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Wednesday, October 27, 2010

We seldom repent of having eaten too little.

This topic prompted me to recall a couple of quotes:

“#5.  Pride costs more than hunger, thirst and cold.

#6.  We seldom repent from having eaten to little.”

Thomas Jefferson – “Ten Rules”

Since the people who put together the CPI statistics obviously do not eat, drive or pay for anything that a normal American might need to they can easily put blinders on when it comes to massaging their models to report low to no inflation. For the rest of us that actually go to the supermarket, put gas in the car, visit the doctor and live everyday life we can see the inflation first hand, which is what prompted me to write this blog post now. This inflation in our everyday lives shows up in many ways, some obvious and some sneaky. A sneaky way that inflation creeps in to our lives every week is at your local grocery when you buy the items to feed yourself and or your family. On the surface it may appear that prices are stable but nothing could be further from the truth. For example, the last time I was in the market I had to pick up some Edy’s ice cream and pasta, which are pretty close to the cost that they have been for a while. Upon closer inspection of these products one discovers that while the price out of pocket may be the same the actual volume of product you get has been trimmed. The ½ gallon of ice cream is now 1.5 quarts instead of 2 and the box of pasta is no longer 1 pound but instead 13 ounces. This is how food manufacturers are dealing with input cost inflation since they don’t currently have the pricing power to charge what they need to for the old volumes.

Food prices are rising because there have been a variety of crop issues around the world and they are impacting global production at a time when the world’s stockpiles of certain commodities are down. Moreover, food is not a product that you can just print up or expand flow by drilling a second well on a proven reserve. Food production takes time and there is nothing that can be done to truly speed up its production. If a harvest is poor you have to wait until the next cycle to plant and re-harvest; so while demand may be stable or growing “mother nature” does not help out in this area.

On October 22nd a Bloomberg report appeared discussing the record crop in India which is helping India’s credit market, but this is more the exception than the rule. The net result is that India with its 1 Billion plus population may be able to stave off inflation for its people but it is not in a position to fix the problems of the rest of the world. Conversely, the crops from around the world have been affected negatively by everything from Russian Drought cutting their harvest by 1/3 and drought in Germany causing crop failures. Meanwhile, there are actual locusts in Australia rivaling those described in biblical plagues are chowing down on the wheat down under. Even Canada is expecting their wheat harvest to be down some 35% due to extraordinarily heavy rain fall as is Pakistan where their wheat crop has been flooded out. Lest you think dear reader that this only applies to wheat; in West Virginia they are losing their apple and soybean crop to the tune of 86% and 83% respectively. Nepal has suffered from a massive corn crop failure as well as South Africa.

I an interview with Don Coxe, a world leading expert on agricultural commodities, he states his belief that there is the potential the world could face a “Mass starvation” following North America’s next major crop failure.  Coxe points out that "During this decade, the annual increase in hectares of global cultivated farmland has been roughly 1.5 per cent, at a time global demand for grains and soybeans has been growing at double that rate". Additionally, the article mentions that the global financial crisis has left farmers scarred and has caused them to curtail their output. He also mentions a theme that is tied to other investment strategies like the “arms dealers”,; which is the rise of China and India and their demand for more protein rich diets will divert staple crops to feed purposes reducing further availability and driving cost. One thing that Coxe does not discuss is the tie in with water and how much water is required to raise the protein stock versus the equivalent in protein rich crops like soybeans; yet another investment theme going forward.

Coxe also discusses how, "We've been incredibly lucky with the weather up to this point. But if you cut the growing cycle by four weeks, that will dramatically reduce yields”. The fact of the matter is that the climate has changed and whether you believe it is man-made or a natural cycle is irrelevant; instead we need to focus on food production in the new environment as soon as possible.

Add prior facts that the world population currently stands at around 6.5 Billion and is expected to grow anther 2.5 billion in the next 35 years, so we will need to figure out how to feed them. In the future the crop disasters of today will be even less tolerable than those of today and will further drive costs.   If you are interested dear reader you can check out the World Agricultural Supply and Demand ESTIMATES form the USDA in PDF format to see what the government is telling us is going on in the food supply.

