A few months ago I blogged about the corn market and how it was overpriced. Since then, the corn price has fallen from USD 830 to USD 740 per bushel, and is likely to fall further. Corn has been studied extensively for its aberrant price behaviour, owing partly to the fact that it is one of the oldest commodities with historical price data, and partly to the fact that a large number of the producers have been classified as ‘hillbillies’ with little economic nous. While modern corn production has moved on from this stereotype, recent price behaviour begs the question as to whether the market still deserves hillbilly status. Read on…
Some facts. The 2012 drought in the US has cut corn production by about 20% based on the latest, end of season estimates. At the same time, corn futures prices rose from around USD 550 per bushel in June to a peak of USD 830 per bushel in August – a rise of over 50%. This data permits a quick calculation of the price-elasticity of demand = 20/50 = 0.4, which is less than unity and so we can conclude that the corn market has been operating at an inelastic section of the demand curve. This means that, even though output has fallen, the total revenue received by producers has risen, since prices have risen proportionately more than output has fallen.
But wait! Basic price theory tells us that profit-maximising behaviour requires demand to be elastic, otherwise producers could increase revenue by cutting production. If revenue has gone up this year because of the drought, why didn’t producers simply destroy part of their crop last year to increase revenue?
It seems that something is wrong in the corn market. It may be that corn producers once again have hillbilly syndrome and are not trying to maximise profits. Alternatively, it may be that hedge funds and speculators have pushed corn prices way beyond their fair price and this will stimulate future supply increases. Most likely its the latter which means that corn prices will continue to fall and the hedge fund community can boast the moniker of ‘dumb hillbillies’.
Go short corn futures.