Should You Buy CORN?

June 14, 2010

As the first pure-play corn ETF launches, should you take a second look at the yellow grain?

 

 

The Current State Of Corn

On Tuesday, June 8, the Teucrium Corn Fund (NYSEArca: CORN) began trading, marking the first time ETF investors have had a pure play on the most important crop in the United States.

Lara Crigger covered the launch in a recent podcast, pointing out a few key features of both the ETF and the corn market, but I thought we'd dig a bit further below the surface.

So, first things first: How's corn doing right now?

 

Long-term Corn

 

Over the past year, the short answer is "not so hot." Corn futures have fallen far below their mid-2008 highs and are sitting even lower than last year's average.

The reason for this underperformance is twofold: Economic growth hasn't really kept pace with projections, thus muting demand; and corn farmers have had a spectacular crop year. Sure, there's always the back and forth about the weather, but according to the World Agricultural Outlook Board, ending stocks this year should be just slightly lower than last, at 1.6 billion bushels. And not only did farmers plant more corn this year (86.5 million acres, vs. last year's 86 million), but they are harvesting 1 million acres more than they did last year, with yields up from 153.9 bushels an acre to 164.7.

In other words, from the perspective of the grain buyer, everything's gone great this year.

But corn farmers remain in a bit of a pickle. You may recall that lovely 2007-2008 commodities run, when it seemed like everything was going up. Between a supposed biofuel boom and a couple of low-yield years, it seemed like corn prices had significant lasting support. Of course, that support disintegrated, and anyone who bought the 2008 top and sold the bottom—which is pretty much right now—has already lost half their investment.

On the plus side, however, China seems to be having a bad year on the corn front. The country has reportedly bought 1 million tons of corn for import; at $291/ton, domestic prices in China are their highest in two years. Keep in mind that overall, corn is not all that expensive per ton, so the localized prices around the world can be quite different. This is quite different than what we see in oil, where the spreads between oil in the North Sea, Texas and Asia can be fairly tight and predictable.

 

And from whom are they buying? Iowa.

 

Chinese corn

 

Here, the more volatile red line represents spot corn in Iowa, while the slowly growing green line represents spot corn in Dalian, China. It's easy to see why China is buying now. The two prices are nearly uncorrelated, with U.S. corn headed to test lows, while Chinese corn hits all-time highs.

 

Contango In The CORN Field

Of course, we all know we can't actually invest in spot corn, at least, not without buying dry-bulk ships and warehouses. What we could buy is the corn futures contract. But that contract lives in contango most of the time, and the monthly roll would generally bleed assets from your position.

To illustrate, here's what life looked like as a corn futures investor vs. a spot seller over the last year.

 

Corn Spot vs. Futures

 

The actual price of corn is "only" down 23 percent. But a futures holder (represented here by the S&P-GSCI Corn Index), would be down almost 31 percent.

 

Enter CORN, the new corn ETF I mentioned earlier. Unlike many futures-based commodity funds, CORN doesn't just hold the front-month contract. Instead, it holds contracts for the second and third months out, and then the following December. That means that right now, CORN holds September and December 2010, as well as December 2011.

Why December? Due to the vagaries of agricultural commodities, natural glut and shortage periods arise, dictated by global trends in harvesting, planting and the cost of storage. In the case of corn, December is almost always a "kink" in the curve (believe it or not, farmers are still harvesting in December, as I reported last Christmas.):

 

Corn contango

 

Right now (the pink line), December 2011 isn't exactly cheap, and it's still in contango vs. September. But December 2012 is actually at a substantial discount to July 2012 ($4.14 vs. $4.22 per bushel), and last year at this time (the black line) the second-December contract was trading lower than the near-December contract.

These kinds of time-series plays are common in commodities, and they're part of the reason many people believe futures essentially have to be actively managed, so as to take advantage of these kinds of seasonal and weather-related differences. In the case of CORN (and corn), however, the pattern is likely repeatable enough that the strategy will reliably mitigate contango to a certain extent, and get investors closer to spot than a pure front-month-roll game plan could.

If you're hot on China or bearish on the weather, CORN is a solid pure play, and its fundamental construction logic is sound. However, you'll pay a pretty penny for your virtual bushels. Corn has a management fee of 1 percent, and an expected total expense ratio of 1.72 percent. That's quite a bit to pay for such a cheap grain.

 

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