At the same time that all these issues have come to the fore regarding crop production the UN issued a report on October 21 that the world is losing arable farmland at an alarming rate of about 75 million acres a year or roughly the equivalent of and Italy a year. The losses are due to farms being paved over for urbanization or industry as well as environmental degradation.

As for the United States the number of farms as of the latest data available from the USDA has held steady at 2.2 million, however, overall acreage has declined by 110,000 acres. The statistics also show that 1.2 million of the farms have revenues of less than $10K per year and another 660K farms have revenue between $10K and $99K. One has to wonder of all those farms how many are able to actually hang on in this atmosphere where their inputs are rising, it is an important question since these farms make up 81% of all farms in the US.

So as you can see Agriculture has its issues and is related directly or indirectly to many issues and areas of the economy from population and land to water and fertilizer. So how does one play this trend? First as I mentioned earlier agriculture is a trending business since if there are issues they are generally only correctable the following year at best assuming that crops and or weather cooperate. Just a month or so ago right on the cover of Bloomberg BusinessWeek was a headline touting their article “Don’t’ buy DBA” or commodities for that matter. When things appear on the cover of BusinessWeek it is usually a contrary indicator just as the proclaimed “the Death of Equities” in 1982.

For those of you who are unfamiliar DBA is the symbol for and ETF that trades on the New York Stock Exchange, AKA Powershares DB Agriculture Fund. DBA is a commodity based price index that reflects most of the major crops from wheat, sugar, corn soybeans, coffee, cocoa and even some cattle and hogs.  This is a far safer alternative to playing in the futures market for exposure to the “softs”, that is not to say DBA it is without risk, but it is kind of like a commodity mutual fund for diversification and less wild exposure.

Now that you have the raw materials covered I would look to the “arms dealers”; in this case being John Deere, Monsato, Mosaic, Potash, Willmar International, Caterpillar, Yara and  Bunge to name a few. Depending on the size of your investment funds you could put together a nice basket of all these and other stocks that supply or aid the agricultural sector; or as you may have guessed like the tag line for the iPhone “there’s an app for that” in this case it is an ETF.  Market Vectors Agribusiness ETF trades on the NYSE with the very appealing ticker MOO. MOO gives you exposure to the “Arms Dealers” both in and out of the United States, this way you get a the added benefit of increasing earnings from a falling dollar. Some of the companies in the MOO portfolio are located outside the US but most of them sell outside and can earn even more if the dollar continues on its current trajectory.

DBA has a $1.9 billion in net assets and MOO has $1.5 Billion, so they are not small funds and  they trade an average of 1.7 million shares and 850K shares a day respectively, so you will not have difficulty in buying in or selling out. As with most securities these days but even more so with commodity related stocks it can be very volatile and people are easily shaken out.If one is going to invest in these areas they should wait for a pull back and use trailing stops as well as demonstrate patience recognizing that this is a longer term hold.

Looking at the charts of DBA and MOO they appear ready to correct as they are overheated and could use a healthy consolidation. As a disclosure I am looking to own both of these ETFs at slightly more attractive entry points, but dear reader you need to do your own due diligence as this is not a recommendation to buy or sell these securities. Just looking at the charts I am looking for a pull back to the 50 Day moving average on both DBA and MOO. Both ETFs are clearly in a nice uptrend and both sport a bullish cross of the 50 day MVA up thru the 200day MVA, but they are both overbought on declining volume meaning that the move is getting long in the tooth and needs to take a breather. In fact MOO looks like it hit a temporary peak on very heavy volume even as its relative strength appears to be waning. As I said I am looking for a drop toward the 50 day MVA to imitate a position in both ETFs. As a side note both ETFs look good on both the daily and weekly charts so the confirmation of the uptrend is in two timeframes which think speaks volumes. There have been many times in my investing career where it is not as clear because and issue will look very good in a shorter timeframe but still be in a serious downtrend for a longer term view; this is not the case with DBA and MOO as they have based for several months doing the sand paper grind riding themselves of the weak hands.

DBA Daily Chart (CLICK the image for a full size view)

DBA Weekly

MOO Daily

MOO Weekly

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