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From Ags To Angst?


Sharp moves up or down tend to exhaust themselves after 19-25 trading days

Uber-Minyan Jeff Saut, whose invaluable lessons grace these pages every Monday morning, often notes that sharp moves up or down tend to exhaust themselves after 19-25 trading days. I bring this up because this "rule of thumb" is now starting to come into play for some of my favorite longs, names like McDermott (MDR), Monsanto (MON), Bunge (BG), and Agrium (AGU), they have me thinking that more than just fundies may be at play here: greed might be rearing its ugly head.

Prof. Krueger has discussed at length the secular attributes of the current bull market in food stuff, much like I've been beating the drum for years that precious metals are in a secular bull market directly correlated to the secular bear market in the U.S. dollar. Still, when trading in a given sector starts getting this giddy (as it did with gold in May 2006), weighing the probabilities of a sharp correction against the possibility of a continued ramp dictates caution. Looking first at MON, AGU and BG, since they are all related to agriculture, the first yellow flag to consider is the pattern of wheat prices, which has gone parabolic. As you can see from this chart, it is almost identical to the May 2006 move in gold, which in short order led to a 20% correction.

Admittedly, MON, AGU, and BG are not directly correlated to wheat, but therein lies the problem: since there are no pure-plays in wheat on the equity markets, those without access to futures trading, are turning to the next "closest" thing, and they are indiscriminately bidding up agricultural names. This increases the chances of a sharp pullback, by adding fundamental risk (i.e. these companies' profits have only marginal correlations to high wheat prices) to already extended charts.

AGU for example is a fertilizer manufacturer; I am not suggesting that AGU won't benefit from higher agricultural prices in general, but a) wheat should hardly be viewed as the benchmarks for where all ag prices are heading; and b) AGU is up 46% since the August lows, which is even more than the 37% move in wheat prices. By comparison, AGU's 2008 EPS estimates have been jacked up 9% since mid June.

Similarly, MON, which manufactures agricultural seeds, has jumped 23% since the August lows, while 2008 EPS have been raised by 13% since April. Furthermore, it can be argued that MON is already rather pricey at 32x '08 estimates. (The counter argument to MON's valuation is that since 2005 it's R&D budget has been massive, that it is likely to moderate in the future, and that this change will directly benefit the bottom line.)

Meanwhile, soybean prices are up fairly sharply as well, which does explain in part BG's recent 22% move. But before getting carried away, keep in mind that some of BG's costs are also heating up, fertilizer costs and transport costs as first line examples (dry bulk rates are through the roof and hence my position in Quintana Marine (QMAR)). Hence the modest '08 EPS estimates increase of 7% since May of this year.

Away from ag names, we were fortunate to spot energy/water infrastructure play MDR early this year, precisely because the fundamentals vs. valutaion seemed favorable; the stock is up 111% since March 1, and 48% since the August lows. Here '08 EPS estimates have been raised a whopping 47% since May, which certainly justifies a meaningful increase in the stock price. But even Hoofy would probably concede that the current rate of upward earnings revisions is not likely to continue, and that for a company heavily exposed to capital spending (and how interest rates affect capital spending), the current problems in the credit markets and the potential slowdown in the US and world economies should be kept on the radar screens as possible hostile objects.

To sum it up, I am not contemplating selling these positions and going short. But whether it is buying puts, selling calls, rolling up stops, rolling up call options, downsizing positions, or whatever may be one's favorite risk control tool, I'm feeling the urge to cover my tail before Boo steps on it.

Have a great day Minyans!!
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Position in MDR, AGU, BG, MON, QMAR, gold/gold equities
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