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6 Stocks to Watch as Grain Prices Soar

How to profit from the parabolic move in grains

by 7/31/2012 2:44:06 PM
Stocks quoted in this article:

In case you have been living in a closet for the past two months, I'll go ahead and let you know that commodities such as corn, wheat, and soybeans have been skyrocketing lately as a result of drought conditions in the Midwest. Many farmers are claiming this is the worst drought they've seen, and the effects of this decreased year of production will be broad-sweeping, and affect not only farmers, but essentially everyone who consumes or uses grains.

Below are a few charts of the grain futures, and as you can see, the moves over the past two months have been staggering. (Click on the charts below to enlarge).

Click to Enlarge
Click to Enlarge

While we don't trade commodity futures here at Schaeffer's, there are a few ways to profit from this recent drought phenomenon. The drought has led to less supply on the market, which in turn drives grain higher. As you can imagine, companies that require grains to support their businesses have been hurt badly because of increased operating costs. A few of these names include poultry producers Tyson Foods, Inc. (NYSE:TSN), Sanderson Farms, Inc. (NASDAQ:SAFM), and dairy producer Dean Foods Company (NYSE:DF). The correlation between these names and commodities is highly negative, which means that strength in commodities typically leads to weakness by these stocks, and vice-versa.

What's troublesome for these names is that this broad grain strength has coincided with a period of dollar appreciation and euro weakness. Commodities are priced in dollars, and a higher dollar typically leads to lower commodities, and vice-versa. However, this is a supply-side problem, and that cannot be fixed by further strengthening of the dollar.

The events that will transpire this week have major macroeconomic implications, many of which could cause the next big move in the grains space. Should there be some sort of dollar devaluation mechanism put in place, it is highly probable that grain prices will continue their sharp rally. In this case, it would be prudent to short the stocks mentioned above and/or go long some of the fertilizer names such as Mosaic Co (NYSE:MOS), Agrium Inc. (USA) (NYSE:AGU), or CF Industries Holdings, Inc. (NYSE:CF). Any stimulus should have a very net-positive effect on both the equity market and commodities. Additionally, the agricultural/fertilizer stocks should benefit greatly from such news.

Should there be no action announced by the Fed tomorrow and the European Central Bank (ECB) on Thursday, then it is likely that the current conditions of dollar strength and euro weakness will persist. In this case, the prudent play would be for a reversion to the mean, and TSN, SAFM, DF, etc. could outperform the market on a relative basis. In this case, buying one of these stocks against a short broad-market hedge makes a lot of sense to me.

The major rally to end last week is a signal to me that the market has priced in some sort of good news this week, and any disappointment on that front could lead to a sharp selloff. For this reason, I advise buying these names against a broad-market short hedge in hopes of relative outperformance.

The rest of the week should prove extremely interesting, and it will undoubtedly offer an ample amount of opportunity. After many weeks of choppy market action, some resolution to the current situation will be a breath of fresh air.

Going forward, keep a very close eye on the dollar and any macroeconomic news -- that information (and the market's reaction to that information) will be very telling as to the next big market move.


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