gas and ethanol to reach equilibrium at $3.15 per gallon. Ethanol/ gasoline blenders also receive a federal credit of $1.30 per bushel. This pushes the breakeven corn price to $10.12 per bushel for ethanol producers.

The price of corn hit an all-time high of $7.79 in June 2008. Remember, this followed the largest crop ever harvested in 2007. We already know that global gasoline demand will increase, as fuel must be exported to Japan. We also know that Japan’s imports of all foods will be higher than ever.

China is doing everything they can to put the brakes on their economy, but it won’t derail the growing appetites of their people. Finally, the continued decline of the US dollar will serve as double-coupon day for global shoppers as we remain the world’s supermarket. 

By Andy Waldock of CommodityAndDerivativeAdv.com

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