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April 11, 2012
 
Corn market cross-currents to end sideways price behavior: Our two quarter forecast
 
Alongside a failed southern hemisphere crop, dwindling US and Chinese inventories are up against record American planted acreage and queer USDA assumptions about the weather. This implies a short-term rally followed by two key market inflection points.
 
An eFeedLink Exclusive Commentary
 
by Eric J. BROOKS
 
 

The last quarter has seen a taming of corn's previous two years of market volatility, trading within a +/- 5% price band of US$6.35/bushel. The historically high plateau corn finds itself on reflects a confluence of factors, both bullish and bearish. These include bottom-touching inventory lows in some major importers and exporters, booming planted area, drought and USDA oversights that we expect to be revisited later.
 
Of course, to properly appreciate its future price path, we need to take the factors which can influence its price, and assign them a proper relative weight before the market does so -and we attempt to do this below. We examine each of these issues in greater detail below, going from factors based on mere chance to more concrete certainties. What we see is a strong market through to mid-year, followed by two inflection points, one around July, another in the late third quarter. The way CBOT corn goes after these two market humps depends on how much the weather fulfils -or disappoints- key USDA inventory assumptions.
 
 
 
USDA goes where no weather man has gone before
 
With this in mind, it gives me no pleasure to declare the USDA's most recent US corn supply numbers the most discountable -and utterly incredulous- of market influencing variables. Farmers never trust the weather but this year, the USDA put its full faith into the weather gods.
 
Early April had analysts sitting on the edge of their chairs, waiting to see how much the USDA would cut its estimated ending corn inventory -only to see them left unchanged at 20.3 million tonnes, after boosting them from 18.3 million tonnes in February.  Analysts were so shocked and the market so disappointed that CBOT corn barely moved in response to this bearish assessment. Why did the market so ignore the USDA?
 
It must be appreciated that since boosting its expected ending inventory by 2 million tonnes in the first quarter, the world has lost 5 million expected tonnes of corn exports from Argentina. As a result, US corn export volumes turned upwards strongly in the late first quarter and early second quarter.
 
Furthermore, this upturn in American corn exports was more than reflected in the USDA's own statistics: By late March, American corn inventories had fallen 3.8 million tonnes or 4.7% lower than it had projected. With America's own harvest six months away and no southern hemisphere country able to make up for Argentina's supply deficit, everything made sense -except for the USDA's reasoning.
 
Following record early spring time sowings, the USDA concluded that end-of-season corn inventories would avoid falling to lower levels by the likelihood of an earlier corn harvest this year:  Japanese style, just-in-time inventory management comes to the US corn market, courtesy of the weather gods?
 
Going where no weather forecaster has gone before, with five months left before the harvest the USDA assumes five straight months of perfect corn growing weather, across an entire continent, with no delays! Of course, traders are a practical lot and the market simply refused to be moved by a forecast based on such ethereal, vaporous assumptions: If anything, the last few years have seen a trend towards America's corn being harvested later rather than sooner.
 
 
Mexico+Argentina+China+ASEAN = low US inventories
 
Hence, we are left weighing the concrete realities of an already failed Latin American harvest and months of declining US corn inventories against the hope for five months of perfect weather in a country spanning three time zones. Obviously bullish inventory trends win out over the bearish possibility of just-in-time good weather over an entire continental land mass.
 
With US corn stocks already some four million tonnes below expectations, demand in Asia is turning upwards in a manner not fully reflected in the USDA's own statistics. It is still assuming that China will import 4 million tonnes of corn this marketing year, even though this number will probably be exceeded by the time you read these words.
 
The USDA also assumed 800,000 tonnes more of imports going to Mexico and an additional 100,000 tonnes going into Southeast Asia but many private analysts expect their import volumes to be higher by at least several hundred thousand tonnes, totaling up to an additional 1.5 million tonnes. But China is the new big fish, capable of moving the market, and it appears ready to move it, though it will do so in the strategic manner we've gotten accustomed to.
 
eFeedLink officially expects China's corn imports to total 6 million tonnes this marketing year, 2 million tonnes more than the USDA.
 
Add that in to the higher Southeast Asian and Mexican corn demand and the following arithmetic kicks in: 3 million tonnes of demand added to the market from East Asia and Mexico plus 5 million tonnes of supply lost to Argentina's drought. Conservatively speaking, unless the USDA's 'miracle weather' corn harvest comes in early, that implies an American corn inventory climb down of some 3 to 6 million tonnes before this marketing year is over.
 
 
Feed & corn syrup demand meets widening CBOT/Dalian spread
 
But the real kicker is China, for we are now in a situation where the low inventories exist in both the top exporter and the world's greatest emerging importer. With nearly all the USDA's 4 million tonne import estimate already in, Dalian futures are at nearly US$10/bushel, some 50% more expensive than CBOT corn. That implies that should policymakers give the go-ahead, China's corn imports will rise far above six million tonnes.

