Harvest Profits in Corn

Posted On February 8, 2016 1:59 pm

I cut my trading teeth on the floor of the Chicago Board of Trade in the Ag ‘pits’ so I always have ears up for what the corn market is doing. Pun intended. Corn, and most other grains such as wheat and soybeans, have fallen to multi-year lows but I think it could be setting up for a big bullish move heading into the spring growing season.

It’s the time of year when farmers are usually in a “Battle for Acres” but for the 2016 crop, that’s not the case. The low price of corn and soybeans and competition from South American growers have farmers thinking twice about what they should plant next year. This could set up a tight supply with little margin should error if bad weather hurts yields or demand increases beyond expectations.

Brazil is shipping corn to South Africa, a traditional maize exporter suffering from an El Niño-related drought, as it seeks new markets for its growing corn production. Brazil exported 321,662 tonnes of corn to South Africa in 2015, up from none the previous year, data from the Trade Ministry showed last Wednesday. The exports are an indication of Brazil’s growing influence as a corn producer with two annual crops and ample room to plant new fields.

The figures are also indicative of the global trade disruption caused by the El Niño climate phenomenon. South Africa may need to import as much as 5 million tons of maize this year, roughly half of its requirements, due to its worst drought in three decades, the country’s largest producer group said on Wednesday. India, another traditional corn exporter suffering from drought, issued a tender to import 320,000 tons of yellow corn free of genetically-modified organisms (GMOs).

Corn exports pie chart

On balance I don’t think the U.S.’s dominate market share will be dented too much as the demand from those traditional exporters will need to be met. In fact, buyers will soon have to look elsewhere for corn, however, as Brazil’s ports will switch from corn to soybean exports in late February or early March.

But with corn prices sitting at multi-year lows farmers may be reluctant to commit too much acreage to corn.

Corn futures chart 2.7.16

Corn is a very picky and sensitive crop especially compared to soybeans which is essentially a weed.   In the early days of planting corn needs both the right amount soil temperature and moisture to take root. But the most crucial time comes around 6-8 weeks in, around mid-June for most of the corn belt, when corn enters the tasseling stage.

There are a couple of important points that can be made about the cost structure associated with these crops. First, the variable costs associated with corn are much higher than for soybeans and wheat. The greatest difference is in the amount of fertilizer that is required to grow corn. In these estimates, fertilizer costs are nearly $100 per acre greater for corn than soybeans. Seed costs are also much lower for soybeans and wheat than corn. These two categories, seed and fertilizer, comprise 70% of the variable costs of corn production and 55% and 46% of the variable costs of soybean and wheat production.

Not only are variable costs of corn production higher in absolute terms, they are higher in relative terms. For instance, variable costs account for about half of the total costs of corn production and 36% to 38% of total costs for soybeans and wheat.   Also, because of the relative sensitivity of corn the land to grow tends to cost 20% more per acre.

But corn is also one of the most profitable crops and there is a certain inelasticity in demand. With the dollar having stopped gaining strength I expect overseas demand to increase back to 2011 -2012 levels. Which also happen to be when the U.S. experienced a heatwave and drought driving prices up by over 150% at their July peaks.

I’m not in the weather prediction business but their certainly have been more frequent and more extreme weather patterns around the globe in recent years. Meteorologist are predicting an especially strong El Nino to persist over the Pacific through the late spring.

Any disruption, or just as important, the perception of a potential weather related diminishment of yield, could send corn prices soaring.

The Trade:

I’m using the Teucrium Corn Fund (CORN), an exchange traded fund, the trading vehicle for establishing a bullish position.

Since the move could be fairly explosive I want to buy longer dated calls outright to have maximum profit potential. Specifically, I’m targeting;

Buy August 22 Calls for $1.00 per contract

These options expire on August 19, 2016 which gives them over five months and covers the crucial part of the growing season, for the bullish thesis to play out.

I would have an initial target of $28 which would give the options a minimum value of $5 for a 400% profit.

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.