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Farm stocks drop on what is, in my opinion, an overly optimistic forecast from the USDA--buying opportunity ahead
05/13/2011 1:17 pm EST
The cause of the plunge? The USDA said that grain inventories at the end of the harvest year will be larger than expected. Corn stockpiles will climb to 900 million bushels, for example. That’s a significant 23% higher than the 730 million bushels this year. Of course, this year’s 730 million bushels is the lowest stockpile in 15 years.
You can understand why that kind of switch would have sent some commodities traders scurrying to take profits. The price of corn has doubled in the last year as traders bet that the slim margin of error represented by that 15-year low in stockpiles would generate enough fear of shortages to keep prices rising.
What’s less easy to understand is how the USDA got to its new projections. I think they include some wildly optimistic assumptions. And if I’m right, the current sell off in farm-related stocks such as Deere (DE), down 4.4% from the May 10 close to the close on May 12 (that’s two days in case you’re counting), and Potash of Saskatchewan (POT), down 5.7% in those two days, could turn what was already a pretty good buying opportunity into a great buying opportunity in the sector.
Here’s what the USDA said that leaves me scratching my head. The USDA’s case for larger stockpiles is built on three assumptions. (Unfortunately for clarity and simplicity when we talk about “years” with grains we’re talking harvest years and not calendar years. And harvest years themselves vary from grain to grain. The corn year, for example, begins on September 1.The wheat year ends on May 31.)
First, higher grain prices will depress demand. That will show up in lower U.S. exports, for example, as overseas customers cut their orders because of higher prices. Exports of corn, for example, will drop to 1.8 million bushels in the harvest year that begins on September 1, 2011. That would be the lowest level of exports in 9 years. Exports will be lower in the harvest year that ends on August 31, 2011 too. Lower exports will result in bigger U.S. stockpiles.
But the USDA isn’t projecting bigger harvests in the United States. For example, in wheat the USDA says that U.S. stockpiles will total 702 million bushels in the year that ends on May 31, 2012. That would be big increase from the 683 million bushels projected before this most recent revision. (It is still 16% less than the stockpiles projected for May 31, 2011.) That increase in stockpiles will come from lower exports, according to the USDA since it is also projecting that the harvest in 2012 is likely to be hurt by bad weather. For example, the winter wheat crop, where the harvest starts next month, will be down 4.1% from the previous year thanks to drought.
Second, the USDA forecast assumes that the weather for the next crop will be not much worse than normal. That’s not the case at the moment where spring weather has been truly terrible in North America. Corn planting in the United States is only half as far along as it was at this time last year because of heavy rain. In Canada wheat fields are so muddy that only 3% of the crop has been sown. Normally 40% has been sown by this time of year.
If the weather breaks right, there’s still time for farmers to catch up on planting. The winter wheat crop in Kansas, the biggest grower of winter wheat, doesn’t have that much time. The crop is forecast to fall by 29% from last year. The total U.S. winter wheat harvest is projected to be the smallest in five years.
But it’s not just in the United States where the weather stands a good chance of being worse than the USDA forecast seems to assume. France and Germany have had unusually dry springs and the United Kingdom experienced the hottest April ever (well, actually only in the last 352 years). That’s not good news for wheat farmers in the European Union, the producer of 20% of the world’s wheat. Parts of Western Australia are in month 16 of a drought. A second straight year of drought is in the forecast for China’s wheat-growing areas.
The weather is nothing if not changeable so there’s no reason current conditions can’t change for the better. No reason that they have to either, though.
And third, the USDA forecast assumes that Russia will recover from last year’s drought—the worst in 50 years—and resume wheat exports. The politics here are at least as iffy as the weather.
Last year, Russia reacted to the drought by banning all grain exports through at lest July 1. This year the USDA projects Russia will not only resume exports but also increase them to 10 million metric tons from the 4 million shipped last year before the ban. The Ukraine, which last year matched Russia’s export ban, is projected to increase exports to 8.5 million metric tons from 3.5 million.
I think the likelihood that Russia will go from ban to unlimited exports this year is just about nil. Right now Russia is in the run-up to elections for the national legislature in December and for president in March 2012. All indications are that Vladimir Putin intends to run for president again in 2012. And I doubt that a man as savvy as Putin would run any risk of a return to full-bore exports producing grain shortages in Russia in the event of a spotty harvest in the months leading up to the election. It would be completely unlike Putin to leave any part of his election success at the mercy of something like the weather.
A 4% to 6% dip in farm-related stocks doesn’t qualify as a big buying opportunity. But the drop of May 11 and 12 just accelerated a decline that reaches back to April 29 and reaches to near double digits from many stocks in the sector.
And commodity prices are so volatile right now that we certainly could see the current 7 to 10% drop turn into a 10% to 15% correction in these shares. I’d look to pick up Deere, Potash, Agrium (AGU), Mosaic (MOS), and Yara International (YARIY). As of the close on May 12, the stocks were down 7.3% (Deere), 9.4% (Potash), 9.5% (Mosaic), 12.4% (Agrium), and 8.1% (Yara) from their April 29 local highs.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Agrium, Deere, Potash, and Yara International as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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