The extremely strong corn basis is currently receiving a lot of attention. In an article posted on FarmDocDaily on Oct. 20, we suggested at the time that the strong cash prices relative to futures prices implied that futures prices may have been under-valued relative to demand strength. We concluded with the statement that “Historically, divergences like this one have not tended to last long. It will be interesting to see exactly how this one is resolved. Stay tuned”
Now, three months later, we find the corn basis is even stronger than in October and at record levels in some markets.
Figure 1 illustrates the magnitude of the average basis at country elevators in South Central Illinois each Thursday from late September through late January for the past 6 years. The cash price used in the calculation is the overnight bid as reported by the USDA’s Agricultural Marketing Service and the futures price is the settlement price of the March futures contract. Since October 20, 2011 the basis has strengthened by $0.15 and stood at a record $.05 on January 26, 2012.
In the previous 37 years for which we have data, the average cash price in this area had not ever been above the nearby futures price on this date.
Some have argued that the small crop of 2011 and ample storage space has uniquely allowed farmers to easily store the crop requiring a strong basis to motivate additional sales. That explanation alone is not sufficient to explain the strength in the basis. By that logic soybean basis, for example, would also be record strong, but it is not.
In addition, storage space is always in surplus in the middle of the marketing year so that this year is not unique in that regard. Farmers may be tight holders of the 2011 crop, but the tightness is not just the result of them having capacity to store the crop. Nor is it due to a “shortage” of physical inventories of corn—at least 9 billion bushels of corn were in storage as of December 1, 2011.
So, if there are so many bushels of corn in storage what accounts for the continuation of the very strong basis? It is useful to step back and consider the basic economic function of the basis. The “job” of the basis is to send the appropriate signals through the marketing year so that an adequate amount of corn is in storage at the end of the year since there is usually a gap before the next harvest becomes available. From this perspective, basis levels should be strong when the flow of corn to the market is slow relative to the pace of consumption.