This year, farmers look poised to deliver the largest corn crop in history, as weather conditions combined with aggressive planting to flood the market with the product. That usually means lower corn prices, which is bad for farmers and for the companies that benefit from higher grain prices. But could prices be approaching a turning point, creating an opportunity for investors?
Three Fidelity managers say the cycle of grain prices may be reaching a low, and a price recovery could provide a cyclical tailwind to stocks in the industry that are levered to a rise in commodity prices.
“In the last several years, corn, wheat, and soy have gone through a cycle of drought and then very favorable weather conditions,” says Tobias Welo, manager of the Fidelity® Select Materials Portfolio. “We have gone from a peak of $8 a bushel for corn down to $3.50—which is close to the cost to produce the crop. This doesn’t mean we’re at the trough now, but I think we’re reaching a level where the invisible hand of supply and demand should start to come in and help solidify the market.”
Today’s corn prices may have come down so far as to be unsustainable. “Ag is self-correcting,” says Fidelity research analyst Steven Calhoun. “Today’s prices are below the breakeven point for many farmers, so I don’t anticipate that farmers will plant 92 million acres of corn again next year—it could be 88 million acres or less. At the same time, we have just seen the best weather conditions in 30 years, so the probability of that repeating next year is low.”
Less acreage and worse weather could combine to reduce supply once again, and that could send the price cycle in the other direction.
“2013 was a difficult year for commodities and commodity producers,” says Joe Wickwire, manager of Fidelity® Global Commodity Stock Fund. “Amid the negativity, I saw companies with very good fundamentals and the potential to deliver attractive returns go on sale. I especially liked North American agriculture names.”
Finding the winners
A knowledgeable and sophisticated investor can attempt to profit from higher prices on corn or grains by investing in exchange-traded funds (ETFs) that hold contracts for those commodities, though these investments come with their own risks and complexities. But choosing the right investments may take more than simply buying all the names in a given industry. Welo and Calhoun start with a view on the price cycle, but they also do deep work on individual companies that may help to identify the best investment opportunities. Recently, they have found opportunities in two of the cyclical parts of the agriculture industry tied to fertilizers.
Potash: Prices may recover
Prices for the fertilizer ingredient potash have historically moved in line with crop prices. But this industry has been undergoing some unusual dynamics. After the industry spent years adding capacity, a Russian potash producer last year dropped out of one of the cartels that helps to manage supply and maintain pricing power. When the potash cartel broke up, prices fell from $400 a ton to a little more than $300 a ton. On the day the cartel broke, potash stocks saw losses of 20% to 40%. Calhoun and Welo had avoided the sell-off, but when stock prices tumbled, they bought a low-cost producer from Canada, PotashCorp. (POT).
Since then, potash stocks have recovered some of their losses. But Calhoun and Welo believe a change in crop prices, and new industry dynamics, could lead to another leg of growth.
Nitrogen: Look for lower-cost producers
Nitrogen producers are another potential beneficiary of a recovery in crop prices, because the fertilizer is tied to the financial condition of farmers. But just as Welo targeted specific potash producers, here, too, picking the potential winners requires analyzing the industry dynamics.
In the case of nitrogen, Welo has invested in CF Industries (CF). Many global nitrogen producers had been struggling because China was flooding the market with very cheap product, sending prices down. As the price went down, it hurt producers who relied on expensive natural gas to produce their nitrogen. But Welo says CF Industries has had a big advantage because of the low natural gas prices in the United States.
The bottom line
Agriculture differs from many other parts of the economy because weather forces farmers to make strategic and operational decisions at the start of every crop cycle. That has the power to change prices quickly, and may produce opportunities for investors. But just calling the cycle may not be enough. You need to do your research.
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Views expressed are as of the date indicated and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the speakers or authors, as applicable, and not necessarily those of Fidelity Investments.
Investing involves risk, including risk of loss.
Tobias Welo manages the Fidelity Select Materials Portfolio and has invested in some of the stocks mentioned in this story. As of June 30, 2014, the fund held 3.7% of assets in CF Industries Holdings, Inc., and 1.9% in Potash Corp. of Saskatchewan, Inc.
Joe Wickwire manages Fidelity Global Commodity Stock Fund. As of June 30, 2014, the fund held 6.7% of assets in Potash Corporation of Saskatchewan, Inc., and 2.1% in CF Industries Holdings, Inc.
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