Why You Should Avoid Agricultural ETFs In 2013?

Agriculture ETFEric Dutram: The agricultural commodity market experienced quite the volatile 2012, thanks to the massive drought in the Midwest growing region last summer that resulted in lower yield and steeper price increases for grains like corn and soybean.

With a majority of agricultural land affected by drought, total crop production was the least in several years, hampering not only crops, but livestock as well.

In short, the highly volatile agricultural commodity market is largely a function of weather and thus subject to extreme volatility. Below is what we see in store for corn, wheat, and soybean in 2013:

Imbalance May Drive Prices, But….

The persisting drought condition in some top corn-harvesting states will affect this year’s production and should raise prices in early 2013. Per the USDA, retail food price inflation has averaged 2.5%–3% each year on average for the past 20 years. But the Department has warned of a slight increase from the historical averages in 2013.

For the 2012/13 year, USDA forecasted total corn supplies at around 11.8 billion bushels, 13% lower year over year and soybean meal prices in the range of $455––$485 per short ton, up from an estimated $394 per ton for the 2011/12 marketing year. In such a backdrop, the global demand for grains will keep the prices firm in the near term, but this is just one side of the coin.

Prices to Calm Down as the Year Moves

This scenario should reverse as the year progresses with easing supply concerns and favorable weather conditions. Crops have already seen its peak last year and could see a decline this year. Further, anemic growth in the global economy and lingering concerns over macro uncertainty, which might drag down overall agricultural consumption in 2013.

There are also some external factors to regulate pricing like the recent cancellation of a big U.S. soybean order by China, one of the biggest importers of soybeans.

Now, industry sources are saying that China booked the soybeans at a price well above current levels and called off the contract watching the softening trend of prices. Soybean futures fell 2.0% to a one-month low following the cancellation. In fact, the prices began to simmer in September last year.

Corn and wheat prices are also trending lower with weak export demand. The competitive scenario is also heating up.

Argentina, the second-largest corn exporter in the highest number of years and currently enjoying relatively uninterrupted weather conditions, remains a key exporter to world economies.

Coming to wheat, the product will likely see a supply surplus in 2013 as suggested by the report of USDA that says U.S. wheat ending stocks for 2012/13 is anticipated to rise 50 million bushels mainly due to a shrinkage in exports.

Higher global supplies stemming from China, Australia (see:Australia ETF Investing 101) and Canada will pull down demand for U.S. wheat and its prices. Relatively good harvest weather is supporting foreign countries. Further, the recent rains in most states could boost the supply/demand balance in favor of production.

With this backdrop, some of the agricultural commodity ETNs might very well be weak picks for investors in 2013. These are Teucrium Soybean (NYSEARCA:SOYB), Teucrium Corn (NYSEARCA:CORN), Teucrium Wheat (NYSEARCA:WEAT), IPath DOW Jones UBS Grains Sub index (NYSEARCA:JJG) and IPath DOW Jones UBS Grains Sub index (NYSEARCA:JJA). But before considering selling these ETNs, let’s take a look at each:

Ebbing Fourth Quarter 2012 Returns

While SOYB seeks to gain exposure in Soybean by investing in futures contract of the underlying commodity, CORN invests in corn futures contracts. Returns for both the products declined a respective of 7.8% and 8.4% in the fourth quarter of 2012.

Most other fundsare also on a downhill ride since New Year’s Eve with a respective negative year-to-date return of 0.91% and 1.99%. Meanwhile, WEAT has registered a sharp fall of 11.1% in the fourth quarter while this year, it receded 3.14%.

Higher total expenses for these ETNs (including expense ratio and bid/ask spread) also add to the woes, potentially making these funds less attractive in the sector for play. The expense ratio for SOYB is 2.08%, CORN is 1.49% and WEAT is 2.34% while bid-ask spreads are average but can sometimes spike(currently they are 0.11%, 0.06%, and 0.15%, respectively) (see Buy the Ultimate Commodity with These Water ETFs).

Returns for one of the largest products in the agricultural commodity space ─ JJG investing in three futures contracts on grains ─ fell 10.6% in the fourth quarter and the uncertainty has continued this year with modest losses.

Another high-asset ETN ─ JJA –– following the same trend which is mainly exposed to Soybeans, corn and wheat collapsed 9.8% in the year-end quarter with another round of losses noticed year-to-date.

The market is abuzz with reports of short selling of corn crops in 2013 with the purpose of repurchasing them at a lower price afterwards. We believe, the time has come when the agricultural commodity futures will begin to deteriorate and chances for these products to gain is less.

zacksWritten By Eric Dutram From Zacks Investment Research

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.

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