Analysis: Speculators, commercials in rare corn position tango

Usually, large speculators and commercial traders take opposing positions in the corn futures and options market, with speculators favoring long exposure while commercials typically sit heavily short in reflection of their naturally long stance in the physical arena.

But this year’s critically low levels of domestic corn supplies have forced commercial players to whittle down their physical and futures market exposure to unprecedented lows, while the prospect of a record-large haul of fresh supplies this fall has spurred speculators to build up their largest short position in over a decade.

As a result, speculators may for the first time build up an even larger short stance in corn than commercials in the widely followed ‘supplemental’ Commitments of Traders report.

MIRROR IMAGE

Since the inception of the supplemental CFTC report in 2006 the net positions of commercial and non-commercial traders have etched a mirror image of each other, with the commercial net position permanently residing on the short side of the market with non-commercial exposure typically on the long side.

But while that pleasing symmetry remains in place, non-commercial net exposure has swelled so aggressively to the short side lately that the lines charting those net positions are close to crossing for the first time, indicating a potential reversal in the typical position patterns within the corn futures and options realm.

BIG EXPECTATIONS

Broadly friendly growing conditions across the U.S. Corn Belt are fuelling expectations for a record large corn crop from U.S. farms this year, which is why speculative traders have been so keen to establish and grow short positions in corn futures in recent months.

At the same time, the relatively poor returns posted by commodities market investments relative to the equities arena over the past year or so have sparked a general reduction in long exposure to nearly all raw material markets.

The end result has been a swing in the net corn position by the non-commercial contingent from long to short – a trend that looks set to extend in the weeks ahead as long as the emerging 2013 corn crop continues to thrive amid yield-friendly growing conditions.

Meanwhile, the steady erosion in the size of the commercial trader’s net short position also looks set to continue as processors, ethanol plants and other end users continue to have difficulty sourcing sufficient quantities of physical corn.

If the pattern of both commercial and non-commercial positions is extended in the weeks ahead, it is likely the speculative crowd will end up sitting on a larger net short position in corn than the actual physical end users of that commodity, which would be a rare development indeed, having not occurred at all since the supplemental report was launched in early 2006 and only on a handful of occasions, according to other Commitment of Traders reports which measure positional exposure in a slightly different manner.

SNAP BACK?

While the establishing of a speculative net short stance in corn is not altogether unprecedented – having occurred roughly 15 percent of the time over the past 6-1/2 years – it remains an unusual situation for non-commercial traders to be in.

Further, the duration of those periods of net short speculator exposure has tended to be far shorter than the spells of net length, which tend to last for several months at a time.

Finally, the switches in non-commercial positions from short to long tend to be quite sudden and aggressive and usually bring about a reversal in the direction of the corn price as the speculative traders attempt to buy back previously sold contracts at roughly the same time.

A similar switch cannot be ruled out once again this year, as speculators are already sitting on their largest short position in years and new-crop corn futures prices are already at their lowest levels since 2010. Indeed, in order to secure any paper profits from their short exposure non-commercial traders must buy back those positions at lower prices than where they were sold, so it is inevitable that a wave of non-commercial buying will take place as that position-squaring occurs.

So it is only a matter of time before the currently net short speculative community reverses its bias in the corn market and starts to buy rather than sell – if only to secure the profits established by that short exposure.

The timing of that buying wave remains the only major unknown. But it is likely to materialize before too long as traders are fully aware of the potential risk from any early frost, which could cause substantial damage to overall crop prospects, or from any large scale end-user buying interest sparked by the prevailing low new-crop prices, which would boost overall market sentiment even if crop prospects remain historically large.

So while the speculative community may currently appear to be on course to building a net short position that overshadows that of the commercial arena, it may not remain so committed to the short side of the market for long as the risks are growing that an unexpected crop problem or end user buying spree may suddenly reverse corn prices and wipe out any potential profits those speculators may be currently sitting on.

Gavin Maguire is a Reuters market analyst. The views expressed are his own.

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