Jeffrey Saut: Weather, Water and Agriculture Continue to Be Viable Investments

by: Jeffrey Saut

Excerpt from Raymond James strategist Jeffrey Saut's latest essay (published Monday, November 1st):

... the weather has turned undeniably weird. In past missives I have commented that while to some degree the environmentalists are right about the climate change being attributable to “man,” this year’s weather is being compounded by a La Niña weather pattern coupled with huge amounts of volcanic ash in the atmosphere. That combination has allowed “The Tropics” to expand toward the “poles.” Accordingly, the Hadley cell winds have shifted outwards... Unsurprisingly, the Hadley cell winds’ outward shift has played havoc with the Trade Winds, producing droughts in otherwise moist parts of the world and monsoons in previously dry locales. Said “shift” has allowed tropical zones, and deserts, to expand dramatically. This is not an unimportant event because the changed weather pattern has major implications for agriculture and the world’s soil bank.

Currently, much of the world’s topsoil is eroding and therefore declining in nutrient quality. According to wiseGEEK:

“Topsoil is the upper surface of the Earth's crust, and usually is no deeper than approximately eight inches. The Earth's topsoil mixes rich humus with minerals and composted material, resulting in a nutritious substrate for plants and trees. It is one of the Earth's most vital resources.”

Unfortunately, topsoil erosion is occurring much faster than nature can replace it. In addition to weather, modern agriculture techniques have hastened the erosion, as has row crop planting (corn, soybeans, cotton, tobacco, etc.) since row crops erode soil much faster than sod crops. Regrettably, once soil is gone you can’t get it back!

Plainly, this has grave implications because as I have stated for years, “When per capita incomes rise the first thing people want is clean water, the second is a better diet.” With per capita incomes rising rapidly in emerging countries, the burgeoning food demand has left global grain consumption exceeding production; and, over the next few decades the situation is likely to get worse because food production needs to expand by some 50% just to meet the estimated demand.

Ladies and gentlemen, this means an additional ~6 billion acres of land is needed to meet the upcoming food demand, but only ~2 billion acres of good land is available. Obviously, that should make farmland a good investment and there are select public companies that play to this theme. Also of interest are ag-centric “technology” companies that hopefully can ameliorate some of the upcoming food shortfall. Companies like Monsanto (MON/$59.42) and Deere & Co. (DE/$76.80), which are followed by our research affiliates, are constantly searching for innovative solutions to the dilemma.

I revisit the weather, water, and agriculture themes today not only because they have been three of my long-standing themes, but to emphasize why they should continue to be viable investments going forward. Water is by far the most undervalued asset I know, yet it is difficult to find water-centric investments. Clearly, that is not the case with agriculture. As for weather, ...last week’s Midwest storms had, “The lowest barometric pressure readings ever recorded in the continental United States.” I think the weird weather will continue to be driven by the shift in “The Tropics.” This implies a cold and wet winter.

Manifestly, a cold winter, when combined with the anticipated Republican victory, should have positive implications for energy stocks. From our Analyst Current Favorites list I offer the following energy names for your consideration: Alpha Natural Resources (ANR/$45.17/Strong Buy); Hess Corp. (HES/$63.03/ Strong Buy); National Oilwell Varco (NOV/$53.76/Strong Buy); Inergy L.P. (NRGY/$39.26/Strong Buy); and Whiting Petroleum (WLL/$100.44/Strong Buy). I also would have you consider Clayton Williams Energy (CWEI/$59.72/Outperform).

As for the equity markets, after being constructive since the end of June, I turned cautious exactly two weeks ago as we approached last April’s price “high” on the D-J Industrial Average (INDU/11118.49). The senior index stood at ~11200 back then and changes hands around the same level today. However, over the past two weeks we have experienced weakening relative stock strength and numerous distribution days. Additionally, the U.S. dollar has stabilized and the 30-year Treasury bond yield has surmounted 4% (both bearish events). Despite those deteriorating metrics, stocks just don’t seem to want to spill into the 5% - 8% correction I have been anticipating.

While I have not given up on a downside correction, I must admit if it doesn’t happen soon, time may be running out for the bears. Indeed, this week begins the best six-month period of the year for stocks (November through May); and with 3Q10 earnings reports beating estimates by 71%, as well as 4Q10 earnings guidance rising, underinvested portfolio managers are experiencing intense performance anxiety. That anxiety should cause them to “flinch,” and buy stocks, if a correction doesn’t arrive soon. Adding to that performance anxiety is an improving economy, for as my friends at the invaluable Bespoke Investment Group write:

“(Last) week’s economic data contributed to further improvement in our Economic Indicator Diffusion Index. As shown in the (nearby) chart, the 50-day rolling net total of better than expected economic reports hit a level of +15 this week. This is the highest reading since early February, and hardly an indication of the economy going downhill.”

The call for this week. ...[P]redicting the weather is as difficult as predicting the stock market, which is why weather is an unknown unknown (aka Katrina). Interestingly, as Donald Rumsfeld evinced, "It's not the certainties that make life interesting; it's the uncertainties. There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things we know we don't know. But there are also unknown unknowns – the things we don't know we don't know.” Or as one old Wall Street wag exclaimed, “It’s not the snake you see that bites you!” Hence, I remain cautious, but not bearish, admitting that time is running out for the bears.