IS CORN UNDERVALUED?
Corn prices have declined significantly over the
past two months. December 2002 corn futures traded to a high of
$2.96 on September 11, declined as low as $2.34 on November 11,
and recovered to $2.42 at the close of trade on November 15. The
average spot cash price of corn in central Illinois peaked at $2.785
on September 11, declined to $2.30 on November 11, and recovered
to $2.37 on November 15.
The sharp decline in prices occurred during a period
when the USDA increased the projection of year ending stocks by
a modest 100 million bushels. The price decline has led some to
conclude that corn prices are "undervalued". In general,
this conclusion is based on the observation that historically, prices
have been higher than current prices when carryover stocks were
small. However, trying to correlate price with stocks, or a ratio
of stocks to annual use, is a shortcut that has a number of shortcomings.
In particular, that type of analysis generally ignores the fact
that price, consumption, and stocks are determined simultaneously,
not independently. Similar stock levels can be associated with different
price levels reflecting, for example, variation in the demand for
consumption , the demand for stocks, and the total supply of the
The best test of whether crop prices at this time
of year are undervalued or overvalued is the rate of consumption
in relation to available supplies. If consumption (seasonally adjusted)
is occurring at a faster rate than can be sustained by available
supplies, it would be safe to conclude that prices are undervalued,
and vice versa. The difficulty in reaching such a conclusion is
two-fold. First, the size of the 2002 corn crop is not known with
certainty. Large changes in the crop estimate in the January report
are not expected, but the magnitude of available supplies may be
different than currently estimated. Some expect a smaller estimate
due to a reduction in the estimate of harvested acreage. Second,
complete, timely information on the rate of corn consumption is
not available. Feed and residual use of corn is the largest category
of use, but the rate of consumption is only revealed in the USDA's
quarterly Grain Stocks reports. The first such report for the 2002-03
marketing year will be released on January 10. The magnitude of
livestock slaughter and livestock inventory reports provide some
insight on the likely rate of consumption, but the quarterly stocks
reports provide the only hard information. The expectation this
year is that declining numbers of cattle and hogs, along with low
hog prices, will result in a decline in feed and residual use of
corn. The year-over-year decline will likely be largest in the last
half of the marketing year. The USDA currently projects a 3.4 percent
decline for the year.
Domestic processing use of corn is partially revealed
in monthly industry reports. The most important sector this year
is the ethanol industry. Monthly reports confirm a record pace of
ethanol production and the USDA projects a 15 percent year over
year increase in the amount of corn used for ethanol production.
Weekly reports of corn export activity are available.
Export inspections through the first 10 weeks of the 2002-03 marketing
year totaled only 255 million bushels, 27 percent less than during
the same period last year. Unshipped sales as of November 7, however,
were reported at 314 million bushels, 17 percent larger than outstanding
sales of a year ago. Total commitments stood at 569 million bushels,
6 percent less than commitments on the same date last year. For
the year, the USDA projects exports at 1.925 billion bushels, about
2 percent larger than exports of a year ago. It is expected that
larger sales to Canada, the entrance of Australia in the import
market, and the tight supplies of grain sorghum will support U.S.
exports at a higher level.
At this stage of the marketing year there is no
evidence that corn is being used at a rate that cannot be sustained.
Based on the current projections for the marketing year, stocks
on September 1, 2003 will total 848 million bushels. That is a relatively
low level of stocks, but is above the minimum pipeline inventory.
There is room for the production estimate to be reduced and/or consumption
to exceed current projections without running out of corn this year.
While there is always the need for more information,
it now appears that current corn prices are significantly undervalued
only if production does not rebound in 2003. In general, it is thought
that current price prospects favor more corn acreage, at the expense
of soybean acreage in 2003. The USDA's Winter Wheat Seedings report
to be released on January 10 will provide some insight into prospects
for spring planted crops, particularly in the plains states. The
major unknown for 2003 is weather. A return to a trend line yield
may be required to maintain consumption of U.S. corn at the current
Corn prices have the potential to add to last week's
gains, but upward potential this winter may be limited if consumption
patterns continue near the projected levels. As always, the USDA's
January reports will provide information to reassess price potential.
University of Illinois