Commodities: A Wise Long Term Investment

Today, our neighbors to the north are celebrating the birthday of Queen Victoria, the most commemorated and longest-reigning British monarch. Frankly, if President Obama manages to get our nation through the current economic crisis successfully in the few years allotted to him, celebrating his birthday from then on would be the least honor we could bestow upon him. No matter how much he wanted the job, being promoted to ship's captain in the midst of a typhoon is one tough assignment.

Of course, many people will find the coming months tough, including investors, who will likely find that any recovery is a double-edged sword. You see, we've noticed a very strong correlation between changes in raw commodity prices and changes in corporate profits, dating back at least a generation. And that relationship implies both opportunities and pitfalls ahead.

For instance, the current stock market rally seems to be anticipating a surge in corporate profits. Right now, the S&P sells for roughly 20X annualized first quarter profits (S&P / (Q1 profits) * 4 = 20). That's far too high. So either the S&P has gotten too far ahead of itself, or corporate profits will likely surge forward in coming months.

At the same time, commodity prices are rallying as well. In fact, the gains in oil prices since the recent bottom far exceed the gains in stock prices. Ditto for many other commodities. If corporate profits are about to go on a tear, we can expect commodity prices will march in step. Unfortunately, such a move would make stock prices self-limiting on the upside.

Here's why...

THE COMMODITY TAX

A bull market in commodity prices would surely lead to slower economic activity. As we clearly saw in 2008, rising prices for commodities (especially oil and gas) act as a punitive tax on the American consumer. We use the word “punitive” because, unlike government taxes which can pay for programs and services that benefit everyone or be used to retire taxpayer debt, higher commodity prices only benefit producers. In the case of oil it is the Middle Eastern countries that reap the bulk of the rewards, for other commodities beneficiaries include nations such as Brazil, Canada, and even Australia.

(Incidentally, because the future looks so bright for commodities, we recommend these resource-rich nations as some of the best places to invest. If you can tolerate a high degree of political uncertainty, you can add Russia to this mix.)

In other words, to whatever extent the economy recovers, it will be accompanied by higher commodity prices. The two factors are wedded.

In passing, we must admit that even we have been surprised by the gains in oil. News from the oil industry has been horrendous, from our point of view. Days-to-cover (oil inventories divided by daily demand) has climbed to the highest level in 15 years. And U.S. demand remains subdued indeed close to decade lows. As far as we can see, the only reason oil prices remain over $50 must be due to rising consumption in China and India. Nonetheless, oil prices are not only hanging in but rising faster than stocks. This positive leverage may have something to do with China – and just their outright need for commodities but also their need to protect their assets.

CHINA'S EFFECT ON COMMODITY PRICES

Let's consider China's response to the massive amount of money that has been poured into the U.S. economy, by both stimulus spending and the Federal Reserve's money creation efforts. So far, these efforts have not resulted in higher inflation, but they likely will in time. Consequently, yesterday's newspaper reports that China has started putting more of their huge money reserves (which they get from selling products abroad) into commodities rather than U.S. Treasury bonds.

We cannot be surprised. Creating massive amounts of U.S. dollars lowers the perceived value of our currency. China naturally feels nervous about holding all its reserves in an asset whose value is destined to drop sharply, at least in their view, so it wants to diversify into more tangible assets. In similar vein, China recently reported adding to its gold reserves.

China's increased buying of commodities naturally helps support commodity prices. In fact, we think it's one reason two of our picks, Mosaic (MOS) and Potash Corp (POT) have done so well recently. They are the two largest fertilizer companies in the world, and big producers of the potassium-based fertilizers known as “potash.”

If there's one thing China needs, even more than energy, it is fertilizer. The country has an enormous population to feed, and requires stockpiles of potash to get through any economic turmoil. We strongly suspect that fertilizer stocks are gaining ground because of Chinese efforts to accumulate fertilizers, and it is a trend which should continue for some time.

