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In This Issue:
Chad Butler of RJOFutures discusses the seemingly wild ride of the Corn futures market, driven by the current ethanol craze.

April 4 , 2007
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Corn's Wild Ride

Corn has been a hot topic for quite some time. Everyone has been jumping on the bull bandwagon driven by the current ethanol craze. But has the market pushed too far, too fast? After Friday and Monday’s limit moves to the downside, some people have certainly been shaken out of the market, and others may have looked to jump in on the short side. Is now the right time to get short? Or is it time to get long?

It should go without saying that quality research is key to trading commodity markets. Unfortunately, too many traders are quick to trade on a tip, a hunch, or just plain “go with the flow” thinking. Over the past year, we have seen the corn market, driven by ethanol demand; make an historic move of nearly $2.00/bushel. It’s easy to get caught in that euphoric mania and not be paying attention to what the market is telling you.

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Friday’s limit move on the heels of planting numbers was a classic case of “buy the rumor, sell the fact.” It was common sense to assume that, with a higher dollar yield per acre that current corn prices offer over beans, more acres would go to corn this year than beans.

(For those new to commodities that might wonder how $4 corn is worth more than $8 beans, a brief explanation is in order. Depending on the region and soil quality, corn can yield 150 bushels per acre resulting in a gross of $600 per acre if corn is at $4/bu. Soybeans, on the other hand, yield more on the order of 42 bushels per acre for a gross of $336 if beans are at $8/bu. There are other costs to consider, and also crop rotations in the bigger picture, but you get the idea.)

With that in mind, it should be no real surprise that we will see the largest corn planting since 1944 – over 90 million acres. If weather is normal, and yields are normal, we could potentially witness a harvest of 12.5 billion bushels, surpassing the previous record in 2004 by over 700 million bushels. A record yield that would exceed USDA usage forecasts of 12.3 billion – that kind of news would spook any market.

One could definitely make the argument that the market was overextended, that a sell-off was inevitable. And just looking at the technical picture, a bearish case for the market could be made. Looking at the December 2007 contract (the first of the new crop), we can see that the uptrend was violated, setting up the potential for this sell-off. All that was needed was the catalyst, and Friday’s report was just that.

Chart Provided by RJOFutures Research

But is that the real picture? Is the corn bull market over? I don’t want to be labeled a “perma-bull” but the corn market fundamental picture does not align so neatly with what has occurred in the last few days. This could be an opportunity to enter this market on the cheap.

Fundamentally, even with the prospect of record plantings, there are two things to consider. First, is the demand there to meet the expected record supply. I believe there is. Look at this chart of ethanol production:

This shows a growing trend being driven by venture capital investment in production infrastructure. Since there is a great deal of debate on whether corn-based ethanol is net energy positive or if other alternative fuels are better, let me point out something that rarely enters that debate. The cost of building an ethanol plant is not cheap. These plants are being built at breakneck speed and money is pouring in from all sides. The parties with vested interest have a lot of money behind them and strong government lobbies. Whether or not ethanol is a miracle fuel does not matter one iota. The ever growing number of ethanol production facilities is going to create demand for corn for the foreseeable future. End of story.

This leads us to another important piece of the puzzle – ending stocks. This is the amount of corn that is not used up in a given year and will carry over into the next year. The current trend is that carryover stocks are dwindling. This means, even though we are harvesting more corn than ever before (remember 2004 was yet another record year), we are using more and more of the corn produced in a given year.

Remember earlier that I mentioned we could see a harvest of 12.5 billion bushels and the USDA usage estimate is 12.3 billion? Where would that put us on the chart above? I’ll give you the answer - less carryover than 2006. And that is IF we produce 12.5 billion bushels.

Based on the ever increasing demand for ethanol, I don’t see the potential for a decrease in demand for corn overall. If weather conditions don’t cooperate, and they often do not, we could see a dent in the 12.5 production number. Put quite simply, this is a tight supply market. And there is nothing better for a bull than that.

A word to the wise: with a tight supply market, the next few months could see some volatile action in both directions. This is the time of year in the US corn production cycle that is heavily dependent on weather. Too much rain, not enough rain, too much heat, not warm enough… you will hear it all. And the market will react.

With that in mind, the outright futures may not be the pool to play in if you are not a well capitalized trader (think commercial end user). For those that like to keep a lid on the amount of risk they take, old crop/new crop spreads and bull call option spreads may be a good way to keep things under control.

Unlike commentaries I have written in the past, I am not going to give specific trades in today’s article. The market conditions at this point are just too volatile. It will require constructing a strategy specific to your market outlook, risk tolerance, available capital, and time horizon. Since everyone’s needs are different, and the market conditions can change quickly, you should have a professional that you can stay in touch with daily through this time of year. Discuss it with one of the knowledgeable brokers are RJOFutures. R.J. O'Brien has a great history in the ag markets, and this is evident in their knowledgeable strategists at the RJOFutures division.

Additionally, access to quality research is critical. I can’t emphasize that point enough. So this week, RJOFutures is offering a trial of their professional research package. In addition to a number of great research sources (where do you think I got the data for this article?), you also have access to RJORadio. This is real commentary from the floor. Specific to our discussion of corn today, the daily grains audio commentary is indispensable.

About Today's Author:

Chad Butler is a Senior Market Strategist with RJOFutures, a division of R.J. O'Brien. His 16 years of market experience includes option spread trading, diversified trend following, and development of a number of index arbitrage programs.

Chad’s published work appears in McGraw-Hill's Complete Guide to Single Stock Futures, Futures Magazine, and other trade publications. He currently writes for various commodities newsletters, including RJOFutures MarketNews and has been a featured seminar speaker teaching his various trading techniques to audiences large and small.