Inside The Corn ETF’s Surge

by on November 19, 2010 | ETFs Mentioned:

ETFs are a relatively new addition to the scene, but they have already begun to impact the world of investing in more ways than one. The bargain basement expense ratios have forced investors to reevaluate the merits of pricey active management, with many turning away from mutual funds. The enhanced liquidity and immediate diversification have caused some active investors to embrace a more high level approach to identifying opportunities, making stock picking and bottom-up research things of the past. And perhaps most significantly, ETFs have democratized asset classes and investment strategies, allowing all types of investors access to assets and tactics that were once reserved for the largest and most sophisticated [see Ten Commandments Of ETF Investing].

This has especially been true in the commodity space, where dozens of new products have popped up offering ways for investors to establish exposure to natural resource prices. Although there have been some growing pains in the commodity ETF arena–some investors have failed to grasp the nuances of futures-based strategies–interest in natural resources continues to climb. Most investors seeking out exposure to commodities gravitate towards broad-based funds, such as the PowerShares DB Commodity Index (DBC), which has more than $5 billion in assets. But beyond the diversified commodity ETFs, there are a number of resource-specific products offering opportunities to bet on everything from copper and cotton to lead and sugar.

Many of these targeted funds have surged in recent months, riding a weak dollar and strong emerging markets demand higher. One of the top performers has been the Teucrium Corn Fund (CORN), the only U.S.-listed exchange-traded product to offer pure play exposure to one of the world’s most important agricultural commodities. CORN has gained an eye-popping 42% since its inception in June, rewarding those investors who established exposure to the agricultural commodity [see all of the ETFs in the Agricultural Commodity ETFdb Category].

Supply & Demand

There are a number of reasons behind CORN’s impressive run-up over the last several months. The supply side of the equation has received a great deal of attention, as the United States Department of Agriculture has lowered its production forecast for this year multiple times in the wake of less-than-ideal growing conditions in much of the U.S. Global supplies were further restricted by developments in Russia, where widespread fires devastated the country’s wheat harvest and forced Moscow to impose restrictions on exports [see Russia ETF On Fire (And Not In A Good Way)].

But a closer look at the drivers of corn demand uncovers some compelling arguments for the crop as an investment opportunity. Corn is primarily thought of as a staple of picnics and barbecues, but it is a relatively small portion of the total corn harvest that is consumed directly. The majority of the corn grown in the U.S. is used in livestock feed, and much of the annual harvest is sent overseas; Japan and China are among the world’s largest corn importers.

Many of the drivers behind the impressive rally in corn prices are the same factors that have boosted global equity markets: red-hot emerging markets. Emerging markets continue to demonstrate impressive growth, thriving off of an ongoing demographic shift that focuses around urbanization. As the rural inhabitants of emerging markets move into cities and take up non-agricultural employment, they begin to generate disposable for the first time and graduate to a higher quality of living. The swelling of the middle class creates a significantly larger universe of buyers for cars, electronics, and leisure activities–a development that has boosted the consumer sector in developing markets [see Case For Emerging Markets Consumer ETF].

One of the first lifestyle changes made by the millions of new members of the emerging markets middle class is an increased protein intake. That translates into increased demand for beef and poultry, which then trickles down into a greater need for livestock feed. Corn is also a key component of many sweeteners (such as high fructose corn syrup), another major addition to the diets of those who have recently graduated to the middle class and for the first time have disposable income. So while the connection between growing urban populations in China and India and corn prices in the U.S. may not be immediately obvious, the relationship is very real.

Other Drivers

Strengthening demand from emerging markets isn’t the only factor that has been driving corn prices higher over the last year. In addition to its primary use in livestock feed and direct consumption, corn is also widely used in ethanol production. “After a disastrous couple of years brought on by high corn prices and low demand, the US corn ethanol business has emerged as a force in global energy markets,” writes Gregory Meyer. The U.S. is now the largest producer of ethanol, considerably bigger than even Brazil in the space. And much of the ethanol produced here ends up overseas; exports have more than doubled over the last year, thanks in part to the impact of a stronger Brazilian real and a surge in sugar prices (Brazilian ethanol is produced primarily from sugar, whereas U.S. ethanol is corn-based). That surge in overseas demand has come primarily from–surprise, surprise–resource hungry emerging markets looking to fuel economic expansion [also read Corn ETF Continues Mind-Boggling Rally].

The setting in which most Americans encounter corn–on their dinner plate–only tells a fraction of the commodity’s story and importance to the global economy. From its use in livestock feed to biofuels used to power cars, the case for corn as a long-term investment opportunity is relatively easy to make.

Corn ETF In Focus

Corn is clearly much more than a food source, and makes an intriguing investment opportunity given the current pace of expansion and ongoing demographic shifts in emerging markets. Corn receives a relatively minor allocation in most diversified commodity ETFs; it accounts for about 6% of the assets of the PowerShares DB Commodity Index Fund (DBC). For investors who buy into the idea that the corn rally still has room to run–an investment thesis that centers around continued growth in emerging markets demand–the Teucrium Corn Fund (CORN) may be an interesting play. Unlike many futures-based commodity ETFs, CORN spreads its exposure across multiple durations: 35% to the second-to-expire CBOT corn futures contract, 30% to the third-to-expire contract, and 35% to the contract expiring in the December following the expiration of the third-to-expire contract.

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Disclosure: No positions at time of writing.