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In This Issue:
Dennis Smith of Archer Financial Services discusses the prospects for Corn futures.
February 5 , 2008
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Corn is a Crack With Only One Way Out

Last winter corn futures rallied to 10-year highs as the market jockeyed for acreage to meet swelling demand. Sure enough, farmers shifted their acreage base and devoted 93.6 million acres to corn production, up a dramatic 15 million acres from 2006/07. This represented the largest corn acreage since WWII. A decent growing season provided a national average yield of 151 bushels per acre, up from 149 in 2006/07. The resulting record large corn crop was confirmed at just over 13 billion bushels in the USDA’s January report. That sounds bearish toward corn prices, doesn’t it?

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As bearish as the supply side may sound, the demand side of the equation is even more bullish. Despite the fact that corn prices remained fairly high during the growing season and rallied even higher during the fall, the USDA recently shocked the grain trade in their January crop report by indicating that demand for corn continues to grow. I’m not talking about ethanol demand; I’m talking about feed demand. The USDA increased their projected feed usage from their December projection by 300 million bushels. This makes feed demand for this crop at 5.950 billion bushels, up from 5.598 billion last year. Keep in mind this is on the heels of 10 months of strong corn prices.

What does this mean? Simply put, it means that corn prices are not high enough to begin curbing demand and rationing tight supplies. Higher prices are necessary, perhaps sharply higher prices to discourage feed usage to poultry, hogs and cattle. The reluctance to reduce livestock feeding can be easily understood as until just recently most poultry and hog enterprises have been profitable. Also, demand for meat products has never been better with export demand for U.S. chicken and pork outstanding. The poultry boys can react fastest followed by the pork man followed by the beef outfit. The USDA, in their January report projected first quarter beef production flat compared to the first quarter last year, first quarter pork production up 4% and broiler production up 3.5%. Evidently, as of the end of 2007, liquidation in the livestock sector had not started. We’re hearing that some large hog producers are liquidating sows since the first of the year but the information is so fresh its not been measured by the USDA yet. Also, the decision to breed sows or liquidate is not crystal clear given that October lean hog futures are trading at 55 cents (live hog equivalent), December futures are trading at 57 cents and February of 2009 lean hogs are trading at 60.5 cents. Even with corn prices just above $5.00 per bushel, these likely represent profitable hedges for most producers.

The function of the corn market and corn prices is to make sure we don’t run out of corn at some point late this summer before harvest or the following summer. The quickest and surest way to accomplish this is by driving corn prices sharply higher to rapidly discourage livestock feeding. Feed demand is considered more elastic than export demand and much more elastic that ethanol demand. Although feed demand appears to have been relatively inelastic over the past year, sharply higher prices will, at some point, change the elasticity of demand for feed. Livestock liquidation will occur and feed demand will decline. Exactly what price this requires is largely unknown. Ethanol demand, by the way, was left unchanged from their December report but is projected at 3.2 billion bushels compared to 2.1 billion last year. Most in the industry are expecting higher ethanol demand for next year. Export projections were also left unchanged in their January report compared to the December report. However, export demand thus far in the marketing year has been outstanding and could actually be understated by the USDA. Current corn export demand is projected at 2.450 billion bushels compared to 2.125 billion last year.

Summarizing the demand side of the corn equation, despite strong corn prices over the last year, every component of corn demand is projected larger this year than last. The most elastic component of corn demand (the most quick to change given a change in price) is feed demand followed by export demand followed by ethanol demand. The USDA is indicating that as of January 1, widespread liquidation of livestock had not begun. It will take higher corn prices yet, and possibly sharply higher corn prices to provide the necessary incentives to adequately depress feed demand and ration tight corn supplies.

Why not just increase corn acreage again? Good question. However, it’s not that easy. In order to properly care for their farm ground, most farmers utilize crop rotation. Most land suitable for corn is also suitable for soybeans, wheat, cotton, barley, sunflower seeds, hay and a few other small specialty crops. Many producers in the Midwest altered their rotation away from soybeans and into corn last spring. This spring, in order to properly maintain their soil, they will likely move back to their crop rotation. Winter wheat is already sowed and thus can’t be put into corn production without plowing up the wheat before harvest.

In addition to crop rotation, another reason why producers may not devote more acreage to corn production this year is due to sharply higher input costs. Corn requires more inputs than wheat and soybeans in the form of fertilizer, pesticide, seed costs and fuel for handling and hauling the crop during harvest as well as more fuel for drying the crop. All of these input costs have been escalating over the past year, mostly due to sharply higher crude oil prices.

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Finally, producers likely won’t devote more acreage to corn production this year because soybean and wheat prices have rallied to all time high levels. With new crop soft red wheat prices at nearly $9.00 per bushel, unless severely damaged by drought or frost early in the spring season, producers will have no incentive to plow up wheat acres for corn production. Soybean prices have rallied to all time highs with the November soybean contract (new crop) currently trading near $12.50 per bushel. Indeed, most private analysts are already projecting that soybean acreage will increase by 4 to 5 million acres this spring and corn acreage will decline by 3.5 to 4.0 million acres.

So what gives? In the face of what likely appears to be a smaller corn crop this year, in the face of continued large demand, we’ll run out of corn a year and a half from now. The function of the market is to prevent this from happening. Sharply higher prices are likely this winter to discourage feed and export demand and encourage producers to plant corn instead of switching to soybeans. I believe it’s possible, highly likely, that corn prices will rally to $6.00 prior to the planting season. During the growing season, if concerns develop, a move to $7.00 is possible.

About Today's Author:

Dennis Smith
Archer Financial Services

Dennis Smith has been a full service commodity broker specializing in grain and livestock trading for over 20 years. Dennis has a wide range of customers, many of whom are grain and livestock producers. Dennis develops and helps execute hedging and speculative strategies in his Daily Livestock Wire which is prepared each afternoon exclusively for his customers. Dennis grew up in Central Illinois before launching his brokerage career.

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