The Week Ahead: Oct 8-12
The drought’s affect on corn prices is still dominating most of the information sources I have found. I am still struggling to understand which factors trigger the Stockout Property of the LOP, since decreasing stocks due to the drought should (intuitively) increase prices with increasing demand. However, corn prices are falling. Forecasts for increased demand from Korea and storms in the Midwest lead me to predict further increased demand and spot price increases. The USDA is “is expected to say this year’s US corn harvest was the smallest in six years and that corn supplies could hit 17-year lows by the end of next summer due to crop losses from the worst drought in over 50 years.” [1]
I decided to take a general view to determine which of the infinite factors at play to observe. If stocks of corn come close to running out, storage costs will decrease. If we follow the logic that the cost of storage is the only driver of price increases, corn prices should decrease. However, lower supply should increase prices. This puts us in a (relative) equilibrium position. Therefore, prices for corn should stay relatively stable, and other global pressures will be the instigators of price changes.
Perhaps decreasing liquidity is an issue; “Volume in Chicago continues to shrink, falling 9% Monday to just 146,212 contracts, according to the preliminary report from the CBOT. Open interest was off 3,163 on modest fund selling.” [2] I am not sure what all of that means, but less liquidity should lead to an increase in prices.
Therefore, we’re looking at three drivers of corn price increases:
- lower supply
- higher demand (from Korea)
- decreased liquidity
Why, therefore, have prices been dropping? Will they continue to fall this week? Bloomberg provides one possible answer: “Corn Prices Set to Drop as South American Farmers Boost Planting.” [3] And while the harvest isn’t set to be ready until later next year, anticipated future supply means there is less need for more storage of low stocks of corn in the near future since they will be replenished in 2013.
Therefore, I have revised my prediction, and in anticipation of lower prices, have reversed my long position for two short December contracts, and two short May contracts, so I can observe the spread over the next week.
My wheat contracts continue their slow progress, so I will hold onto my short contract for at least the next few days.
[1] http://www.brecorder.com/markets/commodities/america/84567-cbot-corn-falls-on-seasonal-harvest-weight-.html (Thanks for the reference, Ishrat!)
[2] http://farmfutures.com/story.aspx/morning-market-review-bryce-knorr-0-30780