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How Ags Will React to Last Year's Drought

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The severe 2012 drought will have a real impact on commodities prices this year.

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The agricultural industry was hit hard by the most severe and extensive drought in at least 25 years in 2012, which had an impact on crops, livestock and food prices at all levels. While prices have already started to increase in the fourth quarter of 2012, the majority of the impact on retail food prices will likely be seen throughout 2013, according to a recent report by the United States Department of Agriculture ("USDA") analyzing the drought.

Effects on the Commodity Supply Chain

The largest impacts may be seen in beef, pork, poultry and dairy products, despite a temporary reprieve in prices due to herd culling in response to higher feed costs. The October Consumer Price Index ("CPI") data suggests that this reprieve has ended and prices are likely to rise throughout 2013. Meanwhile, the full effects of increased corn prices on packaged and processed foods will likely take 10-12 months to move through to retail food prices, according to the report.

Looking into 2013, the USDA expects the following impacts:

  • Corn demand is expected to suffer from diminished export, but benefit from higher food, seed and industrial use, while projected prices for 2012/2013 are estimated to be between $6.75 and $7.65 per bushel. In response, corn futures have steadily fallen from their $800 highs in August and September to around $700 in February.

  • Soybean demand has benefited from both the drought and concerns over South American crops, which resulted in projected prices being raised last month from $13.55 to $15.05 per bushel, but unchanged this month. The result has been a steady decline in soybean meal futures and a recent recovery in soybean oil prices.

  • Wheat was relatively unaffected by the drought, unlike corn and soybeans, since it was harvested in the Spring and early Summer. But, prices for the commodity are projected at $7.75 to $8.45 per bushel in 2012/2013, which is up from $7.24 in 2011/2012.

  • Livestock prices remain in limbo after the drought caused more cow liquidations (rates not seen since the 1980s) and the prospects for herd rebuilding deteriorate. Record high beef prices led to live cattle prices of nearly $135 at the beginning of the year, but these levels have since fallen sharply to below $125 by mid-February.

Analyst Takes on Ag Commodities in 2013

Many analysts are mixed on the prospects for agricultural commodities in 2013, after experiencing such a turbulent year in 2012. On the whole, analysts seem to expect to see stronger corn prices, weaker soybean prices, and are mixed on other agricultural commodities with a bias towards the downside on the whole. Meanwhile, many recommend a long/short strategy to hedge against potential downside to the asset class as a whole.

Here are some specific analyst opinions to consider:

  • Deutsche Bank (NYSE:DB) recommends selectively buying agriculture in 2013, with short-term value in oversold grains and oilseeds. They are constructive soybean oil, which lagged the complex in 2012, but cautious deferred hogs, recommending pairing long cattle versus short corn in deferred months.

  • Rabobank N.A. expects grain and oilseed prices to be volatile, with a first quarter rally giving way to weakness for the remainder of the year. The analyst expects soymeal to be the worst performing commodity of the year, while palm oil could have the most upside as Chinese imports and biofuel demand drive prices higher.

  • Goldman Sachs (NYSE:GS) expects agricultural commodities to be down 3.5% on the whole when factoring in all classes, but noted that the combination of downside risks to crop production and signs of resilient demand will require higher crop prices in the coming months, given already-very-low inventories, especially for corn.

  • Bank of America Merrill Lynch (NYSE:BAC) cautioned investors to prepare for disappointing wheat harvests in 2013, saying that unless U.S. weather turns unusually favorable in the Winter and Spring, next year's winter wheat crop could be severely damaged, providing potential support for prices over the coming year.

The Bottom Line

The takeaway from the 2012 drought and outlooks for 2013 is likely one of mixed results. While the drought undoubtedly led to sharply higher prices, especially in late 2012, the prospects of higher supplies and a global response (in Brazil for instance) have dampened prices moving into 2013. But, according to some analysts, there may be opportunities hidden within the industry, particularly in corn and wheat, where supplies remain tight and future supply is uncertain.

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Editor's note: This article by Justin Kuepper was originally published on Commodity HQ.
No positions in stocks mentioned.
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