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Seeds of Doubt?
New York: May 23, 2011
By John Stephenson

There's a mad scramble underway in the American Corn Belt to get seed in the ground before it's too late. Complicating matters is Mother Nature. Much of the American Mid West has gotten too little rain, while the corn growing region has been suffering from a deluge of rain, which has left many fields flooded and unable to hold seed or fertilizers. And the prospect of a poor corn harvest could help underpin surging corn prices—a bonanza for farmers and a looming crisis for much of the world's poor.

Despite the flooding-related delays to corn planting, the U.S. Department of Agriculture (USDA) in its May 9, 2011 report seemed rather bullish on the prospects for the upcoming American corn harvest. The USDA report called for 92.2 million acres dedicated to corn in this growing season. And the report's release had a predictable outcome for the futures price for corn—it tumbled from well north of $7 per bushel to $6.60 per bushel before recovering.

Helping spur the recent rally in corn futures was the release of another industry report from respected agricultural consultancy OTR Global, which suggested an entirely different outlook for the 2011 corn season. Rather than confirming the USDA's bullish outlook of around 92 million acres of corn plantings, OTR Global came in with a more sobering estimate of 88 million acres. Their channel checks with key agricultural executives suggested that severe weather across vast areas of U.S. growing regions is causing downward revisions for the corn planting estimates.

Corn prices are likely to rise over the balance of the year as it becomes apparent that the USDA's estimates represent a “best case” scenario where both acreage and yields are likely to be revised downward in the months to come. Demand from China is another wild card that could cause corn prices to spike in the months ahead.

China used to be a big exporter of corn, but today, China is a major importer of corn and likely to demand even more corn in the months and years ahead. While the Street had expected U.S. corn exports to top 2 billion bushels this year, the USDA report seemed to suggest that corn exports would be somewhere between 1.8 and 1.9 billion bushels. This seems unlikely especially when you consider that China has just 10 to 15 million metric tons in state reserves versus their long-term average of 35 to 40 million metric tons.

Winter wheat prices have also been heading skyward lately as droughts have impacted the southern states. If prices for wheat remain in nosebleed territory, some corn farmers may switch from corn to wheat, further tightening the supply/demand balance for corn.

But with margins per acre for corn at six times the five-year average, most farmers will be scrambling to plant as much corn as possible. But time is running out. Corn takes many months to grow and anything planted after the end of May runs the risk of a fall frost. The likely consequence of the current field fight is lower than anticipated corn acreage and yields, higher exports and rising farm incomes.

The other likely beneficiary of rising corn prices will be the shares of fertilizer companies. Over the past 15 years, about 90% of the performance of fertilizer equities occurs in the back half of the year. The reason for this is simple. Fertilizer equities are highly correlated with crop futures prices, which tend to rise in the late summer and fall as the optimistic forecasts for acreage and crop yields from the May/June planting season, fail to materialize. Not to mention, that the fertilizer has already been applied by the time the seeds are in the ground and poor weather only increases the likelihood that additional fertilization must occur.

As I pointed out on my recent appearance on CNBC's Fast Money , corn futures and nitrogen-based fertilizer stocks may be your best commodity trade in the next couple of months. Corn uses more nitrogen fertilizer than other primary cash crop and uses much more nitrogen than either potash or phosphate per acre.

With prices for corn and wheat up sharply in the last year, can the price for feeder cattle and hogs be far behind? While feeder cattle prices have risen by around 15 percent over the past year, this pales in comparison with corn's 108% upward surge. Some estimates suggest that a 30 percent rise in grain prices translates into a 10 percent increase in livestock prices (with a three- to six-month lag). But even that may be underestimating the impact of grain prices on America 's beef and poultry industries, considering that corn feed represents about two-thirds of the input costs for the American beef industry. While rising grain prices may be a good news story for grain farmers, it's definitely a bad news story for ranchers and poultry producers.

Investors looking to profit from the rising price of corn and other key grains should consider an investment in the shares of fertilizer companies. Their fortunes go hand in hand with the fluctuations of crop prices, so much so, that these stocks have a 75 to 85 percent correlation to the price of the grains. With grain prices poised to move higher, fertilizer stocks may be one way to boost the yield on your investment portfolio.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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