Crop Circles

In the January 4th edition of the Rude Awakening, we
ventured that agricultural commodities might lead the CRB
Index of commodity prices to "new multi-year highs."

And so it has come to pass…

A spectacular five-week rally in the grain markets has
powered the CRB to new 24-year highs. So what’s an investor
to do?

According to most ag-trading pros, the recent rally in the
"ag pits" has nothing to do with supply/demand
fundamentals, other than the overwhelming supply of hedge
fund dollars demanding to buy commodity contracts of all

"Relentless buying of CBOT soybeans, wheat and corn futures
by commodity investment funds over the past 20 days is
baffling grizzled grain traders," Reuters reports, "The
CBOT agricultural markets rose again on Wednesday,
following a pattern that began in late February when large
speculative funds managed by commodity trading advisors
began buying massive amounts of CBOT commodities. CBOT
soybeans hit a six-month high last week and corn and wheat
reached five-month tops…Inflationary fears with a
weakening U.S. dollar have enticed speculators to shift
dollars away from stocks and bonds to hard assets, like

"Grains aren’t grains anymore," one long-time CBOT floor
trader griped to Reuters, "it’s just another asset class.
That adds a whole new wrinkle to what we do here."

Your editor attempted to iron out the wrinkle by checking
in with Richard Morrow, our go-to agricultural commodity

"What’s with all the fireworks in the grain markets?" we

"Well, it’s easy to see WHAT’S happening," replied Richard,
the CIO of Bullfrog Capital Management, "but harder to say
WHY it’s happening…and hardest of all to predict what’s
gonna happen next."

"Fair enough," we said, "But we’re intrigued by the
apparently bullish action in ag. commodities and were
wondering what opportunities might exist, whether in ag.
stocks or in the futures themselves."

"Okay, but let me begin by issuing a warning," Richard
humbly began, "I’m a part owner of a cotton warehouse, I
own farmland and I trade ag. commodities.  With all of
these supposed advantages, I’m pretty sure I don’t know
what I’m talking about."

"We appreciate your professions of ignorance," we replied,
"but maybe you know a little bit more than nothing about
what’s lighting up the grain markets."

"Sure, it appears that hedge funds are pouring into the
market, even though there’s not much market to pour in to.
There is a flood of money coming into the ag. commodities
and commodities markets in general, despite some very
uninspiring fundamental trends.  It’s tough to see why
anyone would want to be long cotton, for example, but the
wave of institutional money keeps taking all the ag.
markets higher.

"That’s why most of the good fundamental traders I know are
losing money this year," Richard lamented. "Remember, ag.
futures are a small market and just can’t handle several
billion dollars of liquidity, without lurching in some
direction. So it’s relatively easy for hedge funds to make
a big splash in these markets. My fear is that their sudden
departure from these markets might cause a big splat."

"Please continue," said we.

"The question is what to do now," Richard explained. "Is
the wave of money a flash in the pan or will we have to
live with huge spec. funds pushing our markets around?  I
have a strong feeling the wave of money is here to stay for
a while. I also get the feeling that money managers have
decided to be exposed to ag. in a big way and they are
going to throw a lot of money into our markets.

"The ag. futures market is not as big as one would think.
There are only $25 billion dollars worth of corn produced
each year and about $18 billion worth of soybeans, as well
as $5 billion of cotton and $6 billion of wheat. After
those crops, the numbers get small in a hurry.  Over in the
equity markets, there are really only two main pure ag.
plays in the stock market, Bunge [NYSE: BG] and ADM [NYSE:
ADM].  The total market cap for both is about $22 billion.
So it’s a very small sector.  In other words, ag. futures
and stocks combined would be worth significantly less than

"Okay, so, net-net, what’s your feeling about either the
stocks or the futures?" we inquired. "Is there anything to
do in here?"

"Maybe on the sell side," he replied, "Both ADM and BG have
nearly doubled in the last year.  A year ago, end product
prices were high, input prices were reasonably low and
farmers had good yields.  The profitability from the farm
flowed into the revenue and margin streams of ADM and BG.
In short, the wind was at their back and they both made a
lot of money.  This year, inputs prices are higher, product
prices are much lower and yields are a question mark.  I’m
just not sure we can see earnings repeat last year’s
results. I’m not saying earnings won’t be up, but they
probably won’t be up as much as their shareholders expect.

"The bottom line is ADM and BG are both trading at
reasonably high historic PE’s and at 2.5 times book. That’s
pricey, but if Wall Street money flows into ag. stocks, the
limited size of the sector will force prices higher
regardless of the fundamentals.  If I were long these
stocks (which I’m not), I’d be scaling out of them…but I
could be wrong."

"But surely," we insisted, "there’s a bull case to be made
for these stocks if, in fact, a bull market in grains is

"I’m not sure about that," Richard countered. "From a long-
term perspective, the grains themselves seem like a better
long than the ag. stocks. Of course, I should mention that
ADM’s ethanol unit is printing money at $55 oil.  Truth be
told, ADM is more of an energy company than an ag. company.
As long as oil is high, the ethanol unit will continue to
print money in the near term. So maybe that supports the
ADM share price. That said, there are so many ethanol
plants going up that I would think the margins will go down
3-5 years down the road.  The glory days for ethanol are
occurring right now."

"Fine, so let’s look at the commodities themselves."

"Okay, but again I must warn you, I’m neither bullish, nor
bearish, merely agnostic. On the bullish side of things, Ag
futures prices are well below last year’s, despite the big
run up over the last 5 weeks. Even so, it’s hard to get too
bullish in the face of the record crops we’ve been seeing.
The 2004-05 crops were ‘record large’ all over the world
and that’s the primary reason for lower prices vs. a year
ago.  Brazil is still expected to harvest its biggest bean
crop in history. And that’s on the heels of a record-large
U.S. soy harvest last fall.

"Supply is the big question for all these markets," Richard
concluded. "Specifically, ‘Are last year’s monster yields
repeatable, or were they a one-time fluke?’  Unfortunately,
I don’t know the answer to that question. And in the middle
of all this, hedge funds are changing the game by buying
into the sorts of grain markets that fundamental traders
wouldn’t touch. So with all the fund money sloshing around
in the grain markets, we are certain to have very volatile
ag. markets this year. But I’m just not sure in what
direction, or for how long. See, I told you I didn’t know
what I was talking about."

"Thanks, Richard."

Crisis Point Trader

Did You Notice…?
By Options Pro Jay Shartsis

Today’s market reminds me of 1973’s ‘Nifty-Fifty’
experience. Recently I have been discussing the two-tiered
market that has developed with both the Dow and S&P 500
getting up to new highs, while the Nasdaq badly lags with
three declining peaks recorded since its early-January top.

The most pronounced such dichotomy in memory was the famed
"nifty-fifty" market that culminated in January 1973.

That extreme concentration of investment in those 50 "one-
decision" stocks was followed by the most severe bear
market since the 1929-32 period. I am not claiming the
current divergence is anywhere near as extreme as the
nifty-fifty experience. I cite it to remind investors of
the eventual negative outcome. The operative word is
"eventual" and, of course, these things can go on for an
extended time.

Stay tuned.

There couldn’t be a better time to be a resource trader.

Resource Trader Alert


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