Fortunes Made: Repeat in the Making?

By George Kleinman
24 Aug 2006 at 01:51 PM EDT

RENO (Future Market Forecaster) -- During the summer of 1995, few people had any clue that the biggest bull run in the history of the corn market had already begun. Prices had dropped from mid-July into mid-August because the government, in its mid-August crop report, indicated the U.S. would produce a record corn crop - similar to this year.

It was clear by the end of 1995 that a large crop wasn’t sufficient to keep prices down; corn prices rallied to record highs. But the real fireworks had yet to begin.

Fortunes were made in corn during 1996 when corn rocketed to $5.545 per bushel, but not many people realized during the summer of 1995 what was about to happen. Those fortunes were made by relatively few people.

Today, I see signs of complacency among corn buyers similar to those of the summer of 1995. The 1995-96 bull market was a classic demand-driven rally. The factors setting up today are, in my opinion, parallel to the factors that caused that dramatic bull move.

A number of factors contributed to the price spike a decade ago, but the most significant was a demand shock the likes of which hadn’t occurred since the mid-1970s and hasn’t since. Unknown to the marketplace during the summer of 1995 was that China, Asia’s largest corn exporter, was turning into a corn importer due to a poor crop. The U.S., the world’s largest exporter, produced a record crop in 1994-95 of 10 billion bushels. As a direct result of added Chinese demand (on top of normal export demand from Japan, the U.S.’ largest customer, and others), total exports surged.

In 1995, the world believed there was a huge stockpile of corn. But in 1996, a buying panic set in when the new crop looked to be smaller than average. Livestock and poultry feeders and industrial corn users worried the world was about to run out. As a result, prices surged above $5 per bushel - a level reached neither before nor since. We now know the world didn’t run out of corn; instead, record-high prices rationed demand, subsequent crops replenished stocks and prices retreated all the way back.

Here’s the Bottom line for the Current Market

Similar to the 1995-96 market, I believe the dynamics are in place for the next classic demand-driven bull market in corn. Last week I recommended that Futures Market Forecaster subscribers start accumulating positions in July 2007 corn futures. At this time, we’re risking less than $1,000 per contract traded and will look to reduce this risk over time.

The reward potential is amazing, many times the risk. There are no guarantees, and there's certainly risk in every trade. However, I’ll be looking to add to this position over time to hopefully pyramid into an extremely profitable trade.

Right now - when corn buyers are looking at a big crop (an expectation already reflected by cheap prices) and complacency has set in - I believe the corn market is forming a significant bottom. Just as the era of cheap energy is behind us, 2006 is the last year of cheap corn. The reason is ethanol.

With 100 ethanol plants either already up and running or close to production and another 35-plus due to come online next year, corn usage for fuel will surge. An average ethanol plant uses 18 million bushels of corn annually. Corn usage for ethanol will grow in 2006 by 300 million bushels versus last year and is projected to rise by more than 500 million bushels in 2007 versus this year. Even if 4 million or 5 million additional acres are planted next year, there’s no way demand won’t exceed supply by a wide margin in 2007.

This demand growth number is almost half of projected ending supply. For the first time ever, corn usage for ethanol will exceed corn exports. I believe July 1996 could be an analog of the July 2007 contract. In 1995-96, China provided the demand shock. This time the demand shock is ethanol, but the ramifications to the corn market are the same.

The July 1996 corn futures contract actually bottomed in December 1994, but there was a significant correction for a test of the lows in August 1995. (As I indicated, this year’s chart looks a lot like that year’s.) August 1995 was the time to load up on the July 1996 contract because prices bottomed at that time and remained in a major bull market until July 1996.

The July 2007 contract low was registered last December at 254. I believe this price will hold as the contract low. The market has now broken more than 40 cents from the mid-July top, and the bearish sentiment is high right now (just like it was in August 1995, right after the crop report that year).

One additional point: If there are any weather problems during next year’s growing season that create a supply shock, the perfect storm will take place. It could be a history-making bull market with the potential for new all-time-high prices. Should this unfold, we’ll also look to purchase the December 2007 futures contract. But we know nothing about next year’s crop, and today I’m looking for demand alone to pull prices higher (even assuming a good 2007 crop).

Right now appears to be the perfect time to begin accumulating a position, one we’ll look to pyramid over time as the market confirms our expectations.

Copyright © KCI Communications, Inc. 2006

George Kleinman is Editor of the futures trading service Futures Market Forecaster. Click here now to try a risk-free 90-day subscription to Futures Market Forecaster. He is also President of Commodity Resource Corp., a futures advisory and trading firm.