When all is said and done, predicting the damage done to U.S. corn and soy crops from the worst drought in half a century may have been the easy part.
With the harvest imminent and plants mature, most traders are fairly confident they have a handle on this year's supply. Whether corn yields are 120 bushels an acre or 130, it's clear that demand will outstrip supply, possibly by a wide margin. Demand, in trade parlance, will have to be "rationed".
What's far less clear -- and harder to discern now than ever before -- is just how much less food, feed or fuel will be made from corn as buyers cut back. From food companies to livestock ranchers to ethanol plants, the calculations are complex: Can end consumers withstand higher prices? Can they sustain production with cheaper grain alternatives?
For traders, that complexity is multiplied. The unpredictability of dry weather is nothing compared to the vagaries of consumption by livestock producers, exporters, ethanol makers and other industrial users that turn corn into scores of products including plastics, adhesives, explosives and pharmaceuticals.
So after two months of relatively steady price gains as every passing hot, dry day withered the crop a little more, some are bracing for a bumpy spell in which traders attempt to second-guess the price point at which demand is rationed.
"Demand occurs in so many different categories that it's a little hard to get your hands around," said Darrel Good, a respected agricultural economist with the University of Illinois and a foremost authority on the topic.
"The thought process is pretty clear, but quantifying things is pretty subjective."
The U.S. Department of Agriculture cut its 2012/13 U.S. corn crop forecast by 4.011 billion bushels, or 27 percent, over the past two months and slashed its estimate of corn use across all demand segments by 2.55 billion bushels, or 19 percent.
U.S. inventories at the end of next summer are now expected to fall to 650 million bushels, a 17-year low and considered near the bare minimum required to prevent an unprecedented scramble for the last kernels. As recently as June, the USDA had forecast 2 billion bushels.
Few traders expect those numbers to be final, with the agency fine-tuning for months to come.
In theory, the mystery of demand should offer opportunities for smart traders to capitalize on volatile markets. In practice, the evidence needed to quantify demand can be so disparate and piecemeal that it defies order.
U.S. export sales are the easy part, strictly reported on a weekly basis. For everything else it's a case of scouring data on livestock slaughter rates, chicken egg sets or sow liquidation; anticipating government policy on ethanol; or seeking private market intelligence on how much wheat is replacing corn among pig farmers.
Cargill said this week that it was delaying the announcement of its 2013 sweetener pricing, suggesting the agribusiness giant may be anticipating difficulty in sourcing corn.
The change in sentiment from a supply-induced panic to a period of demand uncertainty is already weighing on prices. From Friday through Tuesday, corn for December delivery on the Chicago Board of Trade (CBOT) fell 4.2 percent to post the biggest three-day drop since June 13, just days before traders first fixated on the drought.
From mid-June to mid-July, corn embarked on a remarkably orderly rally, surging for several days and then pausing for another push. Rarely did prices close at their daily maximum.
Never did they fall more than two days in a row. For the past two weeks, however, they've just bounced around.
"The first phase is unidirectional, where the market goes into a little bit of a panic mode, trying to price the day-to-day weather," said Malinda Goldsmith, a partner at agriculture-focused and Dallas-based Four Seasons Commodities, where she oversees a $50 million portfolio that gained 10 percent in July.
"Then you get to a point where the demand gets to be destroyed. And the market gets more choppy. Then you get into a very volatile period, which is the one we're in now, where we have sharply higher, sharply lower prices."
She concluded: "Now it's going to get dicey."
ETHANOL COMPLEXITY ...
Source: Argentine Beef Packers S.A.
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