Corn markets: While we were watching

Feb 7, 2014
by DTN

Do you remember when you were in grade school and the science project was to watch and record the process of metamorphosis from caterpillar to butterfly? One day, the funny looking bug was hanging from a twig, the next it was encased in a cocoon, and then suddenly a butterfly was fluttering around the plastic box.

In much the same way, the corn market has morphed from a sluggish caterpillar slowly inching its way sideways to, if not a beautiful butterfly, a scruffy moth seemingly intent on flying higher for a while. All of this is going largely unnoticed by the countless pairs of eyes focused intently on the market for signs of life.

What has changed? As trade gets under way in February, the nearby contract is pressing the high side of its ongoing sideways trend near $4.40. In much the same fashion, the newcrop December contract is slowly gaining bullish momentum, though at a slower pace than what has been seen in the old-crop market.

What’s interesting about the corn market is that while support has come from both sides (commercial, noncommercial), rally attempts to this point have been meager at best. Initial signals of a possible market turn tends to come from basis. Basis is the difference between the futures market and cash market, with the DTN National Corn Index (national average cash price) representing the latter. At the end of January, the NCI.X was priced about 18 1/2 cents under the nearby futures contract. This is an almost imperceptible strengthening (weekly) from the 20 1/2 cents under seen in mid-December.

Why the strength in corn basis? Another market rule, more or less, is that basis tends to strengthen as the futures market weakens. Theoretically this keeps cash grain flowing to meet demand. And, as discussed in the analysis of USDA’s January Quarterly Stocks report, the first quarter of the 2013-2014 marketing year (September through November, or as of December 1) saw above average demand as a percent of total supplies, and the largest use of total bushels (4.355 billion) on record. With the futures market doing next to nothing, it was up to basis to source supplies.

The second part of the Golden Rule in grains involves futures spreads. In the case of corn, the nearby March-to-May spread has seen its carry weaken from 8 3/4 cents in late October to only 5 1/2 cents at the end of January. As with basis, the strength by the March contract in comparison to the May reflects the attempts of the commercial side of the corn market to push prices as best as possible to find enough cash commodity to meet demand.

The other side of the market, the noncommercial side, has become more active, as well. January’s final U.S. Commodity Futures Trading Commission Commitments of Traders report (positions as of Tuesday, Jan. 28) showed this group still holding a net-short futures position of 55,582 contracts, a far cry from the 135,524 contracts held in late October. If this shortcovering continues, given the ongoing bullish commercial outlook, the market could be poised for a solid short-term uptrend.

How do corn producers take advantage of this type of market metamorphosis? If one is holding cash corn from the 2013 harvest, it should increase in value as the futures market rallies through late winter and possibly planting season, though basis is vulnerable to weakening. If cash corn has been sold, producers could look at buying out-ofthe-money call options that could appreciate as the futures market rallies. Continued low market volatility would allow for buying more time value or closer to atthe-money options. Seasonally, the futures market tends to post a high weekly close the first week of May while the NCI.X tends to continue its rally through mid-June.

If looking to cover previously contracted new-crop bushels, producers have a couple of possible strategies to look at. If only 50 percent of expected bushels are contracted, then producers may not want to do anything, using the potential rally as an opportunity to get more potential production priced. If the producer is looking to roll the dice a bit and try to take advantage of the newcrop December contract’s seasonal tendency to rally through August, then one could look at buying shortdated new-crop September call options. These are a relatively new CME product using the new-crop December as the underlying futures contract, while having the same expiration date in late August as a September contract. And if all that is too confusing, one could also use out-of-the-money December call options due to the low volatility resulting in low-option premium.

Is it a given that corn is going to take off and soar? No, the market in general still has supply and demand issues to deal with. But, according to its charts, and a number of other factors, the ugly wooly worm that corn has been the last couple of years could indeed become a beautiful butterfly, even if its lifespan is expected to be short. — Darin Newsom, DTN