On Rain and Oil
- Details
- Published on Thursday, 19 July 2012 15:52
- Written by Sara Nunnally, Editor, Inside Investing Daily
- Hits: 500
Whatever magic rain dances or prayers were sent up over our little town... thank you.
We got about a half-inch of rain last night, and woke up to damp ground. I'm sure all the farmers are breathing just a little easier today -- even though most of the crop damage has already been done.
I told my Macro Trader readers yesterday that some farmers were just plowing their corn fields under.
It's cheaper to do that then try to feed and water a crop for another two months knowing it will produce zero grain.
Indeed, this is the worst drought since 1956, and the rain won't be able to reverse the damage already done to corn and soybean crops. That's why prices have been soaring for the past six weeks. And things will only get worse.
For farmers, this year will be devastating.
And expensive.
Has anyone noticed that crude oil prices have crept back up above $91 a barrel? How and when did that happen?
Let's take a look.
Here are the past five trading days. Prices have jumped from $86 to more than $91 in less than a week.
Part of the reason for this is demand is picking up in the U.S. It is after all, the summer driving season, and inventories showed a drawdown of gasoline supplies. But this demand was a bit unexpected, and the price moves have been amplified a bit because of that.
Another factor behind the move, though, is tensions in the Middle East -- again. Or is it still? Either way, attention is back on this region... This time with Syrian rebels trying to take Damascus and killing several of President Bashar al-Assad's security chiefs.
And there are escalating threats between Israel and Iran.
From Bloomberg:
[Oil] Prices gained as much as 1.8 percent as Israeli Prime Minister Benjamin Netanyahu threatened a forceful response against Iran, which he blamed for a suicide attack in Bulgaria that killed Israeli tourists...
Five Israeli tourists, the Bulgarian bus driver and the attacker were killed in the blast yesterday at the airport in Burgas, a popular holiday spot on the Black Sea coast.
So how high can crude oil prices go?
From a technical perspective, prices will see some resistance between $93 and $94 a barrel and support at $85.
But geopolitical risks always trump technicals. If tensions keep climbing in the Middle East, that $93 mark isn't going to amount to a whole hill of beans.
And that means higher costs are back on the table for everything from farming to mining to driving to the mall.
Now, some analysts might say the drawdown in gasoline supplies means the economy can handle higher energy prices. And it can -- to a point.
But the markets are already looking to Bernanke for another bit of stimulus. There's not much more the economy can handle in the way of higher costs. This fast -- and sharp -- boost in oil prices is exactly what the Fed didn't need.
Nor do the farmers.
Farming is incredibly energy intensive. In fact, industrial farming and food production account for 10% of our entire energy consumption. It takes about 5.5 gallons of fossil fuel per acre just to produce the chemical fertilizer!
That's not counting the amount of gas and diesel used in all the machinery to plant, harvest and transport food.
The poor outlook for the corn and soybean crops coupled with climbing energy prices means a whole lot of hurt over the next few months. But it won't just be the individual farmers hurting.
Even big companies like Archer Daniels Midland (ADM:NYSE) and Bunge (BG:NYSE) could feel the pinch.
Indeed, as the grain market is jumping more than 2% today, these two companies started the day lower. Less grain means fewer products, and ADM and BG rely heavily on corn and soybeans.
So much so that an ADM chart looks like the inverted version of Teucrium Corn (CORN:NYSE) -- an ETF that invests in corn futures.
Take a look:
This clearly sets up two plays. You can go long grains, or you can short a company like ADM. There's a lot of potential on either side.
I've got my Macro Trader subscribers long grains, and we'll be holding through harvest time. But that doesn't mean an ADM put option wouldn't bring in some green for you. The slightly out-of-the-money September 27 puts are going for about a dollar per contract.
If ADM falls to $26, which is well within reach, these puts would be worth more than $1.80. Should ADM fall to its 52-week low of $24.16, these puts would be worth $3.20.
Not a bad way to play rain and oil at all, is it?
Happy Investing,
Sara
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