Corn traders split over what to do next

CHICAGO: The 2012 corn story is still a work in progress, but we know this much so far: much of the crop is toast and demand has to be rationed mightily if corn stocks are to avoid being totally depleted.
What we don’t know is whether sufficient usage cutbacks are already under way, or if prices need to push higher still in order to achieve the demand rationing that is required.
Much hinges on these unknown factors as trader positions have swelled in recent weeks to multimonth highs as money — and risk — has flowed into the arena that will eventually come back out.
The bullish contingent in the corn market feel they have a whole slew of ammunition to back up their upbeat outlook. Their primary argument centers on the case that the national corn yield is likely to be even lower than the US Department of Agriculture’s latest projection of 123.4 bushels an acre, which itself would be the lowest since 1995 and more than 40 bushels an acre lower than its early-season estimates.
Indeed, some traders estimate that the final average yield could be below 120 bushels an acre, which would lop off several hundred million bushels from the USDA’s current total corn production estimate and further exacerbate the prevailing sense of supply tightness underpinning the market.
This dramatic drop in 2012 corn output has prompted a shift in market focus to how much demand rationing will be required in order to avert a complete depletion of US corn inventories.
And market bulls contend that only a small portion of that rationing has already occurred, and that additional price strength is required in order to complete the appropriate amount of usage reduction.
Indeed, many traders maintain that only a sustained bout of additional price strength will bring about the degree of demand destruction that is required, and so argue that corn prices will maintain an upside bias for the foreseeable future.
And with that continued upside potential in mind, these traders not only established long exposure in the corn futures arena but also built up positions in out-of-the-money call options that would appreciate in value as the underlying market rallied further and allow the holder to buy corn futures at a price well above current market levels.
The $ 10 December call was one particularly popular option that many bulls bought earlier this summer, with open interest in it jumping by more than 2,400 percent during the month of July from around 1,000 contracts to more than 25,000 contracts (125 million bushels).
The price of that option also surged during July, rising from less than 3 cents a bushel to more than 20 cents as a wave of bullish euphoria descended on the market and a growing number of market trackers focused on the urgent need for demand reduction and the likelihood of additional price fireworks.
However, as can be seen in the below graphic, the level of interest and activity in $10 calls has subsided of late as corn prices stalled in their ascent, and open interest has actually started to decline as traders sell out of those positions.
Much of the motivation to sell these options is likely tied to profit-taking by traders, who acquired them at much lower prices, rather than a turnaround in outlook on the market.
But the fact that upside call option prices and open interest have started to diverge from the direction of underlying prices suggests that some of the bullish enthusiasm that defined the market earlier in the summer has started to wane.
For the bearish contingent in the market the recent softening in the tone of the out-of-the-money call option market has been a welcome sight. So has the recent climb in $ 7 December put open interest, which indicates that a growing number of market participants are bracing for a potential retreat in December corn futures to below the $ 7 price level at some point over the coming months.
Open interest in $ 7 December puts has surged by more than 7,000 percent since early July and continues to climb as market players move to lock in price floors in case the market undergoes a reversal.
Much of that put buying is likely by jittery corn producers who have become concerned that overall production totals could surprise to the upside and come in above current projections at harvest. This fear is based in part on the fact that even though many market analysts are forecasting a large number of fields to be abandoned due to poor crop conditions, farmers may actually be forced to harvest every acre they manage in order to comply with crop insurance policies. And should harvested area creep higher from current projected levels as a result, that could equate to additional — albeit meager — supplies at harvest that may prove larger than some traders are currently anticipating.
There is also concern that while crop yields across the top US corn states will be severely cut this year, there are other parts of the country — such as across the mid- and deep South — where corn yields are projected to come in at close to record levels thanks to friendlier growing weather throughout the last two months compared to the Midwest.
Such production, because it is planted earlier in the year than in the top corn states, tends to be harvested earlier in the year as well, and could well prove abundant enough to fulfill the near-term demand requirements of many end users and thereby force corn values lower during the coming months even as concerns linger about the state of the rest of the US crop.
Other put buyers are motivated by expectations of a further drop-off in demand over the remainder of the year as large corn end users scramble to find substitutes for corn or cut back on corn purchases as much as possible.
And such expectations are not unfounded given the recent softening in export market demand and elevator basis levels across key parts of the country. Indeed, only corn processors are showing signs of solid corn demand currently, as meat producers, exporters and other grain procurement professionals attempt to wait out the current stretch of price strength in the hope that weaker prices will materialize at harvest.
Another topic of debate among corn traders currently is whether the 2012 drought market will unfold in the same way that it did following the last serious drought in 1988.
Bulled-up traders are quick to point out that this year’s — and 2013’s — corn inventories are far tighter than in the 1988/89 marketing season, and so prices should find more enduring strength than following the 1988 summer rally which petered out toward the end of the summer.
But others argue that South American growers play a larger role in global corn output now than back in 1988, and that higher output from those Southern Hemisphere counterparts can be expected in the first half of 2013 which should start to weigh on corn values over time.
Further, having risen so steeply since late June on the back of a surge in buying interest stemming from the drought fears, bearish traders argue that corn prices will struggle to find fresh buying interest going forward given that demand is already starting to wane and that South American growers are just weeks away from the beginning of their growing season.
All told, the recent stall in the corn price rally has ignited a debate among market participants over whether there’s more upside price movement to come. And both the bulls and bears have mounting evidence to back up their claims as we round out the growing season.
It remains to be seen which camp — the bulls or the bears — gains the upper hand as we near harvest, but given how high a profile the ongoing drought impact is having, and how high current trader positions sizes are, it is likely the final chapters of the 2012 corn story will feature plenty of surprises.