Monday, May 20, 2013

Commodities for Stock Investors — April

Aaron Levitt

Despite all the hubbub in natural resources over the last few years, some investors still won’t give commodities a place in their portfolios … and that’s a real shame, considering the asset class provides plenty of inflation-fighting muscle, diversification benefits and growth opportunities as the emerging world expands.

After all, commodities are one of the few remaining uncorrelated assets left.

However, even if you don’t want to directly bet on commodity prices via futures contracts or exchange-traded funds, and instead just keep your nose in stocks, you should pay attention to the natural resources markets. Their influence on other company’s bottom lines — from input costs to shipping — is profound.

To give you a few ideas of how these worlds intertwine, here’s a rundown on what’s going on in the commodities markets right now, and how it could affect your bottom line:

In spite of my long-term bullishness on corn demand, prices for the grain continue to plunge on the backs of bullish planting numbers. According to the Department of Agriculture, farmers will sow the most acreage devoted to corn in 77 years — at 97.282 million acres. That’s up from 2012’s 97.155 million. Additionally, inventories of the grain continue to surge and beat analyst projections.

All of this is a complete reversal from last year, when the worst drought since the 1930s cut corn production by 13% and left inventories at a low not seen since 2003.

While plunging corn prices is terrible news for investors in the Teucrium Corn ETF (NYSE:CORN), it’s a big win for those firms that use corn as feedstock or input. Lower corn prices ultimately mean bigger and more robust margins for processed food producers, livestock firms and even ethanol refiners as the prices consumers pay will remain constant.

Thus, stock investors should note that commodity-heavy food producers like General Mills (NYSE:GIS) and Kellogg (NYSE:K) should see boosts to their bottom lines as corn prices drop, as should companies like diversified meat producer Tyson Foods (NYSE:TSN).

The continued story in the oil markets has been about the spread between West Texas Intermediate-benchmarked crude and the international standard Brent. Inefficient pipeline infrastructure coupled with surging production here in the U.S. has a done a number on WTI prices. The spread between the two benchmarks has been a source of huge margins and “crack spreads” for the various refining firms.

Well, things might be getting a bit harder for the refiners to turn a juicy buck.

The price difference between WTI and Brent crude has tightened to its narrowest spread in six months, as oil output rose unexpectedly and changes to energy logistics added to price volatility. Brent oil’s premium to WTI has shrunk to below $11 — at one time, the spread was almost $40.

That could mean some issues for refiners like Valero (NYSE:VLO), HollyFrontier (NYSE:HFC) and Tesoro (NYSE:TSO), as the group has experienced some of the best margins for refined products and gasoline in decades. Also facing some compressed margins and lower earnings could be WTI-heavy E&P firms EOG Resources (NYSE:EOG) and Continental Resources (NYSE:CLR). Lower prices for their product results in lower earnings, as fracking costs continue to rise as well.

For the red metal, it’s always about China, and the latest numbers aren’t exactly painting a rosy picture for copper prices. Copper’s widespread use in construction and manufacturing makes it a fairly good indicator to “diagnose” the broader economic outlook — hence its nickname “Dr. Copper.”

Recent data from China — the world’s largest consumer of the metal — showed that first-quarter growth came in below expectations, putting pressure on the total outlook for global growth. The Chinese economy expanded “just” 7.7% in the first quarter from a year earlier. That amount missed analyst expectations for growth at 8% and was a slight decrease from the preceding quarter’s measure of GDP expansion.

Data also showed that Chinese industrial production rose 8.9% in March. However, that was again below analyst predictions of a 10% increase and was a 1-percentage-point decrease versus the previous month.

The data from China have sent copper prices to a 10-month low. As with oil, major copper producers like Freeport-McMoRan (NYSE:FCX) and Southern Copper (NYSE:SCCO) will feel the brunt of these price decreases, as will emerging-market investors in both Peru (NYSE:EPU) and Chile (NYSE:ECH). Both of these nations are major producers of the industrial metal and have used copper surpluses and high prices to buoy their nation’s balances sheets in recent years.

What a difference a few months makes. This time last year, analysts were predicting sub-$1 prices for natural gas. Today, the commodity has made a complete reversal. Companies in the natural gas space stopped drilling, cut production and reduced costs. Now prices for the fuel are above $4 per MMBtu and quickly approaching the $5 mark.

That price point is critical for producers of the fuel because, depending on where they are fracking, many wells become profitable around the $4 mark. For natural gas-focused companies like Quicksilver Resources (NYSE:KWK) or Ultra Petroleum (NYSE:UPL) that price is a godsend.

On the flipside, higher natural gas prices could punish those firms using it as a feedstock — especially those in the chemical industry. Firms like Dow (NYSE:DOW) and Westlake (NYSE:WLK) have been feasting on these low natural gas prices.

Produced alongside natural gas, ethane is a vital feedstock and sent through a refining process to produce one of most basic of commodity chemicals — ethylene. Ethylene is a key component in plastic, paint, glue and other products. Margins could slip as this trend continues to play out as warm weather blankets the nation.

While the world is gaining a sweet tooth, sugar prices have plummeted in the past year thanks to bumper crops of sugarbeets and dwindling ethanol demand in Brazil. However, the crop might finally see some support as the U.S. government considers taking a large chunk of sugar off the market.

The U.S. Department of Agriculture has sent a proposal to the White House for approval to purchase roughly 400,000 tons of sugar to support stalling U.S. sugar processors. Such a move would remove tons of excess supply from the market and stabilize prices. The USDA would then sell it at a loss to ethanol makers under the Feedstock Flexibility Program created back in 2008.

This market intervention could be a huge win for firms that have sugar operations like Cosan (NYSE:CZZ) and Archer Daniels Midland (NYSE:ADM).

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, http://investorplace.com/2013/04/commodities-for-stock-investors-april/.

©2013 InvestorPlace Media, LLC


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