But there's more than just wide price spreads to China's import demand. The official harvest estimate of 192 million tonnes turned out to be another work of fiction. eFeedLink has pegged this year's harvest at 172 million tonnes, a mere nominal slip below estimated demand of 173 million tonnes.
 
To that demand assessment must be added several other outstanding issues. First, from around 100 million tonnes a decade ago and 47.2 million tonnes in 2009/10, in just two marketing years, China's corn reserves are down by 26.8% to an eFeedLink estimated 34.6 million tonnes in the second quarter of 2012.
 
With China corn near US$10/bushel, no harvest until Autumn and feed demand undergoing a cyclical rise into the late third quarter, the near million tonnes of imports scheduled (as of mid April)  to arrive will not be enough to keep sparse Chinese inventories from falling lower.  Moreover, the shrinking, inter-harvest quantity of China's corn supplies are made worse by quality issues usually not seen in the west.
 
According to eFeedLink's April corn report, "Corn prices rose as a result of active buying from both Sinograin as well as independent traders." The resulting, "Strong processing demand created the expectation of higher prices. This made traders and farmers reluctant to sell their corn, boosting northeastern prices."  However, the entire shortfall was made worse by, "the corn's high moisture content, which made some feed mills reluctant to purchase it. This exacerbated the scarcity of acceptable corn, with implicitly inflationary implications."
 
Furthermore, while China's feed demand is rising, China's demand for corn syrup has been increasing even faster than that for feed corn. "According to eFeedLink, "demand for corn-syrup beverages and processed foods typically peaks in summer. Beverage maker and food processors' corn starch demand is approaching its summer time peak, making for strong buying interest from processors." 
 
Moreover, this year's seasonal production uptick is made stronger than usual by the relatively high price of sugar relative to corn syrup. This has raised the expected returns of China's fast expanding corn syrup makers. Consequently, "With better profit margins, deep processors showed high buying interest and increased stockpiling activities."
 
In sum, dwindling inter-harvest supplies and corn quality issues are meeting rising livestock demand and a stepping up of procurements on the part of corn syrup makers. All this implies that despite the occasional arrival of scheduled import shipments, during the coming inter-harvest months, China's corn supplies are poised to trend downward as the output of livestock makers and corn syrup demand keep rising. . With so much inflationary pressure ahead, Beijing will be forced to run down reserves more -and replenish them with imports in the future
 
However, the price differential between CBOT and Dalian corn is already over 50%. It is difficult to believe that this spread could widen significantly without China opting to import more corn -or without CBOT corn playing 'catch up' and narrowing the spread. 
 
Along with the inevitable, ongoing drop in US corn inventories over the next quarter, all this implies that CBOT corn should cross the US$7/bushel by the late second quarter. Should bad weather in the second quarter force the USDA to admit that the harvest will be delayed, official ending inventories will be forced to fall by at five million tonnes or more -and the resulting price adjustment could be rather abrupt. While this implies that US corn inventories could fall as low as 15 million tonnes, I personally feel that the USDA will never let such a low number be published.
 
 
…different scenarios after mid-year inflection point
 
Hence, a rally appears to be in the cards over the next quarter. The question is what happens after mid-year, as this time period has broken the backs of many a rally, including the one that was under way in the first half of 2011. While there are some bearish certainties on the horizon, they are partly extent counterbalanced by bullish probabilities.
 
Should all of the USDA estimated planted 95.9 million acres of corn materialize and good growing weather ensue, corn could swan dive to US$5/bushel or below by the late third quarter.  If good growing weather coincides with China putting off imports and letting domestic corn prices skyrocket, then this could definitely be in the cards.
 
But five months of cross-continent growing weather creates many possibilities -and the USDA is banking on meteorological certainty. Should the weather turn nasty early on, some Midwest farmers may opt to salvage their growing year by replanting corn acres with soy. This would boost corn prices over the third quarter at the expense of soy. If China were to enter the market just as early US growing weather turns bad, that would be a massive signal in favour of an inflationary autumn.
 
Finally, even if the US crop turns out to be bountiful, timing is everything: The USDA has factored in a large -and speedy- harvest. Should we get a large but delayed harvest the way we did in 2009, that would run down US inventories to levels not reflected in its current, rosy statistical assumptions. This would mean that CBOT corn could ride out its mid-year deflationary hump and stay strong into at least the mid 4th quarter, when South America takes its turn driving prices.
 
Our conclusion? Two quarters of corn shortfalls in America and China are a certainty, medium-term supply assumptions are still materializing -and weather based optimism is the shakiest of all assumptions. Consequently, a second quarter rally is implied but you can only count on a mid-year corn price swoon if the weather behaves perfectly for the next three months.
 


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