wmeubank@ocp.kcmo.com
PRUDENTIAL SECURITIES, INC.
One New York Plaza, New York, New York
(December 15, 1997) CORN: The corn market rallied early last week to test resistance at $2.85 per bushel, but failed to take it out and proceeded to drift lower ahead of Thursday's USDA Supply/Demand report. The report, which included some revised demand estimates, did not reveal much that was unexpected by market participants. However, due to pressure from beans and uncertainty over the Asian markets, prices worked lower through week's end, reaching levels not seen since early October. We expect the market's focus probably will return to the glum export pace that was reflected in the newly reduced 1997/98 export projection.
The USDA started off the December report by leaving the 1997/98 production estimate unchanged at 9,359 million bushels. (The December report typically does not include a production survey.) As for demand, the market was anticipating a 50-million- bushel reduction in 1997/98 U.S. corn exports to 1,875 million bushels from 1,925 million–exactly what the USDA delivered. Because the current export pace is so large that it will not meet the USDA's current projection, some market participants were disappointed the cut in exports was not deeper. However, with about 75% of the marketing year left, there is plenty of time for the export pace to catch up. Two questions remain unanswered, however: (1) Will Eastern European corn exports grow larger than anticipated, much like Chinese corn exports have done so far this marketing year; and (2) Will China import sizable amounts of corn from the world market? Additionally, there is still plenty of uncertainty regarding Argentine and South African corn production prospects.
In a surprise move, the USDA increased feed/residual demand 25 million bushels to 5,650 million, which is a new record. This was surprising because many analysts did not expect any change in the feed/residual component until the stocks report in January because the figure is derived from surveys such as production and stocks. The net impact of the decline in exports and rise in feeding caused the estimate for total demand to drop 25 million bushels to 9,300 million bushels. In turn, the stocks-to-use ratio rose slightly to 10.2% from 10.0%.
We anticipate that the USDA will raise its 1997/98 U.S. corn crop estimate slightly in the January 13 final report, to 9,400 million bushels from 9,359 million; this would equal a national yield of 127 bushels per acre. Additionally, after the January Stocks report has been absorbed, we also expect to see the feed/residual demand estimate decline to 5,600 million bushels or lower. The USDA's current feed demand estimate would be a new record, and appears to be too large compared to other recent years when production and/or supplies were large. We are projecting 1997/98 carryout close to 1.1 billion bushels versus the USDA's current forecast of 953 million, and a stocks/use ratio of 11.7% as opposed to the USDA's current 10.2%. Even though our projection is for a much less tight supply/demand balance and carryout above the magical 1-billion-bushel mark, it is a tight balance by historical measures and demands a large 1998 crop in the United States. Therefore, until more is known about the 1998/99 crop (e.g., plantings, weather during planting, shortened medium-term weather forecasts), we expect to see prices remain volatile and at higher levels than would otherwise have occurred.
On the world front, the USDA left all 1997/98 production estimates for major corn producing countries unchanged: China at 105 million tonnes; Argentina at 13.0 million; South Africa at 8.5 million; and Thailand at 3.3 million. The big speculation going into the report was whether the USDA would adjust South Africa's 1997/98 corn production estimate downward to reflect existing and/or potential weather problems, particularly those related to El Nino. The phenomenon is strongly correlated with dry weather in South Africa, causing drought and ravaging crops. At this early juncture. with South African corn planting yet to be completed, the USDA chose not to make any adjustments. In January, with another month of information available, it may be a different story. Some private analysts already have sliced South African corn production forecasts to 6.0 million tonnes from 8.5 million.
Projected 1997/98 world ending stocks increased 2.0 million tonnes to 67.25 million and spurred an increase in the stocks-to-use ratio to 11.4% from 11.1%. The biggest change in the world balance sheet was a 2.0-million-tonne increase in production for major corn importing nations. These nations still are expected to import 42.4 million tonnes, but their ending stocks have shot up to 13.38 million from 12.13 million, with stocks-to-use ratios increasing to 11.5% from 10.5%–a far less critical level despite the relatively tight world supply/demand balance.
PRICE OUTLOOK–SHORT-TERM–The seasonals for the next 30 days are definitely positive, and the bigger picture continues to have supportive features such as the tight U.S. and world balance sheets and the uncertainty surrounding South African corn production. Additionally, because the supply/demand balances are tight, the United States (as the world's largest corn producer) must produce a big crop for the third consecutive year just to maintain the current stocks-to-use ratio. Until more is known regarding the potential for the 1998 crop, expect the market to remain volatile and at higher price levels than if the supply/demand balance were more comfortable. Thus, we want to be long through the holiday season, and we are looking for an opportunity to reestablish our futures position in March corn. However, we respect the market influence from commodity funds and would much rather wait and buy corn higher than step in now.
We expect a rally into the new year to at least $3.00 and perhaps reaching to the contract highs of 83.07. basis March. Swing factors are South African maize production, fund activity, and the U.S. export program. The corn market probably has risk to the low $2.70's, basis March, which was tested late last week.
Any further breaks should represent opportunities for end-users to start establishing crop disaster insurance with instruments such as out-of-the-money May or July calls. Because we regard this strictly as disaster insurance and fully expect to roll any May calls into July, we are not anxious to spend more than 3-5 cents on the May calls or 4-8 cents on the July options. As a viable alternative, we are not opposed to selling out-of-the-money puts to help finance these calls, as long as the put strike plus the debit is affordable from a long-term standpoint. A good example of this approach currently would be long July $3.10 calls (24 cents out-of-the-money) and short July $2.60 puts (26 cents out-of-the-money) for a 4½-cent debit, basis Friday's close.
LONG-TERM–We fully expect to see a second “harvest” as farmers market their corn and press prices lower starting in mid-January. Considering that this is the third largest crop oil record, farmer selling should be a significant factor in late January and February, especially if prices are hovering near the upper $2.90s to the low $3.00 area. From a projected January high of 83.00-$3.07, March corn could retrace to the $2.80 level by mid-February.
Tom Levis
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