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May 15, 2016

Bottomed out but not turning upwards: Are there any corn market opportunities?

Demand has overtaken supply but with inventories mostly falling in China's disconnected market, fundamentals cannot spark a rally. Weather patterns may create a short-term opportunity.

In markets, the first commodity to enter a bear market is usually the first one to enter a new market upturn. For now, the latest USDA estimates imply that while corn has bottomed out, it still has some way to go.

While America no longer accounts for 60% of world corn exports, it still has an influence disproportionate to its current 40% share of the world market. It is setting the pace for this year's reduction in world corn production, from 2016-17's 1.065 billion tonnes to 1.033 billion tonnes. While demand is outpacing supply for the first time in years, it will take another one or two similar consecutive growing seasons before the golden grain's fundamentals can regain their luster.

US planted acreage is falling sharply and with it, America's corn harvest. The situation is the opposite of a year ago, when higher corn returns (relative to soy and wheat) resulted in planted US acreage expanding from 88 to 94 million acres. With other feed crops outperforming corn, acreage is falling back 4.3%, to 90 million acres.

Similarly, at 170.7 bushels/acre, US corn yields are projected 2.2% below their all-time peak of 174.6 bushel/acre set last year. This reflects the fact that perfect growing weather cannot be expected to happen every year, but keeps yields growing above their trend rate of recent years.

Driven by falling acreage and lower yields, the USDA projects 2016-17's record 384.8 million crop to fall back 3.7%, to 370.4 million tonnes. With total US feed, food processing and ethanol demand for corn staying almost constant near 315.5 million tonnes, the lower crop will cause exports and inventories to fall by a collective 13.6 million tonnes.

By falling from 58.3 million to 53.6 million tonnes, the domestic US stock-to-use ratio falls from 18.5% to 17%. This is a few percentage points below the world corn stocks-to-use ratio but still very much in bear market territory.

From 56.5 million tonnes in 2016-17, the USDA expects American corn exports to dive 15.8%, to 47.6 million tonnes during the current 2017-18 marketing year. There is more to this however, than a lower corn harvest, decreasing acreage or flat corn yields. Combined exports of cheaper Brazilian and Argentine corn are rising from 35 million tonnes in 2015-16 to 61.5 million tonnes in the current marketing year and 62.5 million tonnes for 2017-18.

Despite low world prices, Brazil will at least equal its previous corn export record and Argentina will set a new one. Their 27.5 million tonne boost in Latin corn supplies to the world market completely offsets the 2 million tonne reduction from Ukraine over the same period. Even when the reduction in US exports is factored in, the net 20 million tonnes of Latin American corn added to the world market will keep prices soft.

This is more than a short-term situation: Bountiful Latin supplies cap the potential for US corn exports, which are caught in a long-term stagnation trap. Despite leading the world market, American corn exports have never risen higher than the 60 million tonne volume peak reached in the late 1970s, late 1980s and more recently, the late 2000s. Constrained by almost no acreage expansion potential and a high dollar, the USDA expects American corn exports to stay in the 50 to 55 million tonne range through the mid-2020s.

From a peak of approximately 130 tonnes in the middle of our current decade, the USDA projects the quantity of US corn used to make ethanol will fall to 125 million tonnes by 2026. This reduces the quantity of DDGS available in world feed grain markets, thereby boosting corn demand and providing it long-term market support.

Over the medium term however, corn is getting far less market support from its sharp inventory drop than meets the eye. Superficially, the 12.8%, 28.6 million tonne drop in world corn inventories from 223.9 million tonnes in 2016-17 to a projected 195.3 million tonnes makes for a great market improvement.

Unfortunately, the change in fundamentals, while quantitatively significant, does not have much of an impact on world market fundamentals. Never mind that at over 195 million tonnes, this is the fourth largest world corn inventory level on record. With the world corn stocks-to-use ratio falling from 21.3% in 2016-17 to 18.4% in 2017-18, overall world inventories are still several percentage points above the level required to spark a market rally. The best they can do under the present circumstances is guarantee relatively flat prices in the U$3.60-US$4.00/bushel range.
More importantly, the US and China account for 86% of the fall in world corn inventories. In fact, with Chinese inventories falling from 101.3 million tonnes in 2016-17 to a projected 81.3 million in the marketing year to come, China in fact accounts for 70% or 20 million of the 28.6 million tonne world corn inventory drop.

Superficially, China held over half the world's corn inventories two years ago and will still account for 42% of world corn stocks at the end of 2017-18. The problem, according to Emily French, founder of ConsiliAgra is that due to trade restrictions, China's corn inventory neither interacts with nor materially impact the world corn market.

For this reason, it should be noted that ever since China became an influential agribusiness market player in the mid-2000s, it has taken a world corn stocks-to-use ratio of below 15% to spark a world corn rally. More accurately speaking, the world corn-stocks-to-use ratio (excluding China) needs to fall below 11.5% before corn market rallies take off.

Going forward, China's policymakers are making sure that China's non-involvement in the world corn market will end: Provided Beijing continues to liberalize China's corn market, it will one day enter the world corn market in a game changing way. Consequently, the above mentioned critical stocks-to-use ratio levels may no longer hold after 2020.

For now, however, China's corn vast inventory keeps its corn supply, demand and inventories from impacting the world market -and will do so for a few more years. That means that in 2017, the world market will function as if inventories only fell by 8.6 million tonnes instead of 28.6 million tonnes.

The good news is that with world corn consumption exceeding this year's production by 28.7 million tonnes, significant progress is being made towards balancing corn supply with demand. The bad news is that it will take more of the same, for another consecutive year or two before the market can rally. For markets to become bullish, world corn inventories need to fall more sharply outside of China than inside of it.

You might be asking, 'while this is a good time to invest for the long-term, could there be any short-term opportunities around the corner?' The answer is a tentative 'yes' -and it depends on the extension of a current, worldwide weather pattern.

Since the start of this year, global weather has seen a strong, near world-wide tendency towards heavy, above average precipitation. This is usually a leading indicator of earth's weather cooling off by up to 0.5°C to 1.0°C. Coinciding with the increase in precipitation has been a string of reports of cool, below average spring time northern hemisphere spring time temperatures.

Should the current tendency towards above-normal northern hemisphere precipitation and below normal temperatures extend into the early third quarter, it would imply that the US and European feed crop harvests could be impacted by unusually cool, rainy autumn weather, or even early frost.

That would upset current corn harvest forecasts in a manner that could make for a late summer or early Autumn rally -so do keep on an eye on temperature and precipitation tendencies, especially from the start of the third quarter onwards.

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