One of the biggest stories in the media over the past week or so has been the tremendous drought affecting the nation's Corn Belt. The spike in crop prices has been dramatic ...
Corn has rallied more than 50 percent since mid-June as the condition and size of the crop is consistently downgraded.
Drought conditions are some of the worst in nearly twenty years. And it's a sharp reversal from just two months ago when it was generally expected that the corn crop would be a "bumper crop."
Just last week, the USDA reduced the expected corn production this summer by 1.8 billion bushels, and reduced the per acre crop yield to 146 bushels/acre this month, from 166 last month.
Trading corn in this market is a risky venture because at the first sight of rain the contract will fall hard, but there's no telling how high it can go before that happens. Moreover, higher grain prices can impact other sectors in the market, too.
Normally, when grain prices are this high it's bullish for agricultural equipment manufacturers like John Deere (DE). The general thinking is that farmers, with a lot more money in their pockets from the higher prices, will buy new tractors, plow new fields, and upgrade old equipment. But what we're seeing now isn't a typical price rise in the grains ...
Prices are rising because the general thought is that the crop will be much smaller than anticipated. So while farmers who are lucky enough to have their corn survive will receive a better price, many more farmers will simply have no crop to sell. As a result, we have to be cautious about investing the same old way.
Taking the Contrarian Approach ...
As I think about the potential effects of this drought and the investment opportunities, there is one sector in agriculture that will likely benefit — seeds.
Farmers are not simply going to let their crops fail without trying to get something out of the ground. Consequently, a lot of them will replant certain fields in soybeans or other crops where corn might have failed. In fact, I've read multiple reports of farmers already replanting soybeans where they had just planted corn, in an effort to have something to bring to market at harvest time.
The point is that we can expect increased demand for seeds as we enter the later parts of the summer, and to a lesser extent see an increased demand for fertilizer as well.
In particular, there should be a higher spot demand for drought resistant seeds made by companies like Monsanto (MON).
However, if you prefer the diversification of an exchange traded fund, you might consider the Market Vectors Agribusiness ETF (MOO). It holds some of the largest seed and fertilizer companies in the world, companies that should benefit from additional demand as unlucky farmers try to salvage what they can from a difficult growing season.
As contrarian investors we must always look at an event in the market from multiple angles, and look beyond the typical response. Higher grain prices due to a drought are not a blanket "good thing" for all agricultural companies. But savvy contrarian investors who look deeper can identify the sectors that do stand to profit.
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