How to Profit from Rising Corn Without Buying Corn
Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Much of the news coverage over the last two months has been devoted to the drought impacting North America, especially its effect on the price of corn. According to Accuweather, more than half of the continental United States has been declared a disaster area by the USDA. Commodities traders who bought corn have seen its price surge to over $8 per bushel and have been able to make double digits gains in a couple of months. Buyers of soybeans and wheat have also been fortunate as those commodities also posted double digit gains since June.
This leaves the average small investor to think they really missed the boat on this one. With prices at the levels they are, many question the ability of corn to maintain such lofty levels reasoning that almost any rainfall prediction could cause a crash in prices. Still many are buying corn through ETFs such as Teucrium Corn Fund (NYSEMKT: CORN) in hopes that the rally still has some way to go even though CORN has gone from the mid $30 range to over $50 since June. But there is another commodity that has not risen alongside corn, soybeans, and wheat and that commodity is in a whole different level of the food pyramid.
The Livestock Situation
Often when corn prices rise, livestock prices rise with them as farmers must pay more to feed their herds, but livestock has not returned anywhere close to the phenomenal gains of corn and soybeans have since June. So what gives? Does livestock have nowhere to rally? The answer is yes and no.
With the current drought conditions, many farmers can simply no longer afford to feed their livestock. When feed prices skyrocketed, they had a choice; go bankrupt feeding their herds or liquidate their livestock. Since they, like us, don't like going bankrupt, many chose to rapidly sell their livestock to cut feeding costs and get what they could for the livestock to cover future feed costs.
Welcome to the Livestock Sale
Right now the liquidation has just begun with some farmers being pressed by feed costs, but the sale could ramp up if feed costs remain high for the near future. As farmers are drained of their financial resources by an unending drought they could be forced to sell their livestock in turn creating a glut in the market.
With mass numbers of livestock headed for liquidation the price for livestock is unlikely to rise in the short term future. Prices could even fall due to oversupply and America could enjoy some cheap steak in the meantime.
The Case for Being Bullish
After all of that stuff about "herd liquidation" and "oversupply," the investment potential of livestock may not seem so glamorous but the returns on livestock will not be made this summer, they will be made next summer.
Basic high school economics teaches the law of supply and demand and how it affects prices. Livestock is no exception to the rule of supply and demand. At this point, supplies are getting higher (and could get even higher) due to the liquidation of herds while demand has slightly fallen due to the ending of the summer grilling season. But much of next year's supplies will have been used in 2012 creating a lack of supply for the summer of 2013.
Unlike corn where farmers can choose to plant more or less year by year, livestock takes longer to mature further straining supplies since little new inventory could be introduced in a timely manner. This could send livestock prices soaring as demand picks back up for summer but supply collapses due to previous liquidations.
How to Buy Livestock
Few Fools would want to invest in livestock by actually purchasing cattle and hogs and keeping them in their backyard waiting for them to appreciate in value. Fortunately, there are livestock ETNs (exchange traded notes) that allow small investors a chance to invest in livestock without purchasing much riskier futures.
Some examples include E-TRACS UBS BLOOMBERG (NYSEMKT: UBC) and iPath DJ AIG Livestock TR Sub-Idx ETN (NYSEMKT:COW). COW tends to have higher volume than UBC but the three month average volumes of both are still well under 50,000 shares. Investors who are willing to take on additional risk and are not interested in purchasing futures, could purchase options on COW.
All of this depends on how much livestock is liquidated in the next few months. If the drought ends and feed prices return to lower levels, next year's price increase could be minimal. Either way, I am bullish on livestock prices for the next summer, if nothing else as a hedge against the cost of next summer's cookout.
Alexander MacLennan owns shares of COW. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.