Corn Commodity

The Smart Profits Report: Issue #403
Wednesday, March 14, 2007

Corn Commodity: Cashing In With Sales Up 170% On The Government’s Best-Laid Ethanol Plan
By D. R. Barton, Jr.
Quantitative Analyst, Mt. Vernon Research

When I saw the number yesterday, it struck me as a VERY large increase. A massive 170% jump in sales… To put it in perspective, a 70% rise in sales of a new product or hot retail item is impressive - but not unusual. Getting 70% more laundry detergent for the same price is a pretty nice bonus, too.

But we’re not talking about a 70% rise. We’re talking about 170% surge over last year’s number. And it came in one of the most basic creations on earth: good ol’ corn commodity. Why is this important to us as investors and traders? Simply because it provides two lessons - one in macroeconomics and one in microeconomics. Let’s take a look…

Corn’s Meteoric Climb

The agricultural extension of Virginia Tech reported that seed corn sales in the eastern part of the state are running 170% higher than last year’s levels.

To be fair, Virginia is America’s 23rd largest producer of corn. But farmers are farmers - and when given the chance to choose how to plant their land, like any business person, they will take the most profitable route. (Thanks to our friend Dennis Gartman and his eponymous daily letter for reporting the story).

And a 170% pop is a huge jump for a commodity product that is produced in such a large quantity.

And since so many people are thinking about ethanol and ethanol-oriented investments, the topic is certainly worth a look.

The Unintended Consequences Of The Government’s Best-Laid Ethanol Plan

When oil prices skyrocketed, public outcry turned into political action. And the government leapt on the ethanol story with gusto. Ethanol incentives are all the rage.

It’s a popular story - a home-grown fuel alternative that will help the farming community. But it also created some unintended negative consequences.

All the good intentions had (and still have) ethanol distillers popping up like daffodils in the spring. But last year, those distillers hadn’t had time to bring extra capacity online - so corn farmers saw very little benefit from the government’s ethanol incentives.

When the reality hit home - that you do, in fact, need corn to make corn-based ethanol - corn prices doubled in exactly six months.

This put a margin squeeze on the distillers. And if there’s one thing us chemical engineers (I was a former chemical engineer at DuPont) know how to do, it’s how to ramp-up to take advantage of economies of scale.

So distillers are growing bigger, and the cycle is likely to repeat.

Cotton, Soybeans, Or Corn?

So if you’re an American farmer figuring out what to plant, you have a decision to make…

Cotton? It’s up a little since last year.

Soybeans? The market has enjoyed a good run - up 50% since last fall.

But then there’s corn. It’s up 100% - with many prognosticators saying there’s no end in sight to the meteoric rise. Guess I’ll plant some corn then.

And with seed corn sales up 170%, plus a solidly bullish industry forecast, it looks like there will be fewer acres of soybeans and cotton planted.

So come harvest time this fall, we could see the biggest unintended consequence of all. Representatives are worried that the corn price frenzy has farmers planting it without doing appropriate hedging. And if farmers across the U.S. are planting at rates grossly above the norm, we could see a glut of corn - with the potential for higher volatility.

And with the farmland being used to over-produce corn, shortages in other commodities like soybeans or cotton could follow.

The Corn Conundrum

If the Virginia market is at least partially indicative of the national picture, then the corn-soybean spread is bound to tighten (as will the corn-cotton spread, though that relationship is less direct).

So what can we do in our portfolios?

First of all, be wary of getting carried away in the wave of corn speculation. It’s not a game for the faint-hearted.

Pick your ethanol distillers judiciously. While corn prices remain high, margins will be squeezed. Don’t get me wrong… there is still upside left in this sector - but only if crude oil prices remain relatively strong.

It’s also tough to speculate in soybeans after the strong run they’ve had. But a spread that is long soybeans and short corn might have merit.

Great trading,

D. R. Barton, Jr.

Today’s Smart Profits Cribsheet

There are currently 107 grain ethanol refineries in the U.S., with the capacity to produce 5.1 billion gallons on ethanol per year. There are a further 56 construction projects underway, which will add 3.8 billion gallons of capacity in the next 12-18 months. And because pure ethanol uses 30% less energy per unit than gasoline, the goal is for ethanol to gradually relieve consumer dependence on the 150 billion gallon per year market for gasoline.

Having spent six years as a market-maker (the guys who set and control the prices) in the commodity trading pits at the New York Mercantile Exchange, you’d be hard-pressed to find a more informed authority on commodities than my friend and collegue Lee Lowell. In his new book, Get Rich With Options: Four Winning Strategies Straight From The Exchange Floor, Lee reveals the “insider” secrets that only a select few people know about, and shows you how to execute the four investment techniques that he uses to make money. For more information, find it here.

While many investors jumped blindly on the ethanol bandwagon and lost money on the new companies in what is still an evolving and volatile industry, Xcelerated Profits Report readers are currently up 30% on a well-established, well-diversified company making great strides in the ethanol industry through one of its key holdings. What’s more… two company insiders just loaded up, buying over 60,000 shares. Find out how you can join the Xcelerated Profits Report and claim your share of profits.

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