An inverted market occurs when nearby prices trade at a premium to deferred prices. The corn market is showing a strong inverse; the old crop contract (Jul’12) has traded at a premium of 55-105 cents over the new crop (Dec’12) contract since the start of the year. It currently stands at about 80 cents/bu.
Inverted markets fascinate me because they raise so many interesting questions. For example, how will the inverse be resolved? Will new crop values eventually rise to match old crop prices, or will the opposite occur – old crop values decline to new crop prices? Another question concerns timing – when will the inverse be resolved?
I’ve been examining years since 1987 when the July/Dec corn spread (old crop/new crop) has shown an inverse in early May (I don’t like looking at years prior to 1986 and the Freedom to Farm Act – too many different policy dynamics at play). This definition includes 8 years – 1989, 1990, 1992, 1994, 1996, 1997, 2004, and 2011 – or roughly one-third of the 25 years looked at. Here’s a handful of observations concerning these years.
What do these years have in common with 2012? From a fundamental standpoint, these were all tight carryout years in the corn market. Consider the most recent five years in my list – 1994, 1996, 1997, 2004, and 2011 – these years represent the smallest stocks/use ratio in corn recorded in the last 20 years (ranging from 4.1% in 1995/96 to 10.7% in 1996/97). The other three years were marked by sharp declines in the stocks/use ratio from the previous crop year.
How extreme can these inverses get? Let’s start with the modest ones – in 1992 and 2004, the inverse from old to new crop corn futures was generally less than 5 cents/bu. The next group of similar years includes 1989, 1990, 1994, and 1997. In these years, the inverse from old to new crop futures ranged from 11-21 cents/bu. We are left with the extreme years – 1996 and 2011. Last year, the inverse spent most of the time in a wide range from 40-130 cents/bu, peaking at 133.5 cents on the first day of March. 1996 remains the mother of all old crop/new crop inverses, reaching a high of 187 cents in early July (Jul’96 futures at $5.37/bu. and Dec’96 futures at $3.50/bu.). By the way, 1995/96 and 2010/11 are the tightest years on record in terms of the stocks/use ratio and the current crop year (2011/12) is tighter than last year.
Last week I read with interest opinions of old and new crop corn values. Many analysts are wildly bullish old crop corn, and bearish new crop corn. How can that be? Here’s how – take the current 80 cent inverse and run it out to 180 cents/bu. Is this my bold prediction? I make no bold predictions – I simply find it interesting that the precedence for a much stronger inverse is there.
How were the inverses resolved? In each year, it was the old crop values that eventually collapsed, and the brunt of the adjustment inevitably occurred in the month of July. This is not a shock to anyone as we all know the adage that “July makes the corn crop.” I looked further back in history for an exceptional year and I found it in 1983. This year was a drought year in the Corn Belt.
In these inverted years, what happened to new crop prices from planting in the spring to harvest in the fall? This may be the most interesting observation about the inverted years. Not only did old crop prices collapse, but new crop prices also declined every year, and the decline from spring to fall was sharper than seen in “normal years.” I’ve written and spoken many times about the tendency for December corn futures to decline from spring to fall. Since 1990, the average decline for all years was about 10%. The average decline of December futures from spring to fall in the inverted years was 15%. Again I looked deeper in history for the exception (because nothing is 100%) and there was the 1983 drought year (a 17% increase).
Dec’12 is currently trading near $5.25/bu. A 15% decline in value would put it at about $4.50/bu. at harvest.
Inverted markets are fascinating.