So that gives us two good reasons why commodity prices will rise. First, they will rise alongside any gains in the stock market and corporate profits. Second, commodities will increasingly be seen as a hedge against a falling U.S. dollar. This double kicker is the likely reason critical commodities have been rising even faster than financial assets.

Our general advice is that, to the extent the current rally continues, you will likely profit from commodity-related investments. The only thing that could short-circuit commodity gains would be further declines in economic growth. Any improvement in the economy will only push commodities higher. So stick with commodities, including oil and gold.

As for the market in general, the downside still outweighs the upside at this point. We still could see a retest of the recent low. However, we are heartened by the fact that the government seems determined to do whatever it takes to avoid a real depression. Given the choice, we would rather face the consequences of monetary stimulation than deflation.

With that in mind, if the market does move lower, we would probably see the Federal Reserve buying large amounts of Treasury bonds. Treasury bonds have been under pressure as a consequence of the monetary stimulation taking place. That won't change, especially with the Chinese buying commodities (which reduces demand for Treasury bonds). So the government will need to step in and buy bonds if it has any hope of keeping mortgage rates low and engineering a recovery in the housing market. (Of course, this can become another vicious circle which leads to inflation.)

Longer-term, we expect the stock market will remain stuck in a trading range. The Dow will have a hard time getting past 10,000 anytime soon, which gives us a maximum upside of 20% from here. (Short-term, we doubt it will get that far.) The bottom of the trading will probably be around 5,000. Those boundaries may remain in place for a very long time.

Short-term, too, the downside outweighs the upside. Given the negative signals from our indicators, we think the recent rally has been extremely speculative and could soon run out of steam.

Bottom line: the way to make money in the long-term trading range will be to invest in commodity-related investments.

A Big Upgrade for CVR Energy

Every day, the sun rises on Wall Street, and a plethora of professional analysts wake to issue new opinions on stocks. Here at the Fool, we use our "This Just In" column to examine some of these picks-- and the track records of the firm behind them -- so individuals can make better investing decisions.

In addition to following professional banks, anyone can use Motley Fool CAPS to monitor the collective opinions of more than 130,000 members, many of whom demonstrate better investing insight than published analysts do.

More top-performing CAPS members have piled on the bull train for CVR Energy (NYSE: CVI) recently, enough to upgrade it from its three- and four-star rating to the highest possible five-stars. A total of 210 members have given their opinion on CVR Energy, with many of them offering analysis and commentary explaining the recent optimism.

Although CVR's petroleum revenue dropped significantly in the first quarter, it reported its highest first-quarter operating income since going public late in 2007. It and fellow refiners like Valero (NYSE: VLO), Tesoro (NYSE: TSO), Western Refining (NYSE: WNR), and Sunoco are posting higher refining margins now that the price of crude has fallen precipitously from 2008 highs. CVR is benefiting from the oil market contango, helping its adjusted refining margins jump 20%, which helped it bring in a 38% rise in earnings.

Demand in CVR's fertilizer business has been soft, mirroring the hit taken at others like Mosaic (NYSE: MOS) and PotashCorp (NYSE: POT), as the company waits on a delayed planting season for Midwest corn farmers. Sales in the business rose 8% to $67.8 million and, similar to Terra Industries (NYSE: TRA), CVR had better urea ammonia nitrate (UAN) prices and increased ammonia volume offset by softer UAN volumes and lower ammonia prices. Along with many CAPS members and Wall Street analysts, CVR's management is confident in the fundamentals of the nitrogen business and looks for sales to pick up when planting gets under way.

CF again rebuffs Agrium and pursues Terra

CF Industries Holdings Inc. rejected the latest revised takeover proposal from Agrium Inc., calling the deal price inadequate

The Deerfield, Ill., holding company /quotes/comstock/13*!cf/quotes/nls/cf (CF 79.75, +2.07, +2.66%) for a producer and distributor of nitrogen and phosphate fertilizer products said in a statement that the latest revised proposal from Agrium "continues to substantially undervalue the company and is not in the best interests" of the company and its shareholders.

