Opinion: Law of supply, demand evident in high corn prices, shrinking stock

Regardless of what it was called, it was never in balance; always up on one end or the other. Equilibrium was ephemeral.

The markets are like see-saws. The markets are classic examples of the supply-and-demand equation on steroids. Here, too, equilibrium is a theory seldom proved – else the trading day would end with all markets unchanged, as sellers and buyers would have balanced out and gone home happy.

The law of supply and demand works, although it is sometimes painful for some while rewarding for others. Crude oil and retail gasoline prices are very visible examples.

Corn highs

Let’s look at another example: the price of corn. There’s a huge demand as we rush into ethanol production to meet government-mandated energy standards, driving corn prices to near record levels. So here comes the supply, as the Agriculture Department announces corn plantings estimated for 2007 at their highest levels since 1944.

This brings us to the rule of unintended consequences and three examples. 1. The more acres devoted to corn, the fewer available for wheat and soybeans, which lowers that supply, raising costs. 2. And what happens to the price of cereal and of meats from grain-fed animals? 3. Higher corn prices mean higher costs of ethanol production, making that alternative energy source more expensive.

Are there any solutions? There are a couple of ideas that should be rationally evaluated.

First, let’s not let Congress mandate levels of ethanol use that exceed our production capacity. Second, eliminate the tariff on Brazilian ethanol. Neither of these ideas is likely to make the Corn Belt agriculture industry, their lobbyists, or senators and representatives happy. (Hey, doing the right thing is seldom the easy thing, but isn’t it time for the pandering and partisan bickering to end and logical governing to begin?)

Back to stocks

Let’s apply the law of supply and demand to the stock market. The late 1990s and early part of 2000 flood of initial public offerings has slowed to a mere trickle, eliminating most of that supply. Additionally, the number of mergers, acquisitions and companies going private are shrinking the existing supply of common stock. Through the first three quarters of 2006, the value of companies going private exceeded $173 billion. If the trend continues, the supply side of the equation will ultimately be out of kilter with the demand side. More demand and less supply mean higher prices. It won’t happen overnight and to my knowledge no one has projected a timetable for when it will happen. I expect more will be written on the subject in coming months as the Blackstones, Cerberuses and KKRs of the finance world continue snapping up public companies and taking them private. (And why not go private and escape the burdens and rigors of Sarbanes-Oxley, the SEC and state attorneys general?)

As a long-term trend, any continued shrinking of the supply will be bullish for the equity markets. There also is a possible negative repercussion on corporate bond markets, especially bonds of lower grade, if the financing of taking companies private is leveraged by companies with less-than-solid credit. It’s worth keeping an eye on, and a reason to limit one’s exposure in the area of high-yield bonds, aka junk bonds).

Clark Davis is a 37-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.