Corn Contrarian

The USDA confirmed what the market knew; lack of rainfall and blistering heat during the first week of July has devastated early pollinating corn. The USDA lowered their yield projection by 20 bushels per acre to 146, lowered harvested acres slightly (200,000), giving a projected total crop size of 12.970 billion bushels. If these production numbers were to hold, we’d actually be harvesting the second largest crop on record, second to the record large crop in 2009/10 of 13.092 billion bushels. This is possible because acreage devoted to corn production is the largest since 1937.

Many in the trade don’t believe these numbers will hold. It’s highly likely that harvested acreage will have to be reduced further. Corn that tried to pollinate in the middle of the heat wave could be lost entirely. In addition, if rains don’t arrive in the Corn Belt soon, say by July 20th, further losses in yield will likely be unavoidable. It is possible, however, that drought resistance varieties will surprise nearly everyone with better yields in the “good corn” than expected. The crop was planted early and it was always challenged from a moisture standpoint and thus is thought to be a deep-rooted crop. Of course the function of the market is to evaluate daily through the price discovery process.

The other side of the coin is demand, or in this case, demand destruction. First, the USDA increased projected ending stocks for this year by 50 million bushels to 900 million. They lowered exports, obviously in reaction to sky high prices in the U.S. corn market. Our import customers are expected to move to South America to meet their import needs for the rest of the summer. Australian feed wheat is also available much cheaper than U.S. corn. We’ve even heard of some poultry outfits working to import Brazilian corn into the east coast. Talk about demand destruction! Also, the USDA left ethanol production for this year unchanged. It’s my opinion this is not accurate and ending stocks for this year will be increased again in August. For the new crop, the USDA lowered their projected feed use by 650 million bushels, lowered ethanol use by 100 million and lowered export projections by 300 million bushels. Thus, while the crop size was reduced by 1.8 billion bushels, demand was decreased by 1.0 billion.

Corn futures initially rallied off the supply/demand report. At one point, shortly after the release, December corn futures were nearly 30 cents higher. However, the market reversed course and finished sharply lower, staging a key reversal. In my opinion, the trade was surprised at the level of demand destruction outlined in the USDA report. The trade seemed to forget the fact that we’ve been reducing demand for corn all spring with the sharply higher July contract and strong basis. The USDA, on Wednesday, indicated that current price levels will continue this destruction.

Now that we have a key reversal on the chart, look for a meaningful major correction in this bull weather market. The first level of important support would come in between 650 and 660. If this level is penetrated, look for a test of 620-630. I would not expect the market to correct further than 620.

Other short term factors to watch will be changes in open interest. Watch for a massive drop (liquidation), followed by an increase in open interest right before the market stabilizes and bottoms. Second, watch for meaningful rainfall (or lack of) during the period from July 14 through July 28th. Third, try and get a feel for when the bullish trader is no longer bullish. Then go long.

Dennis will be developing bullish option strategies to execute when the time is right. If you would like assistance in designing and executing such strategies please email Dennis at dennis.smith@archerfinancials.com.