By now, everyone is aware of the incredible increase in the price of corn thanks in large part to the almost unprecedented drought levels across the country. Up another 5% today at over $7.77, the 30-day run has seen prices up over 41%. However, while this is an unbelievable move to record high prices, on a trailing 12-month basis, this price move has merely mean-reverted to the average gain of the last 10 years. From 2002-2011, the average price rise from July-to-July was around $55 and the current July-to-July price rise is only around $75. While things do not look set to improve any time soon for the weather, some longer-term context for Corn may well be worth considering. Furthermore, as Goldman notes the lack of rainfall and extreme warmth has shifted corn yields to the second-largest yield-loss since 1950 (noting that the current 24% rise in the Ag complex is still well below the 35% rise in the 'drought' summer of 1988) and the implications for global inflation are gravely concerning as hopes of China stimulus are impaired.
Corn has rallied dramatically in the last month or so...
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but it appears to be a mega mean-reversion from extreme low levels (the orange line is the average price rise for the trailing 12 months for the last 10 years and the black line is current trailing 12 month price change for Corn)...
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though the reversion seems well-founded in the terrible reality of the weather...
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As Goldman notes:
The agriculture complex is +24% since June 8 due to severe drought conditions in the US. The lack of precipitation and extremely warm weather (which also helped to push natural gas prices higher), caused us to substantially lower our US corn and soybean yield forecasts and raise our price forecasts for both crops as well as wheat. This shift in our expected corn yield suggests that the crop is likely facing the second-largest yield loss since 1950 if we exclude 1983 and 1993 – years with major floods (see Exhibits 1 and 2). In 1988, the US Midwest faced an even worse drought than the current one, and the agriculture index surged by 35% that summer.
But this has dramatic implications for the rest of the world...
As our positive outlook on the industrial commodities, particularly copper, is based upon more accommodative policy in China and the emerging markets, this surge in agriculture prices creates some caution when thinking about the inflationary policy feedback loop. Benign inflationary pressures have given central banks in China and other EM countries room to pursue aggressive rate cuts. However, for many of the emerging markets, food prices still represent a significant share of the overall CPI, which suggests that this rise in agriculture prices could start to pose a threat to the benign inflationary pressures. This is particularly the case for China where food represents nearly a third of the price index. As a result, strong agriculture prices through the policy feedback loop have begun to create a risk to our broader commodity views.
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We currently believe that, barring further deterioration in weather conditions this summer, the current production shortfall is likely priced into the agriculture markets. For example, our just-increased corn price forecasts, which embed a more negative yield outlook than the USDA, remain slightly below the forward market prices. Nonetheless, we believe that the recent rise in food prices, especially soybeans, could lead to a 15% rise in the food component of the Chinese CPI, which would translate into a nearly 5% rise in the overall CPI, all else constant (see Exhibit 3). For now, the downward price pressures in other nonfood price components suggest that the recent rally in food prices will not significantly derail the ability of EM central banks to pursue the accommodative policy that is expected to keep demand supported during the second half of this year. The risks, however, have clearly risen with the recent adverse weather.
Source: Bloomberg, Goldman Sachs