8/14/2012 4:10 PM ET|
Investing for the summer scorcher
With nearly two-thirds of the nation in a drought, corn prices are soaring, and food prices are bound to jump. How might the weather affect what's in your portfolio?
Talk about a summer sizzle. If you think the July scorcher most of the country suffered through was the worst ever, guess what? You're right.
Last month was the warmest July for the lower 48 since 1895, the first year for which we have consistent records, says the National Oceanic and Atmospheric Administration. Blame it in part on a La Niña weather pattern, which moves the jet stream northward in a way that creates warmer and dryer weather for much of the U.S.
This helped push the nation deeper into a massive dry spell. As of July, 63% of the U.S. was in drought, the worst percentage since 1934.
The good news is that some relief may be on the way. "I think we have reached the peak," says AccuWeather meteorologist Paul Pastelok, citing increased rainfall around the northern and western edges of the drought-stricken heartland.
The bad news: This relief is far from certain, and it comes too late to save much of this year's devastated corn crop. "It's a little early to celebrate," says Pastelok.
The drought has spiked the prices of key grains, such as corn and soybeans, which trickle down into hundreds of products. You'll feel the impact of the drought in grocery checkout lines, restaurants and perhaps in your stock portfolio, for at least a year, even if you live outside the sun-scorched parts of the nation.
But while you'll shell out more for food, there are also ways for investors to make a little money. Here's a roundup of stocks and funds to use as drought plays, and the risks, as well as some to avoid for now.
Putting some money into corn
To see why this drought has such broad impact, take a look at corn.
Corn supplies will be stuck at limited levels well into next year, possibly through next fall. But corn demand won't really fall, says James Dunn, a professor of agricultural economics at Penn State University. "The big thing to remember about corn is that there aren't many substitutes."
That's certainly the case with the two biggest uses for corn: feeding livestock and producing ethanol for use in gasoline. For food producers, the third big consumer of this crop, corn is only a small percentage of the overall cost. So they won't buy less just because it costs more. The other main use of our corn is to satisfy foreign demand, which won't ease, because corn shortages are global.
The result of shrinking supply and solid demand: soaring prices. Corn for delivery in December has shot up more than 60% since June to more than $8 a bushel, from around $5. "The next time we see corn under $8 will be in late summer of next year," predicts Dunn. "It might go under for a day or two, but the supply and demand for corn are pretty much locked in until then."
Goldman Sachs commodity analyst Damien Courvalin says corn will probably go up to $9 a bushel within three months. And a hedge fund analyst I know, whose fund just made a bundle on the jump in corn prices, thinks it could go as high as $12 a bushel between now and the end of the year.
One way to play this is to buy Teucrium Corn (CORN), an exchange-traded fund. It's trading just above $50 a share now, up from around $36 in June.
But like any commodity play, particularly one that has already risen dramatically in price, this has risks. "It's very dangerous to get involved in corn when it is up this much," says the hedge fund analyst. While he personally owns shares of Teucrium Corn, he says his fund has already taken profits by selling most of its corn position.
With grain prices likely to stay high, it makes sense that farmers looking to cash out with bigger yields will buy a lot more crop nutrients from fertilizer companies. "They are going to be selling a heck of a lot of fertilizer," predicts Dunn.
But this is only half the story. For the past year or more, global distributors have been reducing inventories of phosphate- and potash-based fertilizer because of concerns about economic slowdowns in Europe and China, and the terribly wrong expectation, until recently, that corn prices would fall because of a bumper crop this year. "There was a global destocking. No one wanted to hold inventory, on the expectation that they could buy it cheaper," says Ben Landy, a materials sector analyst with T. Rowe Price.
Farmers have also been conservative in their use of fertilizers, especially in emerging markets.
Higher grain prices will change this and lead to a bullish cycle of more aggressive buying in fertilizers, Landy predicts. "The improvements in fundamentals still lie ahead, and the stock valuations don't reflect that yet," he says.
Morgan Stanley analyst Vincent Andrews has an overweight rating on Potash, in part because it is the largest low-cost producer of the most profitable fertilizer.
JPMorgan Chase analyst Jeffrey Zekauskas has an overweight rating on Mosaic, the largest phosphate producer and the second-largest potash company in North America. Zekauskas says the stock looks cheap at around $58, far below the $93 a share he estimates as the replacement value of its assets, its mines.
Goldman Sachs analyst Lindsay Drucker Mann has a buy rating on CF Industries (CF), another fertilizer-maker. "We expect positive corn price momentum to put an end to the 'buyer's strike' in the fertilizer markets," says the analyst.
Stocks mentioned in this article include Monsanto (MON).
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