Verdmont Capital SA - Agricultural Equities Commodity Strategy

 Agricultural Equities
Commodity Strategy
April 26, 2012

Grain prices remain close to historical highs (blue),  contributing to solid performance by agricultural equities (gray).

Source: Bloomberg, Verdmont Capital S.A.

We believe that grain prices are due for a correction as high prices are typically met with increased production as the profit incentive encourages farmers to boost planting acreage.

SSource: Bloomberg, Verdmont Capital S.A.

Global grain yields should also return to trend after being impacted by a series of weather related issues. US corn, wheat and soybean yields were hit by drought conditions that are due to normalize this year.

Source: Bloomberg, Verdmont Capital S.A.

Aggregate grain stocks-to-use, as measured in weeks supply, is bouncing as production picks up. Note how the aggregate grain stocks-to-use has been trending higher since 2007 and that current levels are not as critical as those experienced during the previous two spikes in grain prices.

Source: Bloomberg, Verdmont Capital S.A.

In addition to the prospects of additional supply, the expiry of ethanol subsidies in the US could weight on grain demand moving forward.

The ethanol blending credit of 45 cents per-gallon expired at the end of last year, which has been weighing on ethanol prices.    Ethanol inventories have been spiking, which indicates that ethanol prices and production should continue to slide. Given that upwards of 40% of corn output in the US was used in ethanol production last year, weak ethanol industry fundamentals could have a large impact on grain prices

production should continue to slide. Given that upwards of 40% of corn output in the US was used in ethanol production last year, weak ethanol industry fundamentals could have a large impact on grain prices.

Source: Bloomberg, Verdmont Capital S.A.

Agriculture equities have a tight trading relationship with grain prices, so if our thesis for grain price weakness plays out, stocks should under perform.

Source: Bloomberg, Verdmont Capital S.A.

Unlike other resource related equities, agriculture stocks have been outperforming underlying commodity prices over the past year.

Source: Bloomberg, Verdmont Capital S.A.

This has made agriculture equities rich in relation to underlying commodity prices, whereas other segments of the resource market are trading at a discount based on a three year regression.

Source: Bloomberg, Verdmont Capital S.A.

Source: Bloomberg, Verdmont Capital S.A.

 We are also heading into a period that has typically been defined by seasonal weakness for agricultural equities, as illustrated by the average ten year historical performance below.

Source: Bloomberg, Verdmont Capital S.A.

 Summary:

• We recommend clients underweight agricultural equities in resource focused investment portfolios.
• Increased production and rising yields, after a series of weather related issues, should continue to weight on grain prices.
• Uncertainty regarding US policy towards the ethanol industry will place downward pressure on grain prices, particularly corn.
• Agricultural equities have outperformed underlying commodity prices by a wide margin,   suggesting other segments of the resource market offer better value.
• We are entering a period of typically associated with seasonal weakness for agricultural equities.

Recommended Commodity Exposure

Source: Bloomberg, Verdmont Capital S.A.

This report was prepared by Verdmont Capital SA

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