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As the global population continues to grow so has the global demand for food and other raw materials. This is even more evident with the recent run up in the commodities markets, specifically the agricultural markets. The price action in the front month corn futures (/ZC $6.43) and soybean futures (/ZS $13.43) contracts has been very interesting. Considering corn during the first part of 2009 was trading around $3.50/bushel and soybeans were at $9.50/bushel. I was raised in a small farming community in southern Minnesota and after being back home this past 4th of July weekend I found it fascinating talking to local farmers and learning about the types of yields and returns they are expecting this fall. It made me wonder how I too could capitalize in this commodity run up.
There are several ways to capitalize on this as a non-farmer, but one of the most profitable and undervalued assets available to the individual investor are fertilizer companies (AGU, TNH, MOS, POT). As corn and soybeans prices continue to climb farmers will attempt to increase their crop yields by increasing the use of fertilizers and locking in future prices. The price of fertilizer (specifically potash) has continued to increase due to this demand, yet the prices of the underlying fertilizer stocks have not. This has created an interesting disparity that that could create a very nice return.
I particularly like Mosaic Co. (MOS), despite the volatility the stock has seen in the past month. Since Cargill began divesting their majority interest in the company a great deal of volatility has been generated within the stock which in turn has also created a lot value. As Cargill continues to divest their interest in the company the possibility of a merger or buyout from a bigger player increases significantly. Bigger companies see the potential of this market and are willing to pay well to get exposure to it. BHP last year put in an offer of $130/share for Potash Corp. when the stock was trading around the $65-$70 range. This is an excellent example of the type of premiums that could be expected.
In May I sold the June Puts on MOS at the 70 and 67.50 strikes when the stock was trading around $74-$75/share. This created a credit situation to my account that would help lower my cost basis if I was put to the stock. Ultimately, I was put to the stock during the June option expiration. I sold an even amount of 70 and 67.50 MOS puts which put my cost basis at $68.75 (not including the premium I received for selling the puts). Since being put to the stock late last month I have already seen appreciation in my investment. The closing price on Friday (7/8/11) was $70.58, which put me up $1.83/share, not including the premium I received from selling the puts originally. The recent volatility has also given me the opportunity to sell more out of the money puts on MOS at the 60 and 62.50 levels.
Selling option premium on MOS or just buying the stock out right I feel presents great value especially with the stock is trading at a relative discount to what I believe is its fair market value price. Mosaic currently has a book value of $24.59, a price-to-earnings ratio of 13.94, and last quarter had $3.352 billion of cash. These types of numbers only further exemplify the excellence of management and the real potential for the stock.
Analysts are estimating that MOS will generate 1.396 EPS with revenue of $2.54 billion. Based on the increased guidance numbers that came out of Agrium last week, the increase in potash prices over the past year, and the increases in demand for fertilizer from farmers throughout the United States, Mosaic should have no trouble in beating those numbers. I continue to remain bullish on Mosaic and see significant price appreciation between now and the end of the year.
The EU this week officially kicked their financial ‘can’ down the street. The Greek bailout passed this week and was welcomed by a strong rally in global equities. Looking at the pricing action of Greek bonds and the Euro itself the EU really had no choice but to provide Greece with a bailout and implement strict austerity measures. There are a lot of problems with the EU and its current structure but one of its biggest issues is the variations in economic systems within the European Union. If you were to compare Germany to Greece today it would be like comparing 1980s United States to Russia. The methodologies behind each country’s economic policies are radically different. Unfortunately, the EU was basically forced into providing Greece with a bailout. The EU had really three options, all of which were not desirable, but I believe that the EU picked the lesser of the three evils.
Option 1: Allow Greece to default. This would have resulted in a huge ripple across the global financial markets. The fallout potentially could have been worse then what the markets experienced in 2008 when Lehman filed for bankruptcy. This would have further devalued the Euro and potentially pushed the global economy back into recession as risk premiums on bonds and credit rates would have increased dramatically. On the bright side this option more than likely would have increased the value of the dollar and gold.
Option 2: Allow Greece to leave the EU. This would only be good for Greece and bad for every other country in the EU. It would have allowed Greece to print tons of currency to pay for their debts which would have devalue their currency and in theory allow them to be more competitive, in theory. The downside is that the Euro as a currency would have collapsed. If investors felt that every time a country didn’t play ball with the EU’s rules they could just leave and devalue their currency the Euro currency and bond markets would begin to factor this into their risk premium. This would ultimately hurt Germany (and the overall EU) who for all intensive purposes is the backbone of the EU. Germany knowing this would not allow this and thus would provide Greece with what they needed to avert this type of scenario.
Option 3: The EU provides Greece with a bailout (again) on the provision that they enact some austerity measures to get their financial house back in order. Ultimately this was the only option for the EU and the global economy. I think that is why the Euro really did not sell-off that much over the past several weeks while this has unfolded. Knowing this it also why I have been recommending that you buy high value equities on the dips anticipating the rally that we experienced this week.
As I was watching this Greece bailout (and street protests) unfold that I was looking into a crystal ball of our own (US) situation. I think there is an excellent lesson to be learned here at home with what we witnessed this past month in Europe. I also feel that it is all that much more imperative that we get our budget balanced and start to begin living within our means as a nation. I have the utmost faith in this country and its people and therefore would continue to recommend equities and the overall market throughout the end of the year. That being said, if a budget deal is not reach in D.C. in the coming weeks my sentiment on the overall market might change dramatically and become much more bearish.
Right now I would recommend high value blue chip stocks that are paying dividends. I don’t think we are out of the storm just yet and after the 4th of July weekend and traders have had some time to internalize our own situation here at home, I think there could be some more turbulence ahead. This could provide for some excellent opportunities to continue picking up some high value equities at great prices.
Current positions (AAPL, COP, MOS, INTC, MCD, VZ, WM, WFC, USB, BRK-B, KO)
This week's market action has been very interesting. There continues to be growing concerns over the potential of a Greek default along with a slowing economy back home. The government today released 200,000 barrels of oil from the Strategic Petroleum reserve in a hope to drive down the price of oil and in turn gasoline for the summer. This seemed to work (at least today it did). Commodities prices have since fallen dramatically which in my opinion has created a lot of value for bargain hunters.
The current prices of energy companies are creating great value. Considering their current cash flows, dividends, and forward earnings potentials I feel that there are a lot of deals out there. As I state on 'My Strategy' section of this site I enjoy selling puts on companies that I like (or would like to own) at times of great uncertainly.
The increase in volatility creates inflated premiums on put options which can create additional value in writing put options and further help to off set your purchase price if you happen to get put to the stock.
I think selling puts on companies like COP, XOM, or CVX would stand the greatest chance of profit in the coming weeks. For example you could sell the $72.50 XOM AUG puts for $1.01/share. That would generate a 1.39% discount to the purchase price and would require another 7.5% decrease in today's closing price to hit the strike price. COP is providing similar value at the AUG $67.50 strike which is currently trading for $1.31/share. That would generate a 1.94% discount to the purchase price and would require another 7.5% decrease in today's price to hit the strike price.
Overall, I am still fairly bullish on this market and feel that the current sell off is somewhat over done and irrational. There are a lot of great values out there at really great prices. So I would encourage everyone to go shopping and find some value.
My current holdings: (COP, BRK-B, INTC, MCD, WM, WFC, USB, KO, MOS, VZ)