Time To Harvest The Grains ETFs?

by on July 20, 2010 | ETFs Mentioned:

For the investors who had been preaching on the need to brace for a surge in inflation in the wake of massive capital injections, credibility continues to slip away. Recent CPI readings have been tame, to say the least; deflation is a more immediate concern even in an environment where inflation rates are expected to remain near record lows for the foreseeable future.

Some of these “inflation bugs” thought recently that they had seen the tip of  the iceberg, as food prices began to skyrocket across the U.S. But a closer look at the factors driving grains prices reveals that the rally in certain agricultural commodities is not the long-awaited punishment for unprecedented capital injections in Washington, but rather the result of unexpected developments overseas.

Wheat prices have jumped in the U.S. as a drought throughout Europe and Russia, as well other unforeseen ills, has pushed the commodity to a 13-month high. A severe and prolonged lack of rain has forced Russia to lower its production estimate from 85 million tons of wheat output to 56 million tons, a staggering reduction. Russia may soon stop shipments abroad, and is not the only country enduring a harsh and unpredictable growing season. Canada has had the opposite problem, as excessive rains have had an adverse impact on the wheat crop there. Meanwhile, Australia is facing a plague of locusts, making the developments in Canada and Russia seem rather pleasant. This perfect storm of disasters has sent the price of wheat soaring and enhanced the appeal of investing in agricultural commodities, which are often used to protect against inflation [see Ultimate Guide to Agricultural ETFs].

Ian Berry notes that this rally in prices is quite a bit different from a previous surge in 2007 and 2008 that sent wheat to all time highs. “That increase in prices was driven by demand growth that caused spot shortages and provoked a global outcry against rising food costs,” writes Berry. “This time, demand has stayed relatively weak as the supply outlook deteriorates. As recently as June 9, Chicago wheat futures were plumbing two-year lows.”

The U.S. could see its global market share surge as a result of the worldwide wheat shortages. The U.S. plans to increase its wheat inventory next year, potentially accounting for 25% of global wheat trade (up from its current 18%).

Grains ETFs In Focus

The recent rally in wheat prices has given a boost to most of the funds in the Agricultural Commodities ETFdb Category, with some benefiting more than others. One of the best performers in recent weeks has been the iPath Dow Jones-UBS Grains ETN (JJG), which is linked to an index comprised of three grains futures contracts traded on U.S. exchanges. The biggest weight in the underlying index goes to soybeans (45%), followed by corn (32%), and wheat (24%). JJG is down close to 10% on the year, but has delivered huge results recently; this ETN is up close to 8% over the last two weeks [see charts of JJG here].

Another ETF that has rallied on the wheat shortage is the ELEMENTS MLCX Grains Index ETN (GRU), which is linked to a total return index that reflects the performance of a fully collateralized investment in futures contracts on corn, soybeans, soybean oil, and wheat. GRU gives a much bigger weighting to wheat, while maintaining smaller allocations to corn and soybeans. So it isn’t surprising that this ETN has had an even better July; GRU is up close to 10% over the last month [see fundamentals of GRU here] .

Next Up?

Some investors suspect that speculative money has fueled the recent run-up in prices, and wouldn’t be surprised if a pullback is ahead in the not-so-distant future. Futures contracts on the three primary grains commodities have moved into “overbought” territory, a bearish indicator to many [also see Time To Short Grains ETFs?].

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Disclosure: No positions at time of writing.