Growing up I swore to myself that I never wanted to be a rancher or farmer. Moving irrigation pipe, caring for cattle, bucking bales of hay — needless to say the work was strenuous.
But the older I get, the more I find myself yearning for the back-breaking work and solitude that comes with the gig.[ad#Google Adsense 336×280-IA]Luckily, I still have a close connection to it.
Being raised in a tiny village in the northwest, ranching and farming is — next to mining — probably the largest employer.
And my father keeps a pulse on the agriculture business, as it directly affects his business.
So I do my best to pick his brain about happenings in the agricultural business.
And during a recent conversation I found myself particularly interested in what was going on in the corn and wheat sectors.
What he told me was exactly what I wanted to hear…
A Brief History Of The Corn And Wheat Markets
Due to a large supply glut in the corn and wheat markets, prices have tanked roughly 50% since their 2012 highs.
But I think conditions are ripe for a rebound in both corn and wheat prices — especially for corn. And it’s all thanks to an aspect of commodities investing that I doubt many investors know about. But if you can grasp the idea, you’ll make a killing.
I’m talking about “price floors.”
As is the case for most commodities, corn and wheat prices are significantly influenced by supply and demand. It’s basic economics. When there’s an overabundance of supply, prices crash. When there’s excess demand, prices soar.
Right now, we’ve gone below a theoretical price floor for in a couple key agricultural products: corn and wheat.
You see, thanks to near-perfect weather and growing conditions, we’ve seen two consecutive bumper crops in the United States, which sounds like it would be great news for farmers, but there’s just one problem. All of this excess grain has greatly exceeded demand, causing prices to drop significantly over the last few months of 2015.
Now back to that conversation with my dad. That day he made a point to say that corn farmers typically don’t make much money under $4.25 per bushel. I think he’s right. According to this article that ran in the Wall Street Journal, it’s about $4. Either way, we’re now below that price — a bushel of corn recently traded for around $3.68 per bushel.
So bottom line, corn farmers (and wheat farmers as well) aren’t making any money. Soon, they’ll have to cut back production or they’ll be forced to grow other, more profitable, crops instead.
And that’s exactly what they’ve started to do.
The First Signs Of A Turnaround In This Market
According to a recent United States Department of Agriculture (USDA) report, U.S. farmers harvested only 36.6 million acres of all varieties of wheat in 2015, which is a 27% reduction from 2014 (corn has seen a smaller decrease of about 9% since 2013). And I think this trend will continue in 2016.
When this happens, supply will fall, and grain prices have to go up.
That’s the great thing about commodities. Investing in things like corn, wheat, gold or oil isn’t the same as investing in companies in the stock market. The demand for most commodities won’t just go away. Corn and wheat won’t be replaced by a new product or technology. And if you can spot where the “floor” is for these commodities — meaning, when price dips below the cost of production — you can make a lot of money.
Another reason prices could skyrocket has to do with demand.
So far, corn and wheat production has outstripped demand. Now that farmers have started reducing the farmland dedicated to corn and wheat, the equation should begin to right itself — but there’s another factor at play.
With corn prices, in particular, so low, this comes as great news for ranchers. This means they’ll have cheaper feed to help keep their cattle warm during the frigid winter months, and you can bet they’ll be more than happy to take as much cheap corn off of the hands of farmers as they can.
So right now we have near record-low prices, farmers cutting back on their grain harvests to reduce supply, and ranchers scooping up any cheap corn they can to feed their cattle. And this is all forming the foundation for what I think could be the start of a larger uptrend.
Typically you profit from grains via the futures market, but we have another way to access this trade. The iPath Dow Jones-UBS Grains Subindex Total Return ETN (NYSE: JJG), is a “one-click” way to gain exposure to both corn and wheat. (In addition, JJG has exposure to soybeans, which have also tanked recently.)
As you can see we are at just the beginning of an uptrend, but if I’m right then this trade could turn a quick profit. I can’t say for sure how much prices could soar, but I think it could be substantial and quick.
But if JJG should close below $29.79 (its lowest most recent close) that means I’m wrong about this setup and this uptrend is only a short rally on a longer downside trend. If that happens, get out of the trade and we’ll wait for a better, more substantial uptrend.
Risks to Consider: Commodities are fickle and can quickly turn against you. Plus, with Argentina’s new president lowering the agricultural export taxes it could allow for a lot of the grain farmers in South America to flood the market with their cheap corn. This of course will send prices lower.
Action to Take: In the last four of five years JJG has ended the month of February positive, and grain typically rallies into spring, both great signs for JJG. Buy JJG and look to book a quick gain. Once you’re up 20%, go ahead and take your profits. I don’t expect this trade to last longer than a few months.
— Jimmy Butts
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Source: Street Authority