How to Play the Rise in Agricultural Commodities

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So far this year, agricultural commodities have outperformed most other asset classes. While some have outperformed others in general, we have seen strong performances.

  • Corn is up nearly 10 percent.
  • Wheat is up over 10 percent.
  • Soybeans are up over 5 percent.
  • Cotton is up over 8 percent.
  • Coffee is up over 80 percent.

The list goes on, but the point is made. In a market where investors are becoming jittery holding stocks after such a large increase in value, I suspect that some of that money is going to find its way into agricultural commodites and related assets. This could be the catalyst that will drive agricultural commodities to a higher fundamental valuation, which is warranted given the fact that demand for these commodities is steadily increasing, while supply is not.

Investors looking to invest in agricultural commodities have a wide array of options, and while they will all rise in an agriculture bull market, before investing, it is useful to look at their merits and detriments.

Let us look at a couple of options available to retail investors.

1. Broad agricultural commodity ETFs

There are a couple of agricultural commodity ETFs that are designed to track the price of a basket of agricultural commodities. These include the DB Agricultural Commodity Fund (NYSEARCA:DBA) and the Rogers Agricultural Commodity Fund (RJA).  While these funds are small and somewhat illiquid, they provide a critical option to retail investors who want exposure to agriculture but who don’t play in the futures markets, who don’t want to assume the additional burden of choosing individual commodities over others, and who don’t want to assume the equity risk that comes with owning shares in agriculture-related companies.

These two funds hold a wide array of agricultural commodities including cotton, sugar, live cattle, corn, wheat, and coffee. The less-liquid Rogers Agricultural Commodity Fund also holds some of the thinly traded agricultural commodities such as greasy wool, oats, and azuki beans. While there is more upside potential in owning individual commodities or the right stocks, these also have the most downside risk, and the best ones are difficult to choose. Therefore investors who want to own a few positions in agriculture should make one of these two funds a cornerstone of their portfolios.

2. The market vectors agribusiness ETF

The Market Vectors Agribusiness ETF (NYSEARCA:MOO) is a fund that holds shares in companies that earn revenues in some way from agriculture. Its holdings include seed and pesticide producers such as Monsanto (NYSE:MON) and Syngenta; fertilizer companies such as CF Industries (NYSE:CF) and the Mosaic Co. (NYSE:MOS); grain refiners and traders such as Archer Daniels Midland (NYSE:ADM); and agricultural machinery companies such as John Deere (DE). This is a wide array of stocks that should perform fairly well as the prices of agricultural commodity prices rise. However, there are a couple of drawbacks. 

First, like with most equity ETFs, this one emphasizes the largest companies that might not be the best investment choices — a higher-priced company has a greater likelihood of being overvalued. Second, this fund has traded more closely with the equity markets and less in line with agricultural commodities. If investors are looking to sell overpriced equities, they likely don’t want to take a position in an ETF that is going to be correlated with the same equities that they are selling.

Given this, I think investors who want to own agriculture-related equities should be stock pickers and try to find companies that are going to outperform.  Investors can also look for sub-sectors that will likely outperform. One such subsector is the fertilizer space.

While there is an ETF that holds fertilizer stocks exclusively — the Global X Fertilizer ETF (NYSEARCA:SOIL) — I don’t think that this is a good investment option given that it is such an illiquid fund. Instead, I think investors should buy a couple of individual fertilizer companies that have a lot of value and a history of outperformance. Two such companies are CF Industries and Potash Corp. of Saskatchewan (NYSE:POT).

CF Industries is one of the best-performing stocks over the past several years, having gained more than 1,300 percent since going public in 2005. The company produces nitrogen-based fertilizers and is the leading producer of such fertilizers in the U.S. By being aggressive a few years back, when prices were depressed, and by buying out Terra Industries, the company proved itself to be dedicated to growth and value creation in a way that is unrivaled by its peers. While the company’s earnings are down year-over-year due to lower nitrogen-based fertilizer prices, higher grain prices should reverse this. If we see nitrogen prices reverse their downtrend, we should see CF Industries’ profits soar.

Potash Corp. of Saskatchewan is the world’s largest fertilizer producer. It has holdings in all of the fertilizer segments, but its focus is on muriate of potash (aka potassium chloride). Potash Corp. has seen its profits take a big hit as we have seen a sharp decline in muriate of potash prices. Not only did demand abate somewhat when grain prices fell over the past couple of years, but this particular fertilizer saw declines resulting from an unexpected increase in supply coming from Russian potash producer Uralkali (OTCMKTS:URAYY).

Uralkali had previously agreed to limit its production only to renege on this promise last summer. This sent shares of Potash Corp. and its peers tumbling. But while short-term supply sent prices falling this doesn’t have a major impact on long-term supply, and long-term demand is still rising. As a result, Potash Corp. is an excellent long-term holding for patient value investors.

While there are several other options available to investors in the agriculture space, the options I provide in this article are a good place to start.

Disclosure: Ben Kramer-Miller is long shares of Potash Corp., Mosaic Co., CF Industries, and the Rogers Agricultural Commodity ETF.

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