There is a dangerous situation right now in corn.
Late comers who buy into the surge in corn prices at this stage expose themselves to tremendous downside risk in the immediate future.
In a note to Pay Dirt subscribers in late June, I wrote:
"Hot, dry weather across much of the U.S. hasn't been kind to crops and there seems to be some consensus that corn stocks will be low for 2012 as a result. Teucrium Corn (NYSE:CORN), the only real corn ETF out there, has shot more than 15% higher in recent weeks as a direct result… If you're a speculator take a look at CORN for swing trades…"
That was a good trade; at the time the CORN ETF rally was in mid-swing. But lately it's gone parabolic, as this recent chart shows.
Today, everyone from Wall Street to Main Street is aware that corn prices have surged. And that means this is NOT the time to buy into the corn rally. It's time to sell out of corn, or simply steer clear. With such a rapid price move and too many unknowns related to corn fundamentals right now, the downside risk to buying into this rally is simply too great.
The rapid price drop resulting from a quick Midwest rainstorm earlier in the week is just one signal that this ETF could crash at a moment's notice.
It's true that the 2012 Midwest drought is looking like the 1988 drought, when corn production fell by more than 30% as compared to 1987.
Four weeks ago, the USDA stated that only 48% of the U.S. corn crop was “good to excellent.” Last week, that rating dropped to just 31% and this week it is closer to just 25%. It's likely that farmers will abandon certain crops since trying to rescue them is a fruitless pursuit.
Given that the U.S. supplies around 40% of the world's corn, it's also likely that there will be food shortages and higher food costs in other areas of the world. Just take a look at major food producer stocks, like Tyson Foods (NYSE:TSN) which has sold off as corn prices have surged, and you'll see that the market has already factored this in.
But 40% of the U.S. corn crop in 2011 also went toward ethanol production in accordance with mandates. If Washington bows to common sense those mandates should be reduced or eliminated this year, possibly reducing corn demand in the mid-term.
The CORN ETF is up more than 50% since mid-June, and at a strong resistance point near $50.00. If you own a speculative position in CORN, take profits now.
This story has gone mainstream. And while there may be upside to CORN if the drought gets worse, I suspect many traders are looking to take profits given such a rapid rise.
Tyler Laundon, MBA