On May 11, Agrium, /quotes/comstock/13*!agu/quotes/nls/agu (AGU 48.18, +1.26, +2.69%) the Calgary, Alberta, retailer of agricultural products and services and producer of nutrients for agriculture and industry, said it boosted the cash part of its bid for CF by $5 a share.

The latest proposal offers CF holders $40 cash plus 1 Agrium share for each of their shares. Based on Agrium's closing price on Friday, the deal values CF at $88.18 a share, or $4.33 billion, based on 49.1 million shares outstanding at March 31.

The takeover battle began in February, when Agrium proposed to pay $72 a share, or $3.6 billion, for CF.

In its Friday statement, CF said the board decided that the company's best path is to continue its current strategy, including its proposal to acquire Terra Industries, /quotes/comstock/13*!tra/quotes/nls/tra (TRA 28.36, +0.29, +1.03%) the Sioux City, Iowa, producer and marketer of nitrogen products for agriculture and industry.

Terra has rebuffed CF's proposal to pay 0.4235 share for each of Terra's shares. On Thursday, Dow Jones Newswires reported that Terra Chief Financial Officer Dan Greenwell said the company would consider growth via acquisition and might resume its share buyback.

Morgan Stanley and Rothschild are advising CF Industries.

Fertilizer Companies On The Rise

Tight corn supplies might get farmers spending on fertilizer again.

Now not even dirt is safe from the financial crisis.

In an effort to cut costs amid tight credit conditions and weak commodity prices, farmers haven't been laying crop nutrients on as thick--much to the dismay of fertilizer companies. But with price incentives on the horizon with expectations for strained corn supplies, fertilizer companies are enjoying an enriched outlook as farmers scramble to boost yields on the most nutrient-demanding crop

"Corn is by far the most fertilizer intensive of the major row crops, and rising planted acreage translates directly into stronger demand for each of the primary fertilizer nutrients," said J.P. Morgan analyst Jeffrey Zekauskas.

Mosaic ( MOS - news - people ) shares gained 97 cents, or 1.9%, to $51.30, Agrium ( AGU - news - people )'s stock added $1.26, or 2.7%, to $48.18 and CF Industries Holdings ( CF - news - people ) added $2.07, or 2.7%. to $79.75 during Friday's trading session.

According to Morgan Stanley analyst Vincent Andrews, cutting back on fertilizer doesn't actually eliminate costs, it merely delays them since the longer nutrients are restricted, the more fertilizer is needed to reverse soil depletion. That could mean a surge in fertilizer sales as farmers quickly stock up on the supplies needed to produce a bountiful corn harvest.

Farmers are likely waiting for nutrient prices to come down, but, as Andrews points out, that may not make much sense as corn prices rise.

"We believe that current retail potash prices are $39 per acre for corn application. Assuming that prices decline by 50% between now and next fall or spring, farmers could save $20 per acre by deferring application. However, at $4 corn, should farmers' yield decline by 5 bushels, there would be no net savings," Andrews said, adding that farmers risk prices not falling as much as hoped.

On Tuesday, the USDA revised down its estimates of corn stocks by 100 million bushels to 1.6 billion bushels, putting year-over-year supplies lower even as demand is expected to increase by 3.5% from a year ago. (See "Supply Squeeze Seen On U.S. Crops.") Corn production estimates could be even lower if stringent fertilizer applications lower yields even more than expected. Weather could also further weaken yields.

CF rejects latest Agrium offer as too cheap

CF's board rejects Agrium's offer

Calls offer too cheap

LOS ANGELES, May 15 (Reuters) - U.S. fertilizer maker CF Industries Holdings Inc (CF.N) rejected on Friday a roughly $4.2 billion acquisition by Canadian rival Agrium Inc (AGU.TO), as being too cheap, and stood by its own plan to take over Terra Industries (TRA.N).

