Corn: Buying Opportunity Ahead

February 25, 2011

Corn looks ripe for a short-term pullback—but that might be just the opportunity investors are looking for.

Corn prices continued their rally early this week, as the grain traded at its highest level since July 2008 on Tuesday. The new high did not hold long, though. Corn and all grains turned south after the turmoil in the Middle East escalated.

Although the entire sector took a hit on the geopolitical event, however, overall the trend remains bullish—particularly for corn.

The rise to a multiyear high can be attributed to several factors, including inclement weather and increased demand overseas. In early February, the U.S. Department of Agriculture (USDA) reported that at the end of August 2011, when the harvest season begins, the corn reserve will stand at 675 million bushels—the lowest surplus level in 15 years.

The news of low supply of corn in the U.S. sent corn futures above $7 per bushel, double the price the grain hit six months earlier. The all-time high on corn is $7.65 per bushel, struck back in 2008 during the global top for most commodities.

 

Ethanol Supports Prices

Adding to the demand dynamic are federal mandates putting pressure on companies in the United States to use more ethanol. Unlike Brazil, which uses primarily sugar cane for its ethanol production, U.S. producers create domestic ethanol using corn. As of the end of 2010, 40 percent of the corn supply in the U.S. was going toward ethanol production. And considering that the U.S. is responsible for over half of all corn exports, this results in less corn available for other countries around the globe.

It just comes back to simple math: Lower supply with increase in demand (or even flat demand) will result in higher prices.

Until the government gets its hands out of the ethanol subsidy business, oil companies will continue to have incentives to use the biofuel—and thus high demand for corn will remain. In December, the government extended the ethanol subsidies for at least one more year, and it does not appear to me it will end anytime soon. So expect corn prices to have a floor underneath them in the coming year.

 

Higher Oil Equals Lower Corn

While the price of oil spiked on increased tensions in the Middle East, the price of many food commodities fell by several percentage points. The reason for the disconnect has to do with the potential for lower food demand, due to higher energy costs.

A prolonged conflict in the oil-rich Middle East could lead to oil prices soaring through the $100 per barrel barrier, thus eventually taking gasoline prices higher too. Increases at the pump and to heat homes could be major blows to a rebounding global economy, the end result of which would be decreased demand for food and agricultural commodities as consumers cut back however they can.

 

Investing In Corn

Still, even though corn took a hit this week, the overall setup for the remainder of 2011 looks positive, and pullbacks could be viewed as buying opportunities.

Take the Teucrium Corn ETF (NYSE Arca: CORN), a pure-play corn fund that holds seasonally advantaged futures contracts across the curve. CORN fell 6 percent on Tuesday, and is in danger of dropping more in the short term as investors take profits. Another 5 to 10 percent pullback in CORN will put it in the $38/share area, at which time I will seriously consider adding it to our portfolios.

The iPath Dow Jones Grains ETN (NYSE Arca: JJG), whose index is weighted in corn (37 percent), soybeans (39 percent) and wheat (24 percent), also fell 6 percent on Tuesday. The ETN is now 9 percent off its high set earlier in the month.

JJG broke below its 50-day moving average for the first time since November and could continue down to the high $40s before it finds a stable base. Similar to CORN, if JJG falls more, it will only make it more attractive as a long-term buying opportunity.

Due to the several unknown factors that can play havoc with the price of corn, potential investors must be patient when considering an entry point into one of the related ETFs. We have already seen what inclement weather, government mandates and geopolitical turmoil can do to the price of corn. Expect more volatility in the future.

 

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