Ag Stocks Still Outdoing Ags

Brad Zigler

Real-time Monetary Inflation (per annum): 8.5%

Not much of a headline is it? I mean, what more can be said about the market for agribusiness company stocks but that investors seem to prefer them more than the physical commodities in which the firms deal.

It's really a just a matter of relative strength and it's eminently playable by retail customers. First things first, though. Let's look at the trend.

We can monitor the strength of agribusiness at a glance with the Market Vectors Agribusiness Fund (NYSE Arca: MOO), an exchange-traded tracker of the DAXglobal Agribusiness Index. The fund's 44 stocks include companies dealing in agriproducts and livestock operations, agricultural chemicals and equipment as well as ethanol and biodiesel.

Global agribusiness has been no slouch this year. A buoyant equity market and a weaker U.S. dollar have propelled the Market Vectors portfolio to a 36.1% year-to-date gain.

The stuff these firms deal in - corn, soybeans, sugar and wheat - are represented in the PowerShares DB Agriculture Fund (NYSE Arca: DBA), an equally weighted, and fully margined, array of commodity futures. The DBA fund is based upon the ag subset of the Deutsche Bank Liquid Commodity Index [DBLCI].

This year, the DBA portfolio has risen 5.3%

Relative Strength (MOO vs. DBA)

You can see where this is going, can't you?

Owning the Market Vectors fund would have produced your gain with a standard deviation, or risk, of 57.1%. That's a lot of volatility. The DB fund, meanwhile, cranks out its return with a 32.7% volatility.

If you could buy the MOO and short DBA, you could quite literally trade the relative strength trend depicted above, with less volatility than owning the Market Vectors portfolio outright. Such a strategy may not be your cup of investment tea, however. You'd be obliged to use a margin account to short DBA, and that precludes many accounts - retirement accounts, specifically - from employing the strategy.

There are, fortunately, inverse exchange-traded notes based upon the DBLCI agriculture subindex that can be purchased within any account. Buying the PowerShares DB Agriculture Short ETN (NYSE Arca: ADZ), for example, is something like shorting DBA, while purchasing the PowerShares DB Agriculture Double Short ETN (NYSE Arca: AGA) produces returns something like doubling down on a DBA short.

Notice I said "something like," not "just like." There are some keen differences between the DBA and the ADZ/AGA securities besides their directional bias. DBA is a portfolio made of actual futures contracts, complete with frictional transaction costs - the gains and losses associated with the rotation of contracts within the portfolio. Quite literally, the ETF shares can be swapped (by large traders anyway) for the futures contracts held within.

ADZ and AGA, on the other hand, are not ETFs. They're notes, debt obligations of Deutsche Bank's London branch, with a value based upon the fluctuations of the index that DBA follows. There's no recourse to an actual portfolio here. The investor takes on credit risk, relying upon Deutsche Bank to remain solvent enough to honor its obligation and lend value to the notes in the secondary market.

Buying MOO together with ADZ gives you the opportunity to play the agribusiness advantage with little small volatility. Your gains and losses will, in great part, look like the relative strength trend line. Year-to-date, based upon market value, the trade would have made 10.9% with only 22.9% risk.

In today's market, that's a pretty good reward-to-risk ratio.

ADZ + MOO

Comments

[predictorma...:]

Great article. I am in an IRA so that precludes me from directly shorting.

My problem with the short ETFs is that I have been burned EVERY time I have owned them. Some of it is market manipulation, and I have no reason to believe that can't happen with these also. Also if you are holding a short ETF long term, the decay kills you.

I don't trust ETNs, let alone short ETNs. I have owned both, but got out once I understood what was underlying them. A scandal waiting to happen.

I own both DBA and MOO and I'll rely on market momentum and swallow the risk. In this market the risk is not being on board (I know people don't like to here it but it's true- it just doesn't seem to want to correct).

Jun 11 04:19 PM

[RiskReturnO...:]

Watch for reversals.

DBO vs. XLE -- XLE is catching up after being out-performed by DBO.

DBA vs. MOO -- MOO is hitting resistance technically, we'll see if DBA can out-perform from this point on.

Jun 11 04:39 PM

[E.D. Hart:]

Volatility isn't risk. Unless you lock in a loss. If you take the long view you get paid a premium to own more volatile assets.

Why pay the frictional transaction costs of long/short when you could just own MOO for five years? I know, this is so last century.

There are bonds that aren't very volatile, that are virtually guaranteed to lose money after inflation. US Treasuries is what some call them. Standard deviation is fairly low, and risk is virtually 100% of losing money after inflation in say--five years.

You are almost guranteed to lose a percentage of your capital after five years in treasuries, but you have the benefit of less volatility that equites.

What a trade off!

Or you could buy JNJ or XOM and find them more volatile, but less risky at the five year time frame.

If you are willing to accept volatility, you often find greater returns--given the time arbitrage employed--at long enough time frames.

Jun 11 08:40 PM

[Brad Zigler:]

Volatility IS risk. More particularly, downside volatility, as measured by the Sortino rato, is. Keeping the size of your maximum drawdown small demands less of a market recovery to reach breakeven.