The U.S. company, which has repeatedly spurned Agrium's advances, said the latest offer of $40 cash per share and one Agrium share for each CF share was "not in the best interests of CF and shareholders." [ID:nWEN9244]

Agrium, which made a similar offer to shareholders in February but raised the cash portion of its bid to $35 a share from $31.70 a month later, has tried to meet with CF management to no avail.

CF, for its part, has launched its own takeover bid for Terra, and accuses Agrium of trying to derail that deal. [ID:nN11504828]

The company said the latest offer did not take into account increases in its own cash position since the initial bid, and a 36.9 percent in the average share price of its peer group as stock markets rallied.

"Agrium has not significantly changed the terms of its offer since it was first made and the board believes that the offer continues to substantially undervalue CF Industries," CF CEO Stephen Wilson said in the statement.

Agrium executives were not available for comment.

Ag Stocks: More to Reap?

Hello from New York, where I’m spending my day off from television doing a little bit of reaping of the Agrium (AGU) position I sowed over the last few weeks. Whether you’re Egypt or Wall Street, pigs invariably get slaughtered. There may be more to be made in this particular name -- and the ags in general -- but they’ve made a heck of a move in May. Not selling at least some of the position would be greedy and leave an easy, obvious but still amusing pun on the table. That’s not going to happen on my watch, Minyans. One-third of my Agrium has been put in the silo (where 95% of the profits immediately went towards the car industry and wasteful health-care control).

Here’s what I’m doing when not combining trading with gentleman farming:

Nordstrom (JWN) turned in a nice quarter in a tough environment. The stock is up almost 10% and I’m hulking out of my shirt, having been told by the guy who sells Thomas Dean dress shirts to the company (only in stores until they hit the website in July) that he can’t keep up with demand from the chain. I’m the Bill Cosby of promotion; if I don’t believe in it, I won’t talk about it. These shirts are the real deal and Nordies' recovery seems to be same.

Speaking of retail, JC Penney (JCP) has been all over the map after turning in a quarter softer than an over-soaked Nilla Wafer. It’s all about the close, as we say. From where I’m sitting JC Penney goes lower, though not so much so that I’d short it.

Also doing a whole lot of nothing, trimmed to a position size you could fit in your pocket and generally not inspiring me unless I compare it to Wal-Mart (WMT) is Target (TGT). The Minnesota juggernaut reports next week, is up big-ish so far for the year and is expanding its no-margin consumable business. I don’t expect Target to have a much better quarter than Wal-Mart, making it hard for me to want to hold the few shares I have left. Feels like a 5% gain/10% loss potential outcome set-up. The Target position may not make it to end of this post.

I was uncharacteristically too optimistic. My puny Target position didn’t make it to the end of this bullet point.

What do I like right now? Long weekends. Good books. Movies you don’t have to explain and Ultra Short ETFs in both the S&P 500 (SDS) and the Financials (SKF). I only talk about the weekends, books and movies in mixed company.

I also remain long Ford (F), which was described by a guest on yesterday’s Fast Money as “at a competitive disadvantage competing with the government and UAW." I chuckled for 2 consecutive minutes during the ensuing commercial break. Banks getting free money from the government and using it to buy risk-free bonds have a competitive advantage. I suspect Ford feels much less threatened at the prospect of competing with car companies run by hundreds of people who seem motivated by virtually everything except creating marketable, profitable cars.

Two keys to good trading: Luck, and the ability to recognize it. Just yesterday, I got long MGM Mirage (MGM) near the $8 level. It rose in a way that makes me smug even by my own standard, continuing to climb right up until I left for the city. Logging in at the NASDAQ, I was horrified to see a complete and hideous MGM reversal, turning my position from green to a fairly dark red during my train ride. With a memory like an elephant for losses and all the grace of Bobby Knight when I do, this turn of events left me “displeased." Right up until this morning when some kind soul bid the name to the mid 8’s, buying me out along the way. As the old saying goes, fool me once, shame on me. Fool me twice and I’m taking a ball-peen hammer to my own thumb in a fit of rage. Happily, I remain an ambidextrous hitchhiker and am now out of MGM.

