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"Fundamentally, the increase in exports and export sales has
been a supportive factor," said Darrel Good. "Ideas that
ethanol-driven demand for corn will continue to increase at a
brisk pace and that U.S. corn acreage may decline modestly in
2006 also provide fundamental support. "Dry weather has driven
wheat prices higher and has raised concerns about the 2006
growing season for corn and other crops. Speculative demand for
corn and other crops has also escalated, as evidenced by the
daily tally of the net position of the fund traders."
Good's comments came as he reviewed the recent history of
corn prices, which have been on a bit of a roller coaster since
harvest but are now at the highest level since late summer 2005.
The large carry in the corn futures market results in a
relatively high price being offered for the 2006 crop.
March 2006 corn futures traded to just under $2.26 on Feb. 3,
the highest price for that contract since early September 2005.
December 2006 futures traded over $2.60, just about 9 cents
below the contract high. The average spot cash bid in central
Illinois reached a marketing-year high of $2.075 on Feb. 3, 44
cents above the marketing-year low price reached on Oct. 18,
2005.
"The price strength has been a little surprising given the
magnitude of the surplus in U.S. corn inventories," said Good.
"However, over the past 32 years, the central Illinois cash
price has never established a marketing-year high in February,
suggesting that even higher prices might be expected sometime
over the next six months."
Good noted that the recent price volatility and uncertainty
about the 2006 growing season makes pricing decisions difficult.
"For new-crop pricing, it may be useful to try to discern the
size of the 2006 crop that the market is trading at any given
time," he said. "This is not an exact science, since demand for
the 2006 crop is also uncertain to some degree.
"Furthermore, the supply, consumption and price relationship
is not consistent over time. However, it may be a useful
exercise to try to answer the question: What size crop is the
market trading?"
The starting point, Good said, is to estimate the 2006-07
marketing-year U.S. average farm price implied by current
futures prices. Since 1975, the USDA has calculated the
difference between the average monthly cash price received by
farmers and the average closing price of nearby futures for each
month during the marketing year.
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 "That difference is not consistent over time, but using, say, the
average difference of the past five years as the forecast for
2006-07 may be a reasonable approach," he said. "Using the five-year
average and closing futures prices on Feb. 3, 2006, the futures
market implied a 2006-07 marketing-year farm price of $2.51 per
bushel."
The second step is to estimate the supply and consumption balance
implied by the average cash price. The relationship between the
year-ending stocks-to-use ratio and the average marketing-year price
can be used as a proxy for that estimate.
"Based on the relationship between the stocks-to-use ratio and
price since 1998-99, a price of $2.51 implies a 2006-07 year-ending
stocks-to-use ratio of 8.8 percent," said Good. "In comparison, the
current projection of the stocks-to-use ratio for the 2005-06
marketing year is 22.4 percent."
The third step is to determine the crop size implied by a
stocks-to-use ratio of 8.8 percent. That requires a forecast of
likely consumption in order to calculate the implied crop size.
Allowing for a generous increase in both domestic and export use of
U.S. corn in the year ahead, total consumption might reach 11.355
billion bushels, 545 million more than expected to be used this
year.
"A stocks-to-use ratio of 8.8 percent, then, means 2006-07
year-ending stocks of 1.047 billion bushels, implying a crop of
9.966 billion bushels," said Good. "That is, the market appears to
be trading a 2006 corn crop that is 1.146 billion bushels, or 10.3
percent, smaller than the 2005 crop.
"That calculation is obviously sensitive to the forecast of use.
A smaller forecast of use implies a smaller crop and vice versa."
If the 2006 corn yield is near trend value of 149.5 bushels, a
crop of 9.966 billion bushels implies harvested acreage of 66.66
million, 8.45 million less than harvested in 2005. Conversely, if
harvested acreage of corn is reduced by 1.5 million in 2006, a crop
of 9.966 implies a U.S. average yield of 135.4 bushels per acre.
"As the 2006 growing season progresses, decision-makers might use
the concept outlined here as one piece of information in making
pricing decisions," said Good. "The crop size implied by the futures
market can be evaluated against known information about acreage,
weather and crop conditions to make a judgment about whether the
current price is over- or undervalued."
[University
of Illinois College of Agricultural, Consumer and Environmental
Sciences news release]
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