If football is now America's sport (I did a poll, a hotly contested poll, as it was. The results reflect how outdated the old Chevy commercial is. "Baseball, hot dogs, apple pie, and Chevrolet" have been replaced with "football, chicken wings, sushi bars, and foreign cars".), then corn is America's commodity market. Of the three major commodity markets of corn, crude oil, and gold -- corn is the more heavily dependent on domestic (U.S.) issues. That's logical given the U.S. is the No. 1 producer, user, and exporter of corn in the world, with exports usually running well above those for the balance of the world's growers.

I bring this discussion of corn up as it relates to a talk I gave earlier this week in Chicago. I was invited to speak at the National Introducing Brokers Sales and Marketing Conference on the topic of a market bubble in the commodity sector. Given 15 minutes for presentation followed by question and answers, I weighed out the best line of discussion, deciding that corn -- for the above reasons -- made the most sense. Also in corn's favor is that it would act as a follow-up to my talk to the same group last year regarding what makes a demand-driven market.

The central question this year is: How do we tell if the commodity sector, corn in particular, is in a bubble? First we have to define what a market bubble is. I'm not an economist, so I don't have my own textbook definition. A search of the internet comes up with one close to my thoughts though: "Trade in high volumes at prices that are considerably at variance with intrinsic values." A few key points leap to the front: Increased trading volume; 2) High prices: and 3) A divergence from a market's intrinsic value.

Higher volume: There is no doubt corn, as well as commodities in general, has seen a period of increased volume. In 2001, total annual volume (number of contracts traded for the year) in corn was just under 7.1 million contracts. In 2010 volume climbed to over 27.2 million contracts, an appreciation of almost 285% over the decade. Looking at these numbers, it seems the first part of the definition of a market bubble has been seen.

High prices: A look at the price distribution chart for both corn futures and the DTN National Corn Index (national average cash price) show both the futures market and cash market trading in the upper percentages of the five-year price range. The December corn contract near $7.40 and the DTN NCI near $7.10 are both in the upper 5% of weekly closes over the past five years. Therefore, the argument could be made that corn is trading at higher price levels than in years past (as if we really needed a chart to tell us that), meaning the second part of the bubble definition exists.

The key, though, is the relationship between these two prices. Remember that the third part of the definition of a bubble has to do with a "variance with intrinsic value." I call it a divergence or a break from the underlying value of the commodity itself. If the two markets lose contact, then a bubble could strongly be argued. The problem is how to see this relationship. In grains it is easy.

National average basis, simply defined, is the difference between the futures market and the underlying cash market. Think back to 2008, when the corn futures market moved to a then all-time high of $7.65. The cash market refused to follow with basis moving to almost 60 cents under the futures contract. In other words, the collapse in the corn market in 2008 was the bursting of a mini-bubble worsened by the implosion of the financial markets.

This isn't the case in 2011. With the futures market moving to a new high of $7.99 3/4, national average basis has held firm near 25 cents under the futures market. This is close to the strongest the relationship between the two markets has been over the past five years at this time of year. Therefore the futures market is not trading in variance to, diverged from, or broken with its intrinsic value -- meaning a bubble does not exist in corn at this time.

Does this mean corn won't go down? No, the market needs to see rounds of selling to keep it from becoming one-sided. CFTC reports since early July have shown noncommercial traders rebuilding their long futures position from about 390,500 contracts (July 3, 2011) to almost 503,000 contracts (Sep. 4, 2011), though the latter still pales in comparison to nearly 620,700 contracts seen in early February 2011.

As discussed in last week's column, the risk to corn is simple economics: high prices leading to reduced demand. As long as pressure from both sides of the market (commercial and noncommercial) is held in check then it is unlikely the next round of selling will be seen as a bursting bubble.

Darin Newsom can be reached at darin.newsom@telventdtn.com

(CZSK)

© Copyright 2011 DTN/The Progressive Farmer, A Telvent Brand. All rights reserved.