With that I’m off to use my 2 good thumbs to do some writing and drawing with the kids. As Toddo has said repeatedly, S&P 500 875 remains important support. I’ve got 900 as resistance. From where I’m sitting (with a disproportionate amount of cash on hand and a slightly negative skew), JWN and S&P 875 are your tells of the afternoon. We’ve got some space before JWN pulls a Kohls-type of reversal (see KSS yesterday) or we lose 875. But if either should occur, you’re going to see plenty of folks looking for the sidelines for the weekend.

Always one who enjoys a little solitude, I’m beating the rush and hitting the road early. Make it a strong close and safe weekend, Minyans. We’ll resume the grind on Monday!

Monsanto Update

Monsanto (NYSE: MON): We originally recommended on April 30/07 at $60.30. Closed Thursday at $90.03 (all prices in U.S. dollars).

Last month the company announced second-quarter earnings of $1.09 billion ($1.97 per share), down slightly from $1.13 billion ($2.02 per share) last year. However, excluding one-time items, earnings per share for on-going business were $2.16, up from $1.77 last year. Pretty good numbers in a tough economy!

I originally recommended this stock in April 2007 at $60.30 and last mentioned it as part of an agricultural basket in September 2008 when it was trading at $118.41. The stock is currently trading in the $90 range and I expect it to break $100 before this run is over. The 52-week high was $145.80, which was reached last June, and I believe we could go there again. I just bought some more for one of my accounts and I consider it a key holding for the next 12 months.

The stock held up very well through the meltdown and the agricultural production story is still intact. Food consumption is only down 3% but the stock has been punished along with all the other fertilizer stocks like Potash Corp. (POT). All these stocks have begun to rebound and I think it's a sure bet that they will continue to do so.

Fast Money AG plays

Lee shifted the panel's attention to the ag names, which she said made "monster moves to the upside."

Macke said the fertilizer names are finally making a comeback after spending a "year in the penalty box." He told investors they can now play Agrium(AGU Quote) and Potash(POT Quote). Of the two, Adami thought Potash was the better play.

Grain Prices: Back to the Futures

We noted in our May 1st Monthly Outlook summary points that the fundamentals promise bullish support for corn and soybeans prices in the near term, while less so for wheat prices. We often look to the CFTC’s weekly Commitment of Traders (COT) report to give us a better sense how the underlying futures speculation supports or casts doubt on the near term price outlook.

Keep in mind that the COT report is a rear-view look at the previous week’s trading. Even so, we can use this information to validate our assumptions of how the large speculators’ recent trading activity is supportive or restrictive of the current price move.

Performance of Underlying Futures

(weekly reporting period ending May 5th)

Corn: Prices for the reporting period rose 6% with flat open interest, while the large speculators’ net long position exploded by nearly 90% over the previous week. This dynamic tells us that the large speculators are increasingly bullish, yet the market overall is failing to attract new institutional buyers. This will likely change as the dollar weakens further.

Soybeans: Prices for the reporting period rose 13% and continued to see steady gains in both open interest and the net long position for the large specs. This dynamic of the open interest and the net longs rising in tandem demonstrates continued support for soybeans’ bullish leadership of the grains complex.

Wheat: Prices for the reporting period rose 6%. Open interest was down more than 5% over the previous week while the large specs’ net short position decreased by a whopping 78%. This feels more like short covering and spillover optimism from soybeans and the outside markets, rather than a sustainable bullish move for wheat. We have noted recently that wheat has the most difficult fundamentals to overcome in the grain complex. Production shortfalls due to drought and planting delays would need to be near historic levels to substantially impact the supply-demand equilibrium in the near term.

