2006-07-10 06:30 (New York)

By Jeff Wilson and Saijel Kishan
July 10 (Bloomberg) - The September harvest in the U.S. will produce enough corn to fill every one of the thousands of Midwest silos, or cover South Carolina, West Virginia, Maryland and Rhode Island with an inch of grain.

That prospect has money managers at Pacific Investment Management Co. and Ospraie Management LLC drooling. They're betting the surplus will disappear within two years, causing prices to double for the first time in a decade. Corn will outperform oil, copper and gold through 2008, said Christopher Wyke, 51, manager of Schroders Plc's $62 million commodity fund, which doubled the returns of the Goldman Sachs Commodity Index this year. Pimco and Schroders are increasing investments in corn because of a surge in demand for ethanol and livestock feed.

Consumers of corn are "going to have to compete with the rival demands of either fueling the world or feeding the world," said Dwight Anderson, 39, who manages $4 billion at Ospraie in New York and previously worked at the hedge funds of Julian Robertson and Paul Tudor Jones. "We are going to see record agricultural profitability."

Even after reaching an 11-month high of $2.7275 a bushel in Chicago last week, corn is barely half the peak price of $5.135 set during the rally of 1995-1996, the last time prices doubled.

December corn was up 3.5 cents at $2.6925 a bushel in electronic trading, as of 1:39 a.m. in Chicago.

Compared with other commodities, corn is a bargain. The cost of a barrel of oil is equal to 28.4 bushels of corn, compared with 4.7 bushels in June 1998. An ounce of gold will buy 238 bushels, more than double the 105 bushels in 1998.

"Cheap" Corn

"Grains are cheap, cheap, cheap," said Brent Harris, 46, who runs Pimco's $14 billion Real Return Strategy Fund in Newport Beach, California. "Ethanol demand is cranking up" and threats of crop damage from hot U.S. weather are increasing, said Harris. His fund has topped the returns of the Dow Jones- AIG Commodity Index by an average of 5 percentage points a year since its founding in 2002.

The price of corn has jumped 23 percent this year, exceeding the gain in gold, which reached a 26-year high in May.

Oil rose 24 percent since the end of last year to a record $75.78 a barrel last week. The Standard & Poor's 500 Index of stocks is up 2.1 percent. The last time corn outperformed oil, gold and the S&P was in 2000.

"Agricultural products will broadly outperform energy and metals over the next three years as supply restraints worsen," Wyke said, forecasting corn prices may jump another 50 percent.

The biggest boost for corn is coming from ethanol, which the U.S. government ordered be used as a fuel additive to extend gasoline supplies.

Bulging Inventories

Ethanol demand will boost U.S. corn use 34 percent to 2.15 billion bushels in the year that begins Sept. 1, up from a record 1.6 billion this year and a 62 percent jump from 2005, the U.S. Department of Agriculture estimates.

Rising gasoline prices, along with government subsidies and support of ethanol, will help erode U.S. corn inventories that after this year's harvest will reach 12.736 billion bushels, the second-largest ever, the USDA said. The amount is enough to cover 65,785 square miles with an inch of corn.

U.S. ethanol production jumped 21 percent to 12.1 million gallons a day in April, according to the Energy Department. Ethanol makers are earning $6 of profit on every bushel of corn they process, according to data compiled by Bloomberg. An estimated 32 new ethanol plants and six expansions will boost U.S. capacity by 41 percent over the next two years, the Renewable Fuels Association said.

Changing Diets

Corn use in ethanol will increase almost 100 percent to 4 billion bushels in the next two years, leaving no margin for weather damage or poor crops that occur in all agricultural markets, said Bill Plummer, 63, founder of the $110 million Range Wise Inc. futures trading fund in Chicago.

To meet that increased demand, Iowa, the largest corn- growing state, would have to double the size of its crop. Worldwide corn consumption will exceed production for the sixth year since 1999, reducing global inventories to the lowest since 1984, the USDA said. Corn reserves in China, with a population about 4.5 times larger than the U.S. and crops planted on 25 percent fewer acres, will fall to a 30-year low next year, the agriculture department said.

The Organization for Economic Cooperation and Development and Food and Agriculture Organization of the United Nations said corn prices may climb 29 percent in the next four years. Rising incomes are changing diets in developing countries, boosting demand for meat and livestock feed.

Drought May Arrive

The price of corn in Chicago has yet to reflect the returns that investors expect from ethanol makers. Shares of Archer Daniels Midland Co., the biggest U.S. producer of ethanol, jumped 70 percent since Dec. 30, the second-biggest increase in the S&P 500 Index.

Prospects for the coming corn crop are deteriorating as temperatures rise and the sun bakes the Midwest, where some areas received less than 50 percent of normal rainfall this year.

Iowa, the biggest corn and soybean grower, had its sixth driest May-June period in 134 years, state climatologist Harry Hillaker said in Des Moines. June is usually Iowa's wettest month.

A crop-damaging dry spell is likely, if not this year, then during the next three years, said Elwynn Taylor, a climatologist at Iowa State University in Ames.

Rising temperatures in the Pacific Ocean north of Hawaii the last six years are part of 30-year cycle of warmer and drier weather west of Interstate 35 from Forth Worth, Texas, to Minneapolis, he said.

Record Trading

A 19-year drought cycle will peak by 2009, said Taylor, who has studied 800-year-old Cyprus tree rings from Virginia and North Carolina to assess the pattern. The last major peak in the cycle came in 1988, when the U.S. corn crop was cut almost in half by hot, dry weather, Taylor said.

Corn also is getting a boost from investment funds. The amount of trading and number of outstanding contracts for corn futures on the Chicago Board of Trade rose to records in the quarter ended June 30. The number of open positions on June 1 reached 1.351 million contracts, almost double a year earlier, and trading rose to a record 336,422 contracts on May 12.

Investors should hold 10 percent to 15 percent of their assets in commodities, according to an Ibbotson Associates study commissioned by Pimco. Most hold just 2 percent to 6 percent, said Robert Greer, product manager for Pimco's Commodity Real Return Strategy Fund.

Hermes Piles In

Retirement funds including Hermes Pensions Management Ltd., manager of the U.K.'s largest, this year started investing in commodities for the first time. About $100 billion will be spent by pension funds and other money managers in commodity indexes and related products by the end of 2006, compared with $10 billion at the end of 2003, according to HSBC Holdings Plc.

Money invested with commodity trading advisers has more than tripled to $135 billion at the end of March compared with $40.1 billion at the end of 2001.

"The price of corn is about 10 percent higher than it would be relative to historical supply and demand ratios," because of the increased investment by pension funds and other investors, said Paul Meyers, a vice president for commodity analysis at the Connell Company in Berkeley Heights, New Jersey.