Investment Strategies

Sun Shines On Soft Commodities Amid Corn Belt Heatwave - Barings

Wendy Spires Group Deputy Editor London 25 July 2012

Sun Shines On Soft Commodities Amid Corn Belt Heatwave - Barings

Investors have a lot to gain from the soft commodities sector after searingly hot temperatures in the US Midwest have hit the prospects of several key crops, argues James Govan, investment manager of the Baring Global Agriculture Fund.

Temperatures like those seen in the Corn Belt - touching 37 degrees Celsius at times - reduce the potential yield of crops like corn and soybeans, explains Govan. Providing more grist to his mill is the fact that inventories remain low when compared to consumption of corn and soybeans from a historical perspective.

The anticipation of reduced yields has already caused sharp upward movements in grain and soybean prices, and corn and wheat have also trended upwards. The Chicago December Corn Futures rose by 46.5 per cent between 11 May and 13 July, while Chicago September Wheat Futures rallied 38.6 per cent in the same period, Govan notes.

The situation as it now stands with grains is actually a sharp reversal of expectations, since a bumper harvest had been expected off the back of optimal planting conditions earlier in the year. Amid the heatwave in the Midwest, corn yield estimates have fallen from 166 bushels per acre in the June World Agricultural Supply and Demand Estimates report to around 146 bushels per acre in this month.

These factors have caused agricultural companies involved in the “upstream”, such as fertiliser, machinery, seed and crop protection, to perform well in recent weeks off the back of higher grain and soybean prices. The deterioration of the US soybean crop has also bolstered Asian-based crude palm oil equities as overall vegetable oil inventories are revised down.

Against this backdrop Govan is focusing on stocks which stand to benefit from higher grain prices and the fact that farmers are likely to invest more heavily in machinery, fertiliser, seed and crop protection as a result.

“In a strong soft commodity environment, the farmer has greater incentive to use the best seeds and maximise fertiliser application,” he said in an investment note. Farm machinery demand, which is highly correlated to farmer incomes, will also get a boost from enhanced profitability.

Govan’s fund is holding both upstream companies and midstream producers, with a bias towards companies within the machinery and fertilisers sectors.

“In the midstream of the agriculture value chain we have exposure to grain and edible oil processing, and distribution and meat processing companies, where we identify attractive valuations, with many of these companies well positioned in our view, from a long-term perspective,” he said.

“However, we have recently been reducing our position in these types of companies, because of the squeezed expectations for the size of the US crop, which is likely to act as a headwind for profit margins. We have also significantly reduced our position in diversified food groups in recent weeks, because in our view these companies appear to be fully valued, on a relative basis.”

Turning to fertilisers, the fund is diversified both in terms of geography and product, holding companies which produce all three fertilisers: nitrogen, potash and phosphate. “We consider that the oligopolistic (a market dominated by a few sellers) nature of the potash industry should result in a strong price environment, with minimal downside,” Govan said.

On the crop protection and seeds side, Monsanto and Syngenta are favoured stocks due to “significant intellectual property and strong product pipelines”. Machinery names highlighted by Govan include North American, Asian and Turkish-listed companies; in one example, Deere, the US tractor maker, recently said it was confident of continuing growth in agricultural machinery and has announced plans to expand its manufacturing capacity at its Iowa-based Waterloo Works facility.

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