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The Ethanol Boondoggle is Terrible for Consumers, but Great for the Investors Who Saw It Coming

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January 13, 2011 – Comments (4) | RELATED TICKERS: MON , AGU , MOS

As a result of government mandates and subsidies, the production of ethanol now consumers a staggering 41% of the U.S. corn crop.  Ethanol increases the demand for corn, which in turn drives up prices in a world with a finite amount of land.  The impact is not just limited to corn prices.  As corn prices increase, more land is shifted towards planting it.  That leaves less land for other commodities.  This means that food prices are headed higher, perhaps significantly higher for consumers.  That's the bad news.

The good news is that as an investor, one can use this trend to their advantage.  One of the big themes that I have been playing in investing lately is agricultural commodities.  A couple of weeks ago I established both CAPS and real-life positions in a number of companies that stand to benefit if the prices of commodities like corn and soybeans head higher.  Why?  Because naturally I strongly felt and still feel as though the prices of these things are going up...at least through the end of June.  There has been lot of evidence out there that this is going to happen:

Battle for acres: Soybean prices strong, but traders say more corn needed

Bulls beat the bears down on the farm

USDA data seen bullish

My two favorite ways to play the trend of rising food prices is to purchase stock in fertilizer and seed companies.  I was a couple of weeks late to the ag party, and that is party a result of speculation about mergers in the sector rather than the influence of commodity prices, so I only purchased one fertilizer play in real life, Mosaic (MOS). When one expects the price of corn to rise, it doesn't get much better than Mosaic.  Mosaic's stock has proven to be 89% correlated with the price of corn. At the time that I purchased it, MOS was up only 11% YTD so it's not even that over-priced compared to some of the other fertilizer plays.

As an added bonus, China, which accounts for 20% of global phosphate sales, might begin to restrict exports and the fertilizer may end up being in short supply.

Mosaic's production capacity is scheduled to increase by 60% between now and 2020 so it will be in a position to provide ample supply to an otherwise tight market.

Another fertilizer play that I added in CAPS, but not real-life is Agrium (AGU).  Instead of the phosphates that Mosaic uses, Agrium produces nitrogen fertilizer.  Natural gas represents 80% of the cost of manufacturing nitrogen fertilizer.  If you expect nat gas prices to remain low, and it's difficult to see how they will rise much with the huge available supply of it from shale, then AGU's costs will remain low.  High demand for a product combined with low costs, significantly lower than AGU's European competition where nat gas is more expensive, are a good thing.

Lastly I purchased stock in all of the major seed companies here in CAPS and in real life, Monsanto (MON), Syngenta (SYT), and DuPont (DD).  These companies are not as expensive as the fertilizer plays, but then again they probably have less upside as well.  The first two are pure plays on the ag sector, though Monsanto has been fairly poorly managed of late.  Dupont is also a major player in seeds, but its diversified business model will mute some of the impact that gangbuster seed sales will have on its bottom line.  Also limiting DD's upside is the fact that it is in the process of making a major acquisition, a $5.8 billion purchase of Denmark's Danisco.

Deej

4 Comments – Post Your Own

#1) On January 13, 2011 at 5:34 PM, MKArch (99.72) wrote:

I have a gut feeling about the answer to the questions I'm going to ask but I don't know for sure.

How much of the run up in commodities is due to actual demand and how much is due to speculation?

Emerging markets particularly China seem to be a major if not the major catalyst to the run up. What happens to commodities if Jim Chanos is right (and I think he is) that China is in a massive construction bubble that's likely to take commodities down when it bursts? IMHO it will bring their whole economy down to earth and I think even non construction related commodities will get hit.

 Personally I've stayed away from commodities and anything dependent on emerging market growth and focused on the U.S. who I think will ultimately benefit from a popping commodity bubble.

BTW O/T do you have any thoughts on what Falcone plans to do with the money he raised through HRG? They just finalized the SPB deal so I'm guessing we'll hear something soon about plans for the cash but I was wondering if you had any thoughts about what he's going to do to beat 11%.

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#2) On January 14, 2011 at 8:55 PM, devoish (98.71) wrote:

Deej

Your first article suggests that even though more corn acreage is needed to meet demand, it is not being planted, which drives the price of corn higher.

But unplanted acreage does not get fertilized no matter how high the price of corn goes.

Best regards,

Steven

PS. depending upon the timing flooded and drought stricken acreage may not get fertilized either.

 

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#3) On January 14, 2011 at 9:19 PM, NOTvuffett (< 20) wrote:

TMFDeej,

I hope you are ready for the hate you will get by buying MON, lol.

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#4) On February 01, 2011 at 5:24 PM, buylowersellhigh (54.44) wrote:

Deej you got a price target in mind for these stocks, particularly MON.  At what point do you say it is a bubble? 

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