How Investors Can Profit from the US Drought
Tony is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The worst drought in the United States in nearly a quarter century (since 1988) is wrecking havoc on some of the country's most important crops, notably corn and soybeans. The 1988 drought cost U.S. farmers $78 billion in damages. The current drought threatens not only to hurt farmers, but to reignite food inflation for both U.S. and global consumers while at the same time harming the fortunes of some companies which are directly affected by crop prices.
The U.S. breadbasket is important to food consumers all over the world because our country is the world's largest exporter of corn, wheat and soybeans. The U.S. accounts for nearly one third of all the staple grains traded on global markets. So no surprise then that thanks to the ongoing drought, just in the past month, prices for corn have jumped 44 percent, wheat has soared 45 percent and soybeans have risen by 17 percent.
The damage can already be seen in the latest crop report from the U.S. Department of Agriculture(USDA) released last week. In the report, the USDA slashed its forecast for the corn crop by the largest amount since 1988. Not good news in the light of the fact that U.S. inventories of that key grain are falling at the fastest pace since 1996. The USDA report was, of course, music to the ears of corn bulls. It sent prices soaring, to within striking distance of the all-time high for corn set in 2011 of $7.9975 a bushel.
The Department of Agriculture sounded a similar grim tune for the U.S. soybean crop. The USDA said the lower U.S. crop would help erode global inventories of soybeans to “minimum levels.” This wording allowed soybean prices to match its all-time high (seen in the 2007-08 food crisis) last week at $16.795 a bushel.
So how can the average investor position themselves to profit from this ongoing drought?
First of all, there is one sector in the stock market to avoid or even short if that strategy fits with an investor's risk profile. That sector is the meat processing industry. This industry is extremely sensitive to corn and soybeans prices since both crops are used in animal feed. Soybeans, for instance, are mixed with corn and turned into soybean meal which is a key ingredient in chicken and pig feed. Soymeal has been hitting record highs recently.
The raising of poultry, in particular, becomes much more expensive when soymeal prices rise. Poultry eat more than 40 percent of the meal crushed from U.S. soybeans. The only other substantial food item that chickens eat is corn.
Some of the major players in the meat processing industry which will have their profits adversely affected by rising prices for corn and soybeans are Tyson Foods (NYSE: TSN), Sanderson Farms (NASDAQ: SAFM) and Pilgrim's Pride which is now controlled by Brazilian meat processing giant JBS S.A. ADR (NASDAQOTH: JBSAY.PK). Over the past several weeks, the price of Tyson Foods and Sanderson Farms have fallen about 17 percent and 23 percent respectively.
This decline in the companies' stock prices seem to be justified. Both Tyson Foods and Sanderson Farms have done a poor job of hedging. That is, using futures on corn, soybeans and soymeal to protect the company against adverse weather events which would send prices skyward. Both companies have made it known that their “protection” lasted only to June or July. So now they will be fully exposed to the higher prices for animal feed. These costs are substantial...Sanderson Farms, for example, has stated that feed makes up 55 percent of its cost of goods sold.
In case you're wondering, substituting other food for corn and soybeans is rather limited. Pilgrim's Pride is mixing in some wheat instead of corn in its soymeal mix. It is also said to be contemplating using distillers' dried grains, a byproduct of ethanol production, as a substitute for corn in meal.
The other side of the coin from the meat processors is the price of corn and soybeans which looks set to continue higher as long as the drought persists. It is very easy for investors to play this trend on the bullish side through the use of exchange traded funds (ETFs).
Two such funds come from Teucrium: the Teucrium Corn Fund (NYSEMKT: CORN) and the Teucrium Soybean Fund (NYSEMKT: SOYB). Over the past several weeks, CORN has gained about a third while SOYB has added on about 15 percent.
Both ETFs offer investors unleveraged direct exposure to futures for corn and soybeans respectively without having to open a futures trading account. The funds are also set up in a unique way so as to reduce the effects of contango and backwardation. For specific information on how Teucrium does this using three different futures contracts, please visit Teucrium's website at www.teucrium.com.
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