Grain prices have generally continued their upward rallies, as the worst drought since 1956 persists in adversely impacting crop conditions. This drought has not been alone in its devastation, as dry weather in Russia and Eastern Europe continues as well. Soybeans have experienced an upsurge of almost 45% this year, touching a record-high level of $17.71/bushel on the Chicago Board of Trade (CBOT) yesterday. Corn is also hovering above $8/bushel and touched a record high of $8.49 on August 10. In such a scenario, we have developed a trading strategy to play the future movements of three main agricultural commodities that are impacted by the drought the most - corn, soybeans and wheat. Our portfolio suggests long positions in selective stocks of fertilizers, seeds, machinery and grain ETFs, while short positions in crop insurers, meat producers and ethanol makers.
In addition to its supply being squeezed by the severe drought, the crop's price is also benefiting from high levels of sustainable demand. According to a U.S. Department of Agriculture (USDA) report earlier this month, soybean crop will yield 2.69 billion bushels this year, which is 12% less than last year's production. Global supply has also been severely impacted due to poor production in Brazil and Argentina caused by droughts seen earlier this year.
According to meteorologists, Hurricane Isaac is expected to lead to heavy rains in the Midwest in the upcoming days. However, the impact on soybeans' yields will be limited, as much of the crop has already reached the maturity stage. According to the USDA, almost 8% of its plants were dropping leaves, which is a signal of maturity.
Till August 26, almost 6% of U.S. corn had already been harvested, as compared with none a year ago. According to USDA data, corn is being harvested at its fastest pace ever because the crop was planted earlier, and has matured earlier due to the drought. Hurricane Isaac might be a source of some relief for drought-stricken areas, but too much rain at this point in time may actually be a problem for corn farmers, who could face severe difficulties in operating machines in muddy fields during harvesting. According to an analyst at Macquarie Group Limited in London:
The USDA also forecasted that corn production will decline by as much as 13% this year, the lowest level since 2006.
Since mid-June, wheat futures have surged by a whopping 44% as a result of the worsening drought. According to the USDA's forecasts, high prices for wheat, soybeans, and corn, along with larger wheat tonnage, will lead to record farm export sales this year.
- Grain ETFs
We reiterate our recommendation of investing in grain ETFs, iPath Dow Jones UBS Grains Total Return Sub-Index ETN (JJG), PowerShares DB Agriculture Fund (DBA), Teucrium Corn Fund (CORN), and DB Agriculture Double Long ETN (DAG), as a way to play rising agricultural commodities. JJG remains our favorite, as it offers simultaneous exposure to all drought-affected commodities. CORN solely offers direct exposure to corn, but is a potentially riskier bet than our favorite JJG.
Fertilizer stocks are a way for long-term investors (who intend to hold them for at least next year) to play declining crop yields this year. This is because despite falling yields, farmers are going to plant corn and soybeans again next year, which will result in an increase in fertilizer demand, as farmers will be aiming for high yields to compensate for lost production this year. Our favorites remain CF Industries Holdings Inc. (CF) and Agrium Inc. (AGU). Other options include Potash Corp (POT), The Mosaic Company (MOS), and dividend-paying MLPs like CVR Partners LP (UAN), Rentech Nitrogen Partners LP (RNH), and Terra Nitrogen Co LLP (TNH).
We also add seed manufacturers like Monsanto Company (MON) and E l Du Pont De Nemours and Co. (DD) to our portfolio, as farmers' demand for agricultural seeds will increase next year so as to ensure better crop yield, as soils have been extremely damaged by the drought.
As the harvesting of corn crops has started and soybeans are also showing signs of maturity, the demand for agricultural machinery is set to rise, making us recommend Deere & CO. (DE) as well. Although its earnings got hit by depressed economic growth, and its financial services segment is also expected to suffer due to more claims from holders of its crop insurance, we expect the harvesting season to act as a positive catalyst for the company. Other notable players in this industry include CNH Global (CNH) and AGCO Corp. (AGCO).
- Crop Insurers, Meat Producers, and Ethanol Producers
We reiterate shorting insurers who provide crop insurance - Everest Reinsurance (RE), Endurance Specialty Holdings (ENH), and ACE Limited (ACE) - in addition to meat producers - Tyson Foods Inc. (TSN) and Smithfield Foods Inc. (SFD), and ethanol producer Archer-Daniels Midland Co. (ADM). Crop insurers are definitely going to suffer as a result of decimated crop yields. However, these three insurance companies have limited exposure to crop insurance (almost 1-2%). Ethanol and meat producers are going to suffer as they use soybean and grain meals in animal feed. Read our previous article to have a detailed idea of this recommendation.