It’s a terrible time to be an agricultural commodity bull. Recessionary fears caused by Europe’s debt debacle and the United States’ continued political gridlock have taken the wind out of the sails of risk. The dollar has rallied as investors have flocked to anything stable, and worries about China’s “hard landing” still persist. Because of this, a variety of commodities have seen their prices dwindle — but for investors, this might be opening some long-term opportunities not only in the physical commodities themselves, but in those firms that use them.
As Europe and the U.S. fail to get their affairs in order, growth has seemed to stall. It’s no wonder, then, that economically sensitive commodities have sold off hard over the last few weeks. The broad iPath DJ-UBS Agriculture ETN (NYSE:JJA) — which tracks a basket of seven agriculture commodities like corn, soybeans, cotton and coffee — currently is trading for about $18 below its 52-week high. Individual agriculture and soft commodities have fared much worst during the past few weeks.
Cotton futures suffered double-digit declines in November as demand from China waned. Sugar inventories currently are growing, and the short-term fundamentals are not in the commodity’s favor. Coffee, after two years’ worth of poor crops, is expected to see record production from Brazil. Similarly, the USDA expects grain crops to be on the high side. Expanding supplies coupled with drops in global demand because of recessionary fears does not make a high-price environment.
How to Play the Price Drops
For investors, the short- to near-term environment for these soft and agricultural commodities is a difficult one. Long-termed portfolios can use this price drop to add funds like the PowerShares DB Agriculture Fund (NYSE:DBA) or iPath DJ-UBS Cocoa ETN (NYSE:NIB) to play future demand. Growing populations across the planet ultimately will require more food, and ag/soft commodities will be priced accordingly. However, in the medium term, a better bet might be producers and sellers of finished goods. Realistically, retailers and product producers are unlikely to lower the price of jeans or bread just because commodity prices are down. This will result in higher margins and earnings.
The recent 27% decline in cotton should greatly benefit those related to the commodity. Retailer Target (NYSE:TGT), which earns a good bit of revenue from home goods and apparel, should see profit margins increase. TGT had seen profit margins dip on higher input costs, but CEO Gregg Steinhafel said in a recent Bloomberg interview that “Target will see some relief in 2012” because of the costs of materials falling, and the company “will experience far less inflation” than this year. In addition, underwear maker Hanesbrands (NYSE:HBI) already has passed on higher prices to stores via longer contracts and should benefit from the price spread.
The high cost of coffee hurt J.M. Smucker‘s (NYSE:SJM) earnings during the past quarter. Compared to 2010, net income fell by 15% to $127 million. The company produces both Folgers and Dunkin’ Donuts, and with green coffee prices soaring, the company’s gross margins fell to 33.8% from 39.6%. However, with rising coffee crop outputs, J.M. Smucker could find some relief. The company has seen tremendous growth in coffee operations and sales have been rising. Any break in higher coffee prices will serve to help the company. In the meantime, investors are rewarded with a 2.5% dividend.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.