No Raining on Grains’ Parade

05/19/2011 11:34 am EST

Focus: COMMODITIES

Eric Roseman

Editor, The Commodity Trend Alert

Unfavorable weather in the nation’s bread basket has set the stage for higher wheat and corn prices, writes Eric Roseman, editor of the Commodity Trend Alert.

I’m very bullish on the iPath Dow Jones-UBS Grains Total Return Sub-Index (JJG).

[The index currently consists of 41% corn futures, 37% soybean futures and 22% wheat futures, and the exchange-traded note attempts to duplicate the performance of that grains basket—Editor.]

Kansas, the largest wheat-growing state in the union, is on track to harvest one of the worst crops in years. Some parts of the nation are begging for rain. Every wheat-producing state is showing crop projections down about 50% from year-ago levels.

That means we’re probably going to see higher grain prices this summer, as yields disappoint. Soybeans are the wild card, and supplies might dramatically improve.

As the core planting window begins to close on corn, the next subject likely to come under scrutiny will be the extent to which farmers switch from planting corn to planting soy as adverse conditions persist into mid-May. The Dakotas will be extremely critical, as together they represent 1.3 million additional corn acres compared to 2010, which could return to soy and add to what should already be a record soy crop in North Dakota.

The biggest concern to crops already in the ground is the extreme drought in Texas and Oklahoma, which combined account for about 26.3% of the expected 2011 US winter wheat crop. The severity of conditions there has degraded plant health, with only 7.1% of the crop currently judged to be in good-to-excellent condition—versus 66.7% at the same point in 2010.

We’re anticipating a disappointing US corn and wheat crop. This should be supportive of JJG, holding a combined 61.8% in both grains.

Underlying bullish forces such as the cheaper dollar, high oil and gasoline prices, and China’s growing grain imports remain intact. China’s government has long emphasized the need to produce enough grain to meet almost all the demand of its massive population, in order to avoid becoming dependent on foreign suppliers.

But that hasn’t worked. In recent decades, China has dropped the self-sufficiency goal for some crops like soybeans—but continues to categorize corn, wheat, and rice as key grains.

Over the last five years, China has gone from being a net exporter to a net importer of corn, wheat, and soybeans. This is a major shift in the demand outlook for the grains, and one of the most fundamental reasons why we’ll continue to see new highs.

Periodically, buoyant harvests might appear some years. But the long-term trend is already in place, and it’s undeniable. Global population growth is about 80 million people per year and outgrowing the Earth’s resources.

Buy JJG up to $55. [Shares have spiked 9% in the last three days, trading at $55.59 in recent action—Editor.]

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