Agricultural Pullback Signals Opportunity

Nihar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The drought is behind us, or is it? The thing about droughts is that they can actually last a very long time with interspersed wet periods. There is really no guarantee that the drought is over or that it will continue. We will have to wait to see if enough snow and water falls from the sky to alleviate the problems 2012 has caused. So all that can really be said is that 2012 is behind us, and there is no way to know if next summer will see a steep rise in agricultural prices like it did last July.

The thing about food is that it has an inelastic and growing demand. Food is always required, and the world population is growing. Something with a built-in and ever growing demand that must be recreated every year presents an interesting proposition. That means agricultural commodities; via ETFs or companies that trade with agriculture deserves serious attention for building a portfolio. At the very least it deserves consideration as much as raw material companies.

Simplicity in ETFs

Jumping in the commodities market is a hornet's nest so investing via ETFs is a simple way to take part in agriculture without to navigate the complications of actually trading futures. You can go with PowerShares DB Agriculture (NYSEMKT: DBA), which has a broad approach to agricultural products. While the agriculture market tends to move in a uniform way, I prefer getting to understand one market. I would go with Teucrium Corn (NYSEMKT: CORN), because it has both food and industrial demand. It is also one product, and tends to be one of the more robust crops. It does not have to be grown for taste because it might be turned into ethanol or processed into corn syrup.

The drought had serious effects on the price of these agricultural products and both DBA and CORN rose in value over the summer. Both have pulled back now, and that presents an opportunity to invest in agriculture directly. These ETF's are in futures for the actual crops, an indirect investment would be companies that deal with agriculture. This year's drought came as a bit of a surprise because it was so fast for its reach and intensity. The drought may continue, and I think there is a chance it will continue into the summer. This is not based on hydrological data, but weather patterns can go on for years and the Great Plains tend to be drier than its status as a farming area would indicate. Even if the drought is not as severe, I think tight water conditions will persist. Especially because the drought it at least forecast to last into winter. For populations and farmers that rely on snow melt into the spring that is a worrying scenario.

With the recent pullbacks in the ETF I at least expect prices to rise some going into next summer. I prefer CORN if I am thinking beyond the next year, but I prefer both into the next year. A quick end to this issue would be asking for too much. Keep an eye on these ETFs, but always remember that agriculture commodities are cyclical and probably not suited to a very long buy and hold strategy. One serious risk to consider is that the current price is still far above the price before the spike last July. If the drought is over prices could collapse. I wish there were certainties, but I would have to mix strategies of a very small position reinforced by writing puts. If I went long, I might consider purchasing some downside protections by buying puts instead. Commodities can collapse extremely quickly.

Going with Companies that Stand to Benefit

Corn is used to sweeten our processed foods and soda, as well as producing the ethanol for our cars. There are also corn-based plastics. As long as the building blocks are in the corn it has value beyond its delicious taste, and most corn is not very good to eat. That is why Monsanto's (NYSE: MON) drought-resistant strains of corn might be appealing. I know GMOs are a concern for many, and the proliferation of them through pollen also raises problems. However, simplifying the issue the altered crops are fine if they do not need to be eaten. Of course I am assuming that the high fructose corn syrup created from the corn will be the same as that produced from natural corn. I might be wrong, but even then the use in ethanol is still there.

For farmers who are reeling from the drought it might be a tempting proposition to plant some of these hardy, modified crops to get through 2013. The drought resistant corn is supposed to be available widely in 2013. MON's stock has already been doing very well, and I would wait for a pullback or write some puts to generate some income and lock in an entry if the stock pulls back enough. You give up some upside but you get paid for the wait. The stock is just up a lot lately, and with the strong earnings I think I missed most of the boat.

On a long-term human scale Monsanto's efforts will be important to the future, as much as people might be worried about genetically modified food. The company reported a strong first quarter on January 7th and actually increased guidance. On a quick read through I did not see many of the big strategic commentary that I look for. There is a lot there on top of the numbers, but nothing that makes me jump out of my seat. Except maybe that MON's products had a yield advantage in the tough drought. It would not be unrealistic to see an uptake in their products by farmers hurt by the drought. I will be watching.

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