Corn Pops

Americans burn more corn than they eat…maybe that’s the
reason corn prices are sizzling?

According to most old-timers in the Chicago grain pits,
corn prices are rallying for "no good reason." We would not
dare to argue with the pros, but maybe corn is rallying for
a mediocre reason, at least?

Whatever the precise driving force, the price of the nearby
corn contract has advanced 16% to $2.22 a bushel, since
touching a 34-month low last month. The ubiquitous "hedge
fund speculators" receive most of the credit/blame for
powering this perplexing advance. But maybe the rally is
not as nonsensical as it appears. Maybe the corn market has
caught a whiff an impending demand boost from the nation’s
burgeoning ethanol industry. Last year, ethanol production
consumed 11% of America’s record corn crop. And if recent
trends persist, this year’s ethanol production might
capture an even larger share of the crop…in which case,
$2.20 corn might be way too cheap.

But before considering the potentially bullish future
influence of ethanol production on corn prices, let’s
examine the potentially bearish influences of the here and

For starters, U.S. farmers produced a whopping 11.8 billion
bushels last year – up 17% from 2003. Meanwhile, a massive
30% boost in the Argentinean crop produced a similarly
substantial jump in exports. These record supplies all
added up to the largest year-end U.S. corn stockpile since
1987. In recognition of the corn glut, prices tumbled from
$3.35 a bushel last spring to a low of $1.91 in early

But then something unusual happened. Corn prices started
rallying, along with most other agricultural commodities.

That’s good news, right? Not exactly…the "wrong"
investors are buying the stuff.

The so-called "large speculators" tracked by the CFTC have
amassed a very large net-long position, and that’s not
usually a favorable augury for any commodity market.
Whenever this traditionally "dumb money" places a large
directional bet, it’s usually best to head in the opposite
direction…at least for a while.

Nevertheless, we ask ourselves, "Is the recent corn rally
merely the footprint of large speculators diving into the
market, or the foretaste of something more legitimate and

We do not know the answer of course, as our morning bowl of
corn flakes contains the entire scope of our corn market
knowledge. Even so, we naively imagine that ethanol
producers – like UFOs in a cornfield – might begin to exert
a mysteriously potent new influence. If so, the recent corn
rally could be the beginning of a large move, rather than
the end of a small one.

Let’s consider a few pertinent facts…

First of all, ethanol, also known as ethyl alcohol or grain
alcohol, has become the federally subsidized, state-
mandated gasoline additive of choice. When blended with
gasoline, this "bio-fuel" boosts octane, while reducing
tailpipe emissions. Thanks to these virtues, ethanol has
displaced the octane boosting, but ground-water-polluting,
MTBE as the nation’s leading gasoline additive.

Demand for fuel ethanol in the United States reached a new
high in 2004, due primarily to the fact that in January of
last year California, New York and Connecticut all banned
the use of MTBE in reformulated gasoline (RFG). Ethanol
quickly filled the void.

"The growth boom in the U.S. fuel ethanol industry
continues to take the nation by storm," the Renewable Fuels
Association (RFA) beams. "In 2004, the industry produced a
record 3.41 billion gallons, more than double that produced
in 2000. Consider this: It took the industry ten years to
reach our first billion gallons. It took another ten years
to achieve the second billion gallons. It has taken just
two years to reach the third billion gallons.

"Renewable fuels produced from homegrown resources ensure a
safe, reliable source of energy for the homeland," the RFA
gushes, "while at the same time generating significant
economic and environmental benefits to the nation."

To hear the Renewal Fuels Association (RFA) tell the tale,
the only benefit ethanol cannot impart is eternal life.
"The production of ethanol sparks capital investment,
economic development and job creation in communities across
America," the RFA asserts, "while providing value-added
markets for farmers. By raising the price of agricultural
commodities, ethanol also helps to lower federal farm
program costs."

All well and good, but the production of ethanol is not
quite as "renewable" or "green" or economical as
advertised. For starters, ethanol production relies heavily
upon the fossil-fuel-powered muscle of tractors, combines,
transport vehicles and processing plants to deliver its
"renewable" fuel. Happily, according to the U.S. Department
of Agriculture, ethanol delivers 167% of the fossil energy
that is used to produce it.

Then to, there is the issue of a hefty 51-cent per gallon
tax credit generously granted to ethanol producers by the
US government. At the end of the day, therefore, we are not
certain whether ethanol production is a miracle of nature
or a miracle of legislation.

But we do not care to judge the merits of ethanol
production, merely its effects on the corn market. And on
this matter, we would judge that the effects of ethanol
production are likely to be bullish for the corn price…at
least at the margin.

Already, ethanol production in the U.S. consumes more corn
than humans – 11% of the entire crop, to be exact. (Ethanol
also consumes an identical percentage of the grain sorghum
crop). And as the chart above clearly shows, production has
been rising sharply in recent years. The trend seems likely
to continue.

The fact that government subsidies will remain in place
until 2010, at least, suggests that ethanol production will
remain a very tasty business for producers like Archer-
Daniels-Midland Co. (NYSE: ADM). "BioProducts" generated
about 22% of ADM’s total operating profit last year, more
than double the tally for 2003. And what’s good for ADM
should be good for every other ethanol producer, which is
why ethanol plants are cropping up all over the Midwest.

"As individual states continue to ban the use of MTBE
(Methyl Tertiary Butyl Ether) and with the possibility of a
Federal ban, ethanol consumption is due for a significant
boost," the RFA reports. "As of the start of 2005, 81
ethanol plants in 20 states have the capacity to produce
nearly 4.4 billion gallons annually and an additional 16
plants are under construction to add another 750 million
gallons of capacity (RFA)."

More ethanol plants, we would guess, will mean more demand
for corn.

Thus, the most direct play on rising ethanol production
might be to buy a long-dated corn future. As of yesterday’s
close, the Dec 2007 contract traded for $2.50 a bushel.
That’s 28 cents higher than the spot price, but 85 cents
BELOW the $3.35 level reached last spring. Sometime between
now and the end of 2007, corn might take another run toward
its old highs. Then again, it might not. But the current
price of corn seems to reflect more fear than greed…and
we like buying fear.

Corn Bread and Serious Dough

Did You Notice…?
By Eric J. Fry

The G-7 doesn’t want any Ruskies in its club. After all,
the "crony capitalists" from the former Soviet Union hardly
possess the sort of pedigree that begets G-7 membership.

"If you look at Russia’s economy compared to those in the
G-7, it’s hardly in the same league," scoffs Sir Nigel
Wicks, former deputy to the U.K.’s Chancellor of the

Sir Wicks has a point; the Russian economy bears almost no
resemblance to that of the G-7 nations. As the charts below
clearly show, Russia’s GDP grew nearly 7% last year, while
its government operated comfortably in the black.

This sort of thing just isn’t done in a civilized
society…it’s just not "cricket."

And the Markets…



This week

















10-year Treasury





30-year Treasury





Russell 2000


























JPY 104.54

JPY 104.18



Dollar (USD/EUR)





Dollar (USD/GBP)