Hackett Advisors in the News

Rice Is on the Verge of a Breakout

Justin Rohrlich July 23, 2010 1:35 PM|

       If history serves, this could be only the fifth opportunity in 60 years to take advantage of conditions like these.

Quick -- name the second-largest rice-growing state in the US.

If you said California, you're absolutely correct. (Arkansas is number one.) But how many people know California even grows rice? Or that the state’s rice crop is in bad shape due to this spring’s weather? (The weather conditions will likely lead to lower yields, tightening supply, and significantly raising prices.)

In a report released this morning, money manager Shawn Hackett, founder and president of Hackett Financial Advisors, a firm with a specific focus on agricultural commodities, wrote:

The rice market seems to be on the verge of breaking out from a classic bottoming base pattern. Any weekly close over $10.20/hwt would create a major technical breakout that should finally begin the process of recalibrating rice prices to a more appropriate higher level.

In an interview with Minyanville, Hackett explained the fundamental side of California’s rice situation:

California’s rice crop can suffer badly if they have a very cool, wet spring. This creates a situation where you have delayed planting and much slower development. Every time we’ve seen these weather patterns in the past, it’s led to a 20%-30% yield reduction. The USDA, which is expecting a record crop, is in denial. It simply can’t happen if California is down 20%-30%. Obviously, that’s a contentious point; many people think I’m nuts. But what hurts California rice crops is precisely all the conditions we’ve seen this year; going back to 1950, we’ve seen four seasons with identical weather patterns. Why would it be any different this time?

Hackett also pointed out the weather conditions in Asia that are affecting their rice crops:

[There have been] devastating flooding rains in China that have averaged 150% to 200% above normal during the current rice-growing season with up to 16 inches of rain falling in June alone. The irreversible damage that has already been done to the rice crop will likely reduce China’s rice production by about 3% from expectations.

To put this into perspective, China was expected to produce a total rice crop of 137.5 million tons. A 3% reduction in expected crop production would shave 4 million tons of rice supply. China was expected to export 1 million tons of rice in 2010/2011. With a 4 million ton reduction in Chinese rice supplies, China would now become a net importer of 3 million tons. This would represent half of the Vietnam’s total expected exports for 2010/2011, and Vietnam is the second-largest exporter in the world.

This China rice story is another very bullish supply-side development that, when added to the reduced rice crop supplies in Vietnam and Thailand due to drought this year and the reduced rice crop supplies in California due to a cool wet spring in 2010, will require a dramatic decline in global ending rice stocks in the months just ahead. The total lost global rice production from China, Thailand, Vietnam, and United States (California) from current expectations would be around 15 million tons.

Hackett’s bullishness on rice also stems from what he calls the “rice-to-wheat price ratio”.

With current prices near $10/hwt and well below the cost of production, to say there is the potential for huge upside in rice prices is an understatement. Another powerful relationship has started to flash major buy signals as well. It is the rice-to-wheat price ratio. Remember, these two food commodities are the most important in the world as they are essential for feeding over half of the world’s population and preventing global famine. When the price of one gets too high relative to the other, a major substitution effect takes place. This rice-to-wheat price dance between these two agricultural commodities has tended to range between 1.5:1 and 3.5:1. At 1.5:1 rice is cheap relative to wheat thereby making rice the better buy. When the ratio is closer to 3.5:1, rice is expensive relative to wheat and wheat would then be the better buy.

He said, “Rice is not a particularly closely followed market. My job is to find these price misrepresentations so people can take advantage of a misfiring like the one we’re seeing now. It takes a while for the market to respond to severe weather issues in Asia. In that sense, you can get in early and take advantage of the discounted prices before the market recognizes it and becomes common knowledge. Wheat is a classic recent example. The former Soviet states have been suffering through a drought for months, but in the last 30 days, it suddenly jumped more than 40% when people finally noticed it and said, ‘Oh my god!’ But where were they when it was really time to be bullish? Right now, there is a tremendous opportunity to take advantage of inefficiencies in the rice market, akin to what we just saw with wheat.”

Further bolstering the case for rice, Hackett notes that, “the commercial operators are near record long while the speculators are near record short against a price level that is well below the cost of production. Rice remains my number-one commodity investment idea at this moment in time based upon the overall risk versus reward profile.”

For those who aren't commodities investors, there are a handful of stocks that could benefit from these developments.

Hackett mentions “the usual suspects” which include John Deere (DE), Potash (POT), and Mosaic (MOS), and also sees potential in two companies that are lesser-known names to the average investor but have “dominant market positions” in the ag space:

Titan International (TWI), a “leading global supplier of complete wheel and tire assemblies for off-highway vehicles” and Trimble Navigation (TRMB), which manufactures GPS systems used for everything from precision self-steering mechanisms for farm equipment to flow and application control systems like the WeedSeeker, which “senses the presence of living plants, allowing targeted herbicide application and savings of up to 90% in herbicide costs.”

So now, when someone asks you for a favor and you say, “I wouldn’t do it for all the rice in China,” you’ll be talking about 4 million tons less than usual.

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