As we all know, food prices in the shops are rising. Prices of almost all agricultural commodities have soared over the past year as some experts predict major food shortages. Is this the right time to invest?
Many respected analysts have predicted a 20-year period of broadly rising prices for natural resources including energy, minerals and foodstuffs.
We are probably at an early stage of such an uptrend since prices only really started rising four years ago, and in real terms - adjusted for inflation - most agricultural commodities are cheaper now than they were in the 1980s, even after a typical 30% rise over the past year.
People buy based on cost
You can bandy figures around about the huge growth in the numbers of people in China and India who now have higher incomes and therefore spend more on food, increasing demand for meat, which in turn (it takes 16 kilos of grain to create 1 kilo of meat) raises demand for crops. On top of that we have subsidies for biofuels, which are distorting land use away from food production, especially in the US.
But all the food charts I have seen simply show straight-line projections that assume people will consume more as they move towards Western-style diets. This ignores the biggest truth economics has taught us, which is that what people buy depends on what it costs.
In fact, any economist would expect people’s demand for more expensive foods to be reduced by hefty price increases, just as oil at $100 a barrel is teaching us all to turn down the heating and take our foot off the accelerator.
Where will the food come from?
Still, the trend is undoubtedly there and with over 80% of all the farmable land in the world already being farmed - and only relatively poor-quality land left to bring into production - there isn’t a lot of scope for increased production from new sources. On the other hand, countries like India and Indonesia have completely ignored their farmers for the past 20 years.
They got a big boost to production in the ‘green revolution’ of the 1970s and haven’t improved their productivity since - in fact, in many countries agriculture is less productive now