After a 10% loss, for example, an 11% recovery is needed to break even; after a 50% loss, a 100% clawback is required.


On Jun 11 04:19 PM predictorman1000 wrote:

> Great article. I am in an IRA so that precludes me from directly
> shorting.
>
> My problem with the short ETFs is that I have been burned EVERY time
> I have owned them. Some of it is market manipulation, and I have
> no reason to believe that can't happen with these also. Also if you
> are holding a short ETF long term, the decay kills you.
>
> I don't trust ETNs, let alone short ETNs. I have owned both, but
> got out once I understood what was underlying them. A scandal waiting
> to happen.
>
> I own both DBA and MOO and I'll rely on market momentum and swallow
> the risk. In this market the risk is not being on board (I know people
> don't like to here it but it's true- it just doesn't seem to want
> to correct).

Jun 12 07:39 AM

[E.D. Hart:]

If the NAV of a business is $45 per share, and the shares trade at NAV, and the shares lose 10%, who cares if the market has to claw back 11%?

Over time the market is a weighing machine...so that 11% is not greater than 10% as hard as that is to comprehend, its a return to a NAV. It doesn't matter.

Commodities are volatile, and Treasuries are less so. Nevertheless, treasuries are much more risky than commodities.(assuming no leverage is used) because of the environment of quantitative easing.

If you had to invest all of your net worth for ten years, and lock it away, and you could only choose T-bills, or gold--what would you choose?

I'm going with gold, and I'm not a gold bug, I'm a dollar bear. What do I care if gold is highly volatile?

Risk is about 100% that you will lose money after inflation in t-bills, in spite of their so called "safety", and low volatility. I'm guaranteed to lose my money slowly with low volatility. What a deal.

Also, what do I care if oil prices are volatile if the supply/demand fundamentals are highly favorable to higher oil prices? The risk is almost nil that oil will be cheaper in ten years, but the volatility will be all over the map. Again, volatility is not risk of loss of capital.

Jun 12 08:52 PM

[Brad Zigler:]

The fatal flaw is the time assumption. Investment horizons for rmany investors don't allow the time needed to clawback large losses. Funding needs for such events as retirement, home purchases and tuition payments may be near term.



On Jun 12 08:52 PM E.D. Hart wrote:

> If the NAV of a business is $45 per share, and the shares trade at
> NAV, and the shares lose 10%, who cares if the market has to claw
> back 11%?
>
> Over time the market is a weighing machine...so that 11% is not greater
> than 10% as hard as that is to comprehend, its a return to a NAV.
> It doesn't matter.
>
> Commodities are volatile, and Treasuries are less so. Nevertheless,
> treasuries are much more risky than commodities.(assuming no leverage
> is used) because of the environment of quantitative easing.
>
> If you had to invest all of your net worth for ten years, and lock
> it away, and you could only choose T-bills, or gold--what would you
> choose?
>
> I'm going with gold, and I'm not a gold bug, I'm a dollar bear. What
> do I care if gold is highly volatile?
>
> Risk is about 100% that you will lose money after inflation in t-bills,
> in spite of their so called "safety", and low volatility. I'm guaranteed
> to lose my money slowly with low volatility. What a deal.
>
> Also, what do I care if oil prices are volatile if the supply/demand
> fundamentals are highly favorable to higher oil prices? The risk
> is almost nil that oil will be cheaper in ten years, but the volatility
> will be all over the map. Again, volatility is not risk of loss of
> capital.

Jun 13 12:42 AM

[E.D. Hart:]

I agree with you Mr. Ziglar about the fatal flaw.

Jun 13 02:49 PM

[Mad Hedge F...:]

Here's why. I don’t normally rely on National Geographic magazine for investment advice, but in the June issue the screaming long term bull case for the soft commodities is there in all its glory. During the sixties, new dwarf varieties, irrigation, fertilizer, and heavy duty pesticides tripled crop yields, unleashing a green revolution. But guess what? The world population has doubled from 3.5 to 7 billion since then, eating up surpluses, and is expected to rise to 9 billion by 2050. Now we are running out of water in key areas like the American West and Northern India, droughts are hitting Africa and China, soil is exhausted, and global warming is shriveling yields. Water supplies are so polluted with toxic pesticide residues that rural cancer rates are soaring. Food reserves are now at 20 year lows. Rising emerging market standards of living are consuming more and better food, with Chinese pork production rising 45% from 1993 to 2005. The problem is that meat is an incredibly inefficient calorie transmission mechanism, creating demand for five times more grain than just eating the grain alone. I won’t even mention the strain the politically inspired ethanol and biofuel programs have placed on the system. It is possible that genetic engineering, sustainable farming, and smart irrigation could lead to a second green revolution, but the burden is on scientists to deliver. The net net of all of this is that food prices are going up, a lot. Entertain core long positions in corn, wheat, and soybeans on the next dip, as well as the second derivative plays like Agrium (TO), Potash (POT) and Monsanto (MON). You might also look at DB Commodities Tracking Index Fund (DBC). These will all surpass last year’s stratospheric highs at some point.

Jun 15 11:27 AM