This week the trade turns its immediate attention to the May 12th supply-demand report, where the USDA will give the market its first official estimate of ending stocks for the current marketing year..seeking alpha

Agrium Ups Bid for CF Again

Today, Agrium Inc. (NYSE: AGU - News) announced it is substantially increasing its exchange offer to acquire all of the outstanding shares of CF Industries Holdings, Inc. (NYSE: CF - News) to $85.20 per CF share based on Agrium's closing stock price on May 8, 2009. Under the revised terms, CF stockholders would receive $40.00 in cash, an increase of $5.00, or 14.3 percent, in the cash consideration, and one common share of Agrium for each CF share.

The increased offer represents a premium of 53 percent to CF's closing price on February 24, 2009 -- the day before Agrium announced its initial proposal, and 68 percent to the previous 30-day volume weighted average price. While it is too early to see if this is the final offer, ultimately we believe that Agrium will prevail, and CF Industries has a fiduciary responsibility to accept the offer.

Cramer's recent take on POT

Says Terra Nitrogen is a better pick than POT. What is your opinion ?

Bulls Are Hungry for Grains

The following excerpt is taken from our monthly Agriculture Outlook Report, issued to subscribers on the last Friday of every month.


Near-Term Grain Price Outlook:


+ We expect soybeans to maintain their bullish momentum on Chinese purchases and international demand diverted from the South American market. U.S. ending stocks continue to shrink at a remarkable pace, and will remain tight until Chinese demand abates or South American production returns to normal next year.

+ Corn’s upside will begin to brighten as selling pressure from farmers’ unloading of old-crop storage subsides. If heavy rains continue to blanket the grain belt, the trade will see increasing concerns that planting delays will encourage growers to switch to soybeans. This development will provide a bullish double-whammy to corn’s price outlook because it reduces both expected yields (late planting) and overall acreage (switch to beans). We should note, however, that any planting delay premium for corn may be somewhat muted, as last year’s results are still fresh in traders’ minds. Recall that we had record pre-season rainfall that flooded fields throughout the western grain belt, yet we still realized superb productivity with the national yield at 153.9 bushels/acre.

+ The supply-demand equation is far too bearish to allow any significant momentum to develop in the near term for wheat prices. Record prices in 2008 did their job to spur enormous production increases, which now leave us with quite ample global supplies to meet current demand. If the U.S. dollar’s strength persists, U.S. wheat sales will continue to lose marginal orders in the export market. One bright spot in the wheat outlook: Prices will benefit from significant production cuts both in the U.S. and abroad, although any gain will be muted by the influences of excess supply noted earlier in this month’s report.seeking alpha

Agriculture Stocks Still Make Sense, When Selected Wisely

Friday morning we got some disappointing news about slowing sales at Caterpillar (CAT). There's been a softening of orders in new machinery / equipment tied to global infrastructure and agriculture, which has led the company to slash costs and forecasts.

Earlier this month, we heard a similar story from Deere (DE), which has seen orders for agricultural equipment drop sharply.

You might be tempted to conclude that weak orders for agricultural machinery equates to a weak outlook for "ag" as an industry. It doesn't. You just need to pick your spots.

My checks of farmer demand indicate that, while uncertainty about the global economy remains a concern, farmers still need to grow their crops. To get the most from their crops, demand for nutrients, chemicals and fertilizer remains very high. Suppliers I've checked in with are very happy about orders for the coming season.

My two favorite nutrient/fertilizer plays here are Potash (POT) and Agrium (AGU) -- with trailing enterprise-value-to-EBITDA ratios of under 6 times and 4 times respectively. Both should see their stocks rise over the summer as results come in.

I also mentioned AgFeed (FEED) last week, a favorite Chinese small-cap of mine, selling pork in that market -- it's up about 20% since my mention last Thursday.

Ag makes sense. You just have to realize that not all in the space are created equal at this stage in the cycle.