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Heat Wave Could Trigger a 10% Rise in This Fund by Labor Day

Jim Woods

The summer of 2013 is turning out to be very, very hot. In fact, as you're reading this right now, I'd venture to say you have the air conditioning on.

What makes this year's hot weather different than years past is we are experiencing what some are calling a heat wave that's "stuck in reverse." According to a recent AP story, the current hot spell in the Northeastern part of the United States has surprised meteorologists, not because it's hot in July (it usually is), but because it's actually moving backward across America.

This westward heat migration is something that rarely happens, as weather systems normally move from west to east. According to Jon Gottschalck, the operations chief at the National Weather Service's prediction branch, "It's definitely unusual and going the wrong way." Gottschalck added, "This is pretty rare."

The unusual, and very hot, weather moving east to west is putting a strain on many different energy infrastructure assets, and as you might expect, aging power grids are at times running at full capacity to keep up with demand. And while the energy consumption spike is quite predictable this time of year, what's far less predictable is the high heat's effect on crops.

According to a July 15 U.S. Department of Agriculture (USDA) report, dry conditions in parts of the western Midwest left the nation's corn crops far less healthy than they were the prior week. That report caused corn prices to rise 1.7%, and it also caused a lot concern over further damage to corn crops from the hot weather.

The USDA report of worsening heat conditions and the damage to corn crops in states such as Nebraska, Kansas and Missouri came as a surprise to many analysts who had been expecting conditions to hold steady or to improve slightly.

To make matters worse, forecasts for more heat over the next couple of weeks, along with insufficient moisture during the corn crop's pollination phase, could cause irreversible damage and lead to smaller-than-expected corn harvests.

The solution to this "insufficient moisture" equation is where I think there is opportunity for traders. Greater demand for water in order to ameliorate the negative effects of the heat wave on crops means more water consumption than usual, and that means more profits for water utility providers such as those that make up the PowerShares Water Resources (PHO).

This water ETF is pegged to the NASDAQ OMX US Water Index. It holds some of the biggest water utility and water-related companies around. The top five holdings in PHO are Waters Corporation (WAT), American Water Works Company (AWK), Roper Industries (ROP), Pentair (PNR) and Flowserve Corp. (FLS).

Technically speaking, PHO suffered along with the broader market in the June sell-off. That selling sent the fund below its 50-day moving average, but buyers stepped in well before support at the 200-day moving average.

PHO Chart

Since its June 24 low, PHO is up about 10%. I expect this recent trend higher to continue in large part due to the 2013 heat wave in reverse, and the pressure that current weather conditions are having on corn and other crops that need to rectify the "insufficient moisture" factor.

I see a move into PHO here good for at least 10% more upside by Labor Day, when hopefully the weather gets a lot cooler.

Recommended Trade Setup:

-- Buy PHO at the market price
-- Set stop-loss at $21.43, approximately 8% below the current price
-- Set initial price target at $25.60 for a potential 10% gain by Labor Day

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