Agricultural Stocks

Many analysts are forecasting lower food prices this year, and that's taken a toll on many agricultural stocks.

But there are two reasons why investors shouldn't be so quick to abandon the sector.

In fact, two stocks, Deere & Co. (NYSE: DE) and AGCO (NYSE: AGCO) are poised to reap gains now that ag stocks have pulled back

Here's why.

1. Much of the pessimism surrounding crop prices is overdone.
2. Many ag stocks are still excellent long-term plays - despite any short-term trepidation.

I'll explain.

It's true that farmers currently are planting more staple crops in an effort to exploit high prices. But as we've seen in just the past few months, floods, droughts, and rapidly rising demand could easily intercede to keep prices near record levels.

The most important crop to watch right now is corn.

Preliminary USDA data suggest that farmers this year will plant the biggest corn crop since World War II. However, that's exactly what will be needed, since corn is facing the greatest supply constraints of any staple crop.

Indeed, even a bumper crop will first have to compensate for the shortages of the current crop year, which are significant. By this year's autumn harvest, global stocks of corn as a share of consumption will have fallen to the lowest level since 1974.

"There has been no rebound in global corn stocks," Ed Allen of the USDA's economic research service told the Financial Times. "This has maintained very tight markets for corn."

And while global corn production is expected to rise, there's still a chance bad weather will damage the harvest just as it has in the past two years.

Last year, wet weather early in the season delayed planting while hot weather in the summer scorched young stalks. That contributed to two consecutive years of shrinking supplies.

Analysts say a third straight year would be rare, but according to economists at the University of Illinois, there is a 40% chance corn yields will fall short in any given year.

"The odds slightly favour a corn yield above trend in 2012, but there is certainly precedent for another year below trend," the economists wrote last month. "More specific expectations about the 2012 average yield will depend on how the planting and growing season unfolds."

Good News for Agricultural Stocks

Corn isn't the only crop facing supply constraints, either.

January droughts in Argentina and Brazil reduced global soybean production by 7.2% this year. And with farmers focusing on corn there's less land available for soybeans. The USDA anticipates soybean production will fall by 12.7 million metric tons this year.

On Oct. 1, the start of the next season, soybean inventories will be 20% lower than they were last year, according to Jefferies Bache LLC. As a result, soybean prices, which are up nearly 9% year-to-date, will gain another 6.7% by June, the New York-based commodities trader estimates.