How To Trade Increasing Corn Prices

by: Greg Group

The U.S. cut its corn-harvest estimate 12 percent and said inventories next year will be smaller than fore cast in June as the worst Midwest drought since 1988 erodes prospects for a record crop. With the increase in corn prices, companies using corn will be hit with higher expenses while those increasing corn yields will prosper. The rise in corn prices will affect food prices as corn is a primary food source for livestock. Investors must be wary of how the increase in corn prices may affect their portfolios.

A recent Live Sceince report described the drought as: "Just under 56 percent of the contiguous United States is in drought conditions, the most extensive area in the 12-year history of the U.S. Drought Monitor. The previous drought records occurred on Aug. 26, 2003, when 54.79 percent of the lower 48 were in drought and on Sept 10, 2002, when drought extended across 54.63 percent of this area."

The condition of corn in the 18 states that produce most of it has deteriorated due to widespread drought. The July 10th report from the U.S. Department of Agriculture says 30 percent of the crop is now considered in poor or very poor condition. A week ago, it was 22 percent. Indiana and Illinois have been particularly hard hit. The USDA said Monday that Indiana's corn is now 61 percent poor or very poor compared to 50 percent last week. In Illinois, 48 percent of the corn is rated as poor or very poor, compared to 33 percent last week. The amount of corn rated good to excellent also is dropping, to 40 percent this week from 48 percent a week ago.

Corn futures for December delivery rose 3.3 percent to $7.4125 a bushel, after touching$7.48, the highest for the most-active contract since Sept. 13.

Stocks Negatively Affected by Tighter Corn Supply

Corn prices through yesterday surged 42 percent since mid-June on the Chicago Board of Trade as areas of moderate to extreme drought expanded to 53 percent of the Midwest. Crop conditions as of July 8 were the worst for that date since the drought of 1988, government data show. Tighter supplies than expected may boost costs for ethanol makers including Archer Daniels Midland Co. (ADM) and several meat producers.

ADM, the biggest corn processor, said yields already are expected to be20 percent smaller than the five-year average of 175 bushels an acre. Higher corn prices will hurt ADM's ethanol business "while the limited crops in storage prior to the harvest will not provide the typical offset (i.e., benefit) from rising corn prices. ADM is trading at $27.50 following a 20% price decline in the last two months. Numerous analysts have downgraded the stock in past weeks.

Meat prices are expected to increase as corn is used as feed for livestock. Investors are lightening up on their protein diets, unloading shares of Sanderson Farms Inc. (SAFM), Pilgrim's Pride Corp. (PPC) and Tyson Foods Inc. (TSN) over the past month amid a swift rise in futures prices for feed grains. Over the past month, shares of chicken producer Pilgrim's Pride have tumbled 24%, while rival Sanderson Farms is down 20%. Tyson, which also sells beef and pork, is off 11% over the same period.

Stocks that Benefit From Lower Corn Yields

Fertilizer stocks are moving higher after the government reported greater than expected damage to corn crops. Shares of fertilizer makers CF Industries (CF) and Potash (POT) gained recently morning after a Dahlman Rose stock analyst raised his rating on both companies to buy from sell. On Monday, CF rose 4% to $184.72, while Potash advanced 2.5% to $41.37. Mosaic added 2% to $51.45. Dahlman Rose hiked Mosaic (MOS) to buy from hold. The Dahlman Rose report said a large corn crop seems to be priced into the share prices already. As such, if the crop is large, the shares seem to have limited downside. The alternative scenario of a crop reduced by weather issues is likely to result in even greater share outperformance. Either situation produces a positive outcome so now is time to own the shares.

On the ETF side, Teucrium Corn Fund (CORN) seeks to replicate, net of expenses, the daily changes in percentage terms of a weighted average of the closing settlement prices for three futures contracts for corn that are traded on the CBOT. This fund is up 245 in the last 4 weeks. However, its market cap is small at $88 million so investors run the risk of getting whipped around. A more stable alternative may be Powershares DB Agriculture Fund (DBA) that covers some of the widely traded agricultural commodities - corn, wheat, soy beans and sugar. DBA is more liquid with a market cap of $1.9 billion. DBA is up 10% in the past 4 weeks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.