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Jeff Saut: The Business of Pork

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This agricultural theme should have long legs as 3 bln new entrants (read: people) join the world's economy and per capita incomes rise.

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Editor's Note: The following article was written by Raymond James Chief Investment Strategist Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.


Well, it's National Pork Month (October), yet not the kind of "pork" served up inside the D.C. Beltway that proposes $400 mln "bridges to nowhere," but rather the pork (read: pigs) that Smithfield Foods (SFD) serves up to the world. Enter China, the world's largest pork-consuming country, which ironically is celebrating the year of the pig! It's ironic because of the vicious outbreak of Blue Ear disease that has wiped out 20% of China's pig population, causing pork prices to jump some 70% over the past year.

Because of the porcine respiratory syndrome, last month Smithfield agreed to supply 60 mln pounds of pork to China, which could lead to additional Chinese purchases. Note that it takes almost two years to raise a pig for slaughter to sate the burgeoning pork demand created as Chinese per capita incomes rise and the desire for more pork increases geometrically.

Interestingly, pigs eat corn as well as other grains, which is one of the reasons I have been steadfastly bullish on agriculture for years. Over that time frame grain prices have been rising, a point often written about in these missives, like last May when I opined:

"Verily, times are good in the Corn Belt with factories like Archer Daniels (ADM) and Caterpillar (CAT) operating at full tilt. Clearly this is being driven by a couple of my macro themes. First would be with more and more people entering the world economy (read: "Chindia"), and subsequently per capita incomes rising, people are consuming more 'stuff' (grains, meat, energy, etc.). Second would be alternative energy, in this case ethanol (as a sidebar, when I flew into Bloomington, Illinois I saw a plethora of electricity generating 'windmills' that were not there a year ago)."

I revisit "grains" this morning because last month commodities, largely driven by the grains, had their best monthly price gain in decades! As Friday's Wall Street Journal noted:

"Rising prices and surging demand for crops that supply half of the world's calories are altering the economic landscape. The run-up could last as long as a decade, economists say, raising the cost of all kinds of food. Also, global grain stockpiles are being drained to their tightest levels in three decades. . . . 'The days of cheap grains are gone,' says Dan Basse, president of AgResource Co., a Chicago commodity forecasting firm."

The article went on to say:

"Not only have prices remained high, but the rally has swept up other commodities such as barley, sorghum, eggs, cheese, oats, rice, peas, sunflower and lentils. In Georgia, the nation's No. 1 poultry-producing state, slaughterhouses are charging a record wholesale price for three-pound chickens, up 15% from a year ago. What's changed is that powerful new sources of demand are emerging. In addition to U.S. government incentives that encourage turning corn and soybeans into motor fuel, the growing economies of Asia and Latin America are enabling hundreds of millions of people to spend more on food. A growing middle-class in these countries is consuming more meat and milk, which in turn is increasing the demand for grain to feed livestock. In the U.S., a beef cow has to eat roughly six pounds of grain to put on a pound of weight, and a hog about four pounds."

If all this sounds familiar, it should. Indeed, for years I have espoused the merits of investing for the long-term in agriculture and all things related to it.

Two of my better "calls" have been Bunge (BG) back in 2001 at under $20 per share, as well as Caterpillar in November 2002 when it possessed a 4%+ dividend yield and also changed hands under $20. Still, I don't think the agriculture theme has run its course.

Unsurprisingly, China is importing nearly 13% of all the soybeans grown in the U.S. to feed its livestock and continues to "throw" cash at its farmers in an effort to produce more meat for Chinese consumption. And that cash flow has caused the U.S. Agriculture Department to estimate that net farm incomes in the U.S. will soar by nearly 50% this year with an attendant increase in demand for farm equipment, irrigation equipment, fertilizer, seeds, etc.

Ladies and gentlemen, this theme should have long legs as 3 bln new entrants (read: people) join the world's economy and per capita incomes rise. While some of the "easy money" for investors has already been made from my firm's recommendations, I think there is still room for additional investment returns. Clearly, there are numerous individual agricultural stocks for participants' consideration (see recommendations from my previous missives and/or research correspondents), but a broader-based approach for most investors is likely the best strategy. To this point, I embrace investment vehicles like MK Vectors Agribusiness (MOO), as well as other open-end and closed-end investment funds.

Despite soaring commodity prices, however, and concurrent rising inflation, the D-J Industrial Average (DJIA) has rallied back to within "sneezing distance" of its all-time high. This should come as no surprise, for if past is prelude the DJIA should record a new all-time high before a downside retest attempt of the August 16 lows begins. Such an upside breakout would tend to cause the sideline cash to buy stocks, as well as force the last of the short-sellers to cover, before the "downside trap" is sprung. "But Jeff," a portfolio manager said to me last week, "while you were pretty aggressive on the long-side around the mid-August lows, you have been cautious over the last three weeks as the DJIA climbed higher. What gives?" Obviously that's a valid point; but while the DJIA has rallied, most of the stocks I bought or recommended in mid-August made their respective throwback rally-highs two to three weeks ago and have gone sideways since then.

Moreover, I don't like the D-J Transportation Average's (DJTA) refusal to confirm the Dow's rally, as seen in the attendant chart from my friends at thechartstore.com. Further, there are bearish divergences between breadth and volume, volume has lagged as the rally matured (read: bearish), and the weakening pattern of Lowry's Buying Power Index suggests the rally over the past few weeks has been more about the withdrawal of sellers rather than genuine buying.


Click here to enlarge.

Consequently, here I sit looking rather foolish. However, I have looked foolish for most of this year as I continued to scale-sell partial long positions as stocks rallied from their March lows into their mid-July highs. That strategy left us with a substantial cash position when the selling-stampede began on July 20.

Near the August 16 lows I put roughly half of that cash back to work and have subsequently been rewarded. Still, I am not convinced the averages are totally out of the woods. Additionally, I have to once again ask the question, "Are stocks rallying or is the measuring stick declining?!" Indeed, measured in U.S. dollars the S&P 500 is up 7.7% year-to-date (YTD). But, change the measuring stick from dollars to euros and the S&P's gain evaporates because the euro has appreciated against the dollar by some 7.7% for the year. And, if you change the measuring stick to bushels of wheat, barrels of crude oil, ounces of gold, etc. the S&P 500's YTD return is negative.


Click here to enlarge.

(Charts courtesy of thechartstore.com)

Consistent with these thoughts, I remain cautious for technical reasons, as well as the fact that I can't decide if the "collateral crunch" will morph into a real credit crunch that then has the potential to spill over into a recession. Therefore, I am sticking with the themes I think do the best no matter what the economy does. Clearly agriculture is one, and some of the others remain electricity, water, defense, security, healthcare, RFID, and the list goes on.

The call for this week: Well, here I am again in a cautious mode and looking foolish. Yet my firm's short-term caution this year has not hurt its performance, with The Analysts' Best Picks List better by 34%, while the Focus List is up nearly 18%. When one compares these returns to this morning's Barron's article about "(The) Best 50 Hedge Funds," my firm's out performance is noteworthy. And don't look now, but 2.7%-yielding General Electric (GE) said this morning that its international sales will exceed its domestic sales for the first time ever. I continue to invest accordingly.

No positions in stocks mentioned.
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