Three Ways to Profit as Growing Demand and Tight Supplies Send Corn Prices Higher

We've already seen the effects of the global currency wars - the so-called "race to the bottom" that's helped send gold to all-time-record highs.

And we'll soon see the fallout from the worldwide skirmish over rare-earth supplies, which is certain to impact the high-tech sector.

Trust us when we tell you that the next big battle in the global financial markets will be all about food.

That will bode well for food-commodity prices in general.

And it should be particularly bullish for corn.

Weather Worries

Three factors indicate that corn prices are headed higher in the U.S. market - as well as in markets around the world. The reality is that:

  • The United States is the world's largest grower and exporter of corn, and thanks to some wild weather swings U.S. corn production is down more than 4% from last year's record crop.
  • Industrial uses of corn are contributing to escalations in demand, even during a supply squeeze. New food uses for corn will also help boost demand.
  • The weak U.S. dollar will make corn an even hotter export, further escalating demand during a period where supplies are tighter than usual.

A number of weather-based events have damaged the current or upcoming harvest of key crops in exporting nations worldwide.

In Brazil, for instance, it was a drought that may damage the 2011 coffee crops.

In Russia, an endless dry summer heat wilted the wheat crop.

In China, Pakistan and India, monsoon rains shrank the cotton crop.

And here in the United States, it appears that exceptionally wet weather in June and July and devastating heat throughout the summer may have damaged the corn crop. This has led to lower yields per acre this year compared to last year.

How much lower is the yield compared to what the U.S. Department of Agriculture (USDA) predicted during the summer? The September yield was projected to be 162 bushels per average acre. The October yield was initially projected to be 159.9 bushels, but was then slashed to 155.8 bushels - and both estimates were well below the 2009 record of 164.7.

In November, the USDA lowered estimates again - to 154.3 bushels per acre. If realized, that would still be the third-highest yield on record. But corn production is forecast at 12.5 billion bushels, down 4.4% from last year's record. Corn growers are expected to harvest 81.3 million acres of corn this year, up 2.1% from last year's acreage.

Since those forecasts were posted, this year's harvest has shaped up as very "spotty" - with significant swings in field-by-field yields. This has caused a small crisis in estimated supplies to break out.

What is a small crisis you ask?

Well, when prices go up by 50% in a single season and up by 15% in just a few trading days - as we saw a few weeks ago - that's a supply crisis. Food buyers here in the United States and in markets throughout the world are about to experience some major "sticker shock" as food prices spike due to the ongoing currency wars and the accelerating industrial demand for food-related commodities.

U.S. Corn Prices Headed Higher

The United States remains the world's largest producer of corn. And U.S. farmers last year (2009) produced the biggest bumper crop of corn in the nation's history - in excess of 13.11 billion bushels.

Normally, this would represent a crisis for farmers, as a record bumper crop usually crushes the price for that commodity.

This hasn't been the case with corn, however, which has experienced a major escalation in demand here in its home market, and for one simple reason: Corn is a key ingredient in the production of ethanol, whose use as a gasoline additive has grown substantially in the U.S. market - in large part due to tax breaks that are coming up for renewal at the end of the year.

Total U.S. ethanol subsidies - including corn-based ethanol - reached $7.7 billion last year, according to the International Energy Agency.

And ethanol isn't the only catalyst for U.S. corn demand. The corn lobby has started a new campaign, which has seen corn relabeled as "corn sugar," America's homegrown sweetener. In my opinion, this is brilliant marketing; given today's devalued greenback, U.S.-based businesses are looking for viable sweeteners that can be purchased domestically.

Indeed, given that weak U.S. dollar, the demand for U.S.-grown corn can be expected to zoom overseas - even as these competing catalysts boost the demand for corn here on the home front.

And if you combine soaring demand with inconsistent - or decreased - yields, there can be only one result: substantially higher prices.

This is an issue that few market pundits are touching upon - that a devalued U.S. dollar will drive up domestic food prices (and not just in products for which corn is a direct ingredient. Corn is also used as feed for poultry and livestock, meaning a spike in corn prices will have an impact on meat, poultry and dairy-product prices - including milk, eggs, cheese and ice cream, to name just a few).

Think of it this way: The weaker the U.S. dollar becomes, the greater overseas demand will be for this "cheap" U.S.-priced food source (and corn is just the start; by that, I mean that we'll see a similar financial arithmetic play out with other U.S.-produced food commodities). This will boost U.S. exports, giving the United States a new position in the international markets. But it will also push up food prices here at home. After all, in finance, there is no "free lunch."

And growing industrial uses of corn - both at home and abroad - will only exacerbate this situation.

Corn Supplies to Become Even Tighter

The spread between growing demand and shrinking supply, has prompted the USDA to tighten up on corn supplies. Just this month, in fact, it revised its forecast for ending corn stocks to 827 million bushels from October's 902 million bushels, which is now less than half of the 1.8-billion-bushel ending-stock estimate made by the USDA in early spring.

The U.S. "stocks/use ratio" is now at 6.2%, the tightest since it was at 5.0% back in 1995-96. The current ratio is also less than half of what it's typically been over the past five years. The stocks/use ratio is one way to illustrate the supply and demand situation for a particular commodity. It indicates the amount of "carryover" as a percentage of the total use or total demand.

Now, this is a vast oversimplification, because it doesn't factor in all the variables. But with corn, the general rule of thumb is that a ratio of less than 12% is an indicator of a strong price advance. Currently, the ratio is 6.2% domestically and about 15.4% globally. But that global figure is misleading - it represents the second-tightest ratio in the past 30 years.

The bottom line: Let's look to go long on corn when the market says to and not when the market is overheated and looking to make popcorn out of the late players to the show.

Action to Take: It's time to go "long" on corn (**). The action in the pits for the last few months has been crazy, with most of the volatility being generated by the USDA's updates on the projected U.S. corn crop. In September, the USDA announced that the crop was expected to be another record supply.
The USDA then announced that it had found 300 million tons of extra corn. This drove the price of corn down by about 10%. This happened just as investors began to receive reports of lower-than-expected yields to start the harvest season.

On Friday, Oct. 8, the USDA cut its corn forecast from the month before by 3.8%, stating that bad weather would reduce the U.S. harvest. This caused the corn futures markets to close "limit up" that Friday, as well as on the following Monday.

I mention all this to illustrate the confusion and whipsaw trading patterns corn investors have to deal with. Ignore it: The bottom line is that my long-term expectations for corn prices haven't changed - even if the price is currently pulling back after the long, hot summer of lowered expectations.

Here is how we are going to consider playing the longer-term projection for higher prices. We're going to do so via exchange-traded funds (ETFs).

The first recommendation is the Teucrium Corn Fund (NYSE: CORN). Surprise ... you can buy direct exposure to corn in the stock market. This summer the first dedicated corn ETF was released. It is based on the daily movements of three different currently traded corn-futures products.
The second ETF is the PowerShares DB Agriculture Fund (NYSE: DBA), which gives you exposure to the entire grain market. That means that, besides corn, you get a blended exposure to wheat, soybean and sugar - a true benefit, given our broader thesis for food-commodity prices.

Lastly, if you are an international investor, and have access to the London markets, the ETFS company has a series of ETFs based on the corn futures markets, including the ETFS CORN Fund (LON: CORN.LN).

(**) Special Note of Disclosure: Jack Barnes holds no interest in corn.

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