The Bottom In Agriculture

by: Burt Rothberg

Crop prices have been hit hard by excellent growing conditions and the China trade spat.

This is an early crop, so I believe we have just seen the lows.

The China situation will fester, but I argue it won't alter the long-run US ag situation.

I am long futures and Deere and AGCO.

I have written two articles over the last several years advocating a long position in the US ag complex, the last on Feb 17, 2017. Both had immediate gains, but the tide eventually reversed. Note: I recommended getting out on my blog. The reason is that world growing conditions have been great for the past few years. Demand has also been good, but you can't fight a great crop.

This year, crop prices have also had to worry about the US-China trade spat (and possibly US-Japan, Korea, EU, etc.) In an attempt to punish Trump with the greatest domestic political leverage, China has concentrated its retaliation on US ag exports. This is surprisingly heavy-handed for the Chinese, and I doubt it will do them much good, but it has put panic into the futures markets.

I was interviewed by Caijing Magazine about this last week. My view is that it won't make much difference beyond a few months. Here's what I told them:

It is important to realize that the major agricultural products of the US Midwest are commodities. That means they are fungible. A soybean in Iowa is almost identical to a soybean in Brazil and even most soybeans in China (although China also grows premium varieties for human consumption). So if China boycotts US soybeans and buys from Brazil, the other Brazilian buyers will have to come to the US. There will still be some economic losses because of transportation, but they are small. This will take some time to work out, but the grain trading companies are very good at this sort of thing.

The point is that Brazil cannot create grains or soybeans out of thin air. What really matters is the global supply/demand. Here's a table on total world feed grains for the past few years. You can see that demand has outstripped supply for several years.

Year Production Consumption End Stks/Cons
2014/15 1,311 1,276 19.3%
2015/16 1,262 1,258 19.8%
2016/17 1,369 1,355 19.2%
2017/18 1,315 1,356 16.3%
2018/19 1,337 1,378 13.1%

Source: USDA

Soybeans are a little different. Soybeans have been a huge growth crop for over a generation. World production has grown by 4.1% annually for the last 20 years. Soybeans have gone from a largely US crop to a world mainstay challenging grains. Because of this it's hard to know what level of stocks are desired. Also, this year has had a lot of switching from corn to soy in the US. Nonetheless I expect soybeans to be the main beneficiary of the continuing increase in worldwide poultry capacity.

My thesis about the current US crop is that it will be good, but that it's priced in. Not only were temperatures moderate and rainfall adequate, but the crop is early. As of today's USDA Crop Progress report, 38% of corn had silked and was in the dough stage. This compares to 20% for the average at this time. Some 60% of soybeans were setting pods vs. 41% average. The early crop also lowers the risk of harvest complications later on; farmers will have plenty of time to get the crop out.

The market knows all this. So we have a good crop with little risk going forward. That's why prices have been hit so hard. It's also why I think the market will start looking to demand early. And demand is good. The trade spats have put some risk into the growth of the Asian economies, but these countries are still growing smartly. As I said, I think the grain traders will shift cargos around to compensate for the China boycott of the US.

In fact, I think there's upside optionality to a solution to the US/China situation. Many observers have noted that China has a lot more to lose than the US, simply because of the trade imbalance. So far they seem to be digging in their heels, demanding an (ironic in my opinion) adherence to established rules. But China's leadership is pragmatic. If it looks like Trump will not back down, and this will be the new normal, it will be in their interest to compromise. Should this happen, there will be big upside surprise.

So how to trade this? For the short-termers out there, I am trading corn from the long side. I am not keeping a large base position, but am buying dips and letting some go on rallies. For investors, I recommend (and am long) the tractor companies. Not only will they benefit from rising crop prices, but I believe the tractor replacement cycle has bottomed. I am long Deere (NYSE:DE) and AGCO Corp. (NYSE:AGCO).

I wanted to get this out quickly. I'll follow up with an article on the financials of DE and AGCO.

Disclosure: I am/we are long AGCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.