Go Against the Grain, Bet Against Another Corn ‘Pop’

It happened very fast.

The prices for grain futures skyrocketed through June and much of July. Corn was the main focus as heat and drought destroyed and threatened a substantial amount of U.S. crops. Soybeans and wheat felt the heat as well, both here in the U.S. and abroad.

As extreme weather conditions continue, so do price increases. Also fueling this “pop” in corn was a U.S. Department of Agriculture report that categorized only 40% of the corn crop’s health as “good to excellent.” Meanwhile, a whopping 30% was categorized as “poor to very poor.”

With U.S. supply down, the question becomes …

Will Consumers, Traders Pay up or Give up on Grains?

That was two weeks ago. And though fresh reports of heat and drought keep support under the grains, I believe prices are overextended at current levels because of a very uncertain demand outlook.

I’ve been keeping a close eye on the futures and agricultural companies with exposure to actual crop production. As you can expect, companies that produce fertilizers and agricultural chemicals, for example, have seen their shares follow grains higher. That’s because demand for these products has soared to help farmers salvage existing plantings and help new plantings to compensate for recent losses.

However, it usually takes time for price action in the futures market to impact producers. But not this time, as we’re also seeing quick price moves in companies like Tyson Foods (TSN) and Smithfield Foods (SFD). These players are already feeling the hurt from investors concerned about the companies’ ability to manage higher costs.

Considering the state of the global economy, I can’t disagree. Take a look at this chart of TSN and SFD over the past two months.

What does it mean, going forward?

Broadening our perspective with a weekly chart, it looks like there is more room for these shares to fall:

But let me go back to the grains now …

Amid the supply-induced price surge, there are already some question marks when it comes to demand.

Corn Belt Expectations Tightening

Before the weather wreaked havoc on the U.S. Corn Belt, corn usage for ethanol production was already falling below USDA projections. And with corn now considerably more expensive, corn usage for ethanol production is likely to fall increasingly short.

Not to mention, U.S. exports of corn are also undershooting expectations.

From the USDA:

The United States was poised to regain a significant share of the global corn market based on early forecasts of a record crop.

However, the recent dry and hot conditions throughout much of the U.S. Corn Belt during a key stage in crop development has caused a dramatic cut in expected production and led to a month-to-month drop in projected exports from 48 million tons to 40 million.

That leaves the United States with the same market share as in 2011-’12 … which is far below its historical position as the supplier of more than half the world’s corn exports.

And from the Des Moines Register:

The U.S. Department of Agriculture said Thursday that corn exports were down 25 percent for the week ending July 19 from the previous week and 21 percent from the prior 4-week average as higher corn prices continue to cut into demand.

Also, last week it was reported that ranchers began selling off livestock as the cost of feed jumped.

Is a Lean Holiday Season in Store?

As the Minnesota Public Radio News website reported on Friday, a turkey grower anticipates losing $40,000 on the birds he sells to the market ahead of Thanksgiving, and a hog farmer with 8,000 pigs at various stages is expecting to lose $20 to $30 on every hog he sells.

Sure, increases in costs can often be passed on to the consumer. But there are some items worth considering at this stage of the game:

• The increase has been sharp and swift, which makes shoring up margins by passing on costs much more difficult.
• The economy is under immense pressure (consumption was a weak spot in last Friday’s U.S. GDP miss).
• In order to sidestep some of the above obstacles, demand from companies at various stages along the line will erode if prices remain high.

Indeed, it may take a while for the higher costs of grains to pass completely through the system. But corn and soybean bulls should be very cautious, as demand destruction is already beginning.

Plus, growers and farmers may feel the pinch another way. With the cost of meat, eggs, milk, butter and a host of other processed foods to rise, the market process may encourage consumers to embrace a stricter budget and buy cheaper cuts or smaller portions of meats.

In that case, it may make sense to be short the companies exposed to higher grain prices now, companies like Tyson, Smithfield or Kellogg (K).

And when the hot and dry weather forecasts pass, turn bearish on the grains — or agricultural-focused companies like Potash (POT) or CF Industries (CF) — as investors rethink the demand side of the situation in an extremely challenging global economy.

Best,

JR

P.S. To learn more about how to benefit from the current trend in grains, as well as other recent developments, sign up for a risk-free trial to my Master Trader service.