Corn Prices: Where’s the Bottom?

November-10-08

Everyone knows there are many uncertainties facing agricultural markets. There are a set of arguments for corn prices to be stronger, but also some large negative arguments as well. The most positive argument for corn is that USDA expects ending stocks to be very tight. USDA’s update on November 10th suggests that U.S. ending stocks will be just 1.1 billion bushels, the lowest level since 1995/96. World ending stocks will also drop to just 14% of use, the lowest levels since 1973/74.

Prices normally reach lows during harvest and then rally. As of November 9, the country’s corn was 71% harvested, so maybe the post-harvest rally is almost ready to kick-off. Some also believe that the world’s stock markets have already accounted for the worst possible outcomes and will recover somewhat in coming months. That would help corn prices rally as well.

December futures dropped to about $3.70 per bushel three times since mid-October. This “triple testing” of the lows may be forming the base for a rally. The upside potential seems to be to the $4.30 to $4.50 range on December futures over the next month. By next spring and early-summer, that could push July 2009 futures into the $4.75 to $5.00 range. There are higher price possibilities by that time, but assumes the world financial crisis has passed and the downturn is not as severe as currently anticipated.

The negative arguments revolve around weaker demand than USDA has built into their usage. Those include poor corn export sales, declining livestock numbers, declining livestock exports, narrow ethanol margins, and more wheat feeding that will substitute for corn use. The three driving forces are the continued world financial crisis, falling energy prices, and the rising value of the U.S. dollar.

There is concern that the U.S. and the world economy may now face a “liquidity trap” in which consumers and businesses want to hold more cash and less physical and financial assets. In a liquidity trap, central banks make more money available and lower interest rates, but these fail to stimulate spending. In essence, consumers and businesses decide to repay debt and save rather than borrow and spend. This can causes a deflationary impact on prices of physical and financial assets such as commodities, real estate, and stock values. Stock market indexes such as the Dow Jones Industrial Average and the S&P 500 are barometers of the general economy and will likely be associated with the direction of the corn prices as well.

Oil prices are another gauge for the general direction of corn prices. Like the corn market, oil prices are trying to find a bottom at the $60 per barrel level. If that holds, then it is much more likely that corn has found a bottom as well.

The direction of the U.S. dollar is also trending against higher corn prices. A stronger dollar means weaker energy and corn prices. The U.S dollar has appreciated about 19% since mid-July as measured by the dollar index futures. A higher valued dollar makes it more difficult for foreign countries to buy U.S. commodities. The stronger dollar already appears to be weakening livestock and poultry export demand as well as grain export demand. Corn export sales have been weak so far. USDA expects corn exports to drop by 20%, however, export commitments are currently down 42% compared to this time last year. The ultimate question is how will reduced world income growth impact demand for corn?

Another negative for corn prices resides in ethanol markets. Ethanol producer margins have been very tight this fall. My estimate is that margins have averaged a loss of about $.07 per bushel since September 1. The ethanol industry is expected to have excess capacity in the coming year, and this often means narrow or negative margins. If the industry just meets the renewable fuels standard in the next year, this would require about 250 million less bushels from the 2008 crop. In addition, the blender’s tax credit drops from $.51 per gallon to just $.45 per gallon on January 1, 2009. This reduces the subsidy for ethanol and will have a downward impact on corn prices of up to $.17 per bushel.

If December corn futures prices drop below $3.70, this may signal a drop of another 50 cents per bushel with December futures falling to the $3.10 to $3.20 per bushel.

So, if you have read this far, I have presented an upside price scenario and a downside price scenario. Which will it be? Those who cannot accept the possibility of cash corn prices falling to around $3.00 may want to consider forward contracting now for delivery in the late winter or early summer. Also hedge-to-arrive contracts using the July futures could be considered and will provide for higher prices if basis bids improve.

For corn prices to move upward, the financial crisis must not be worse than currently anticipated; crude oil prices need to hold at $60 or higher; and the U.S dollar must not appreciate.

With such high uncertainty, diversified pricing helps to move prices received toward the average. USDA has lowered their expected average farm price for the 2008 crop to $$4.40 per bushel. Hopefully, most producers who use diversified pricing did some forward contracting back in the spring or early summer at much higher prices.

For the 2009 crop, positive margins are non-existent given current crop prices and anticipated costs of inputs. This means that something must give—either crop prices need to rally, or costs will have to come down. If crop prices can’t rally then expect nitrogen and phosphorus prices to come down sharply, fuel costs are already much lower, crop insurance premiums will be down, seed incentives will be high, and cash rents may have to come down as well, at least where rents had moved up quickly in 2007 and 2008.

Use of This Information: This information is based upon current evaluations by USDA and Purdue analysts. While it utilizes the latest known information, future outcomes can be much different due to shortcomings in analytic methods, to inaccurate anticipation of future events, and to unforeseeable new events. Ultimate outcomes are often different than provided in the outlook. Thus, this information should be used in conjunction with other outlook sources and decision makers should always evaluate how a range of potential outcomes would impact their firm or organization.

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Chris Hurt
November-10-08
Purdue University