In our previous article, we recommended a portfolio to play the movements in the prices of two major commodities impacted by the drought - corn and soybeans. Yesterday, the United States Department of Agriculture (USDA) released its monthly supply-demand report, entitled "World Agricultural Supply and Demand Estimates," according to which the crops are severely impacted by the drought, but the impact is less devastating than was expected. The following note analyzes the report's forecasts for both these major agricultural commodities, and updates our portfolio in accordance with the report's forecasts and our future projections. The most notable change is our view for the corn commodity, changing to bearish from bullish as a result of the now dipping demand for the commodity amidst sky-high prices. We remain bullish on soybeans, as we see a further upside since demand has not rationed despite the huge rallies.
Last month, relatively milder temperatures and rains were able to slightly reduce the dreadful impact of one of the worst droughts since 1956, but were unsuccessful in improving corn yields, which kept on deteriorating. According to this recently released USDA report, this year's corn harvest is estimated to be about 10.727 billion bushels, the smallest crop in six years, which is slightly lower than last month's 10.779 billion but more than analyst consensus expectations of 10.38 billion. Corn yields have been reduced to 122.8 bushels per acre, the lowest since 1995, from last month's 123.4 bushels per acre, and last year's 147.2 bushels an acre. However, less-than-expected reductions in production have led to a drop in corn prices to a 2-month low, as the Chicago Board of Trade (CBOT) new-crop December corn dipped by 1% to close at $7.69-1/2 a bushel.
Meanwhile, almost 15% of the corn crop in the U.S. has already been harvested, as relatively warmer springs caused earlier plantings, and the severe drought caused earlier maturities. Furthermore, record high corn prices have resulted in a reduction in livestock production, as producers have started slaughtering their animals amidst rising feed costs and pasture damage from the drought. Consequently, corn demand for the year as of August 31, declined by more than analyst expectations, as the USDA has reduced the grain export estimate by 0.6% and the "feed and residual" category's estimate (which includes corn used in animal feed) by 3.3%.
The USDA forecast soybean harvest at 2.634 billion bushels, which trails the previous month's 2.692 billion. Likewise, the yields have also followed a declining trend from last month's levels, showing a 2.2% drop from last month's 36.1 bushels per acre. The USDA is projecting the soybean harvest and yield to be the lowest in 9 years. However, unlike corn, these forecast cuts were greater than analyst expectations, further fueling the price of soybeans. Its most-active November futures rose by 2.6% to reach $17.5 yesterday, way close to the record of $17.9 achieved last week. However, unlike corn whose demand has started to drop following high prices, traders feel more price increases are necessary for soybeans to decrease its demand, as the stock-to-use ratio is set to be the lowest in five decades.
According to Dan Roose, the commodities' president In West Des Moines, Iowa, "Corn numbers show we were rationing demand pretty aggressively in the old crop. Soybeans could not do a good job of rationing demand. If you can't ration demand when prices are high, you can't ration demand with lower prices."
Brazil and Argentina are the second and third largest soybeans exporters after the United States, but their soybean harvest is at least five months away, making the U.S. the sole major supplier these days, where the crop yields have been decimated a lot already. However, the fact that the soybean harvest is just beginning makes USDA's chief economist Joe Glauber claim, "Soybeans still have a little chance to improve" considering that its yields are slightly up in the U.S. Southeast.
We see a further upside for soybeans' prices, as demand remains sustained, while supply is already squeezed as a result of the drought, not only in the U.S. but also in Brazil and Argentina, last year.
- Grain ETFs
We remain bullish on soybeans amidst high demand and declining yields, but our corn outlook is now bearish, as declining demand is offsetting production cuts. Consequently, we recommend investors to take a long position in Teucrium Soybean (SOYB) and a short position in Teucrium Corn (CORN), as we feel that corn has likely peaked already. We are still bullish on soybeans (39.16%), corn (39.14%) and wheat (21.70%) ETF, iPath Dow Jones UBS Grains Total Return Sub-Index ETN (JJG), as it will help us realize gains if soybeans keep on climbing. Meanwhile, it has the additional advantage of hedging our short position in CORN if corn prices start to rise again, against our expectations. Other possible ETFs worth considering to bet on rising commodities' prices are PowerShares DB Agriculture Fund (DBA), PowerShares DB Agriculture Double Long ETN (DAG) and even PowerShares DB Commodity Index Tracking (DBC).
- Fertilizers and Seed Stocks
We reiterate our previous recommendation of adding fertilizer companies and seeds manufacturers to our portfolio. Reduced crop production is set to benefit fertilizer players like CF Industries Holdings Inc, (CF), Potash Corp. (POT), Agrium Inc. (AGU) and the Mosaic Company (MOS). The demand for yield-enhancing crop seeds is also set to increase, as farmers will be aiming for better crop yields next year given this year's poor output. With these companies also developing drought-tolerant seeds, we see a potential for a huge upside. Consequently, we keep Monsanto Company (MON), E. l. du Pont de Nemours and Company (DD) and Syngenta AG (SYT) in our portfolio. Please read our previous article on these seeds' manufacturers.
- Ethanol Refiners and Meat Producers
Since corn is used as a livestock feed, tighter supplies of grain may increase costs for ethanol refining companies like Archer Daniels Midland Co. (ADM), along with meat producers such as Smithfield Foods Inc. (SFD) and Tyson Foods Inc. (TSN). We recommend a short position in each of these companies.
- Agribusiness ETF
We also add agribusiness ETFs, Market Vectors Agribusiness ETF (MOO) to our portfolio, as its diversified exposure in fertilizer companies and seeds' manufacturers makes us target relatively less-risky returns. ADM (4.46%) and TSN (1.50%) are also among the constituents of MOO, but their proportion in this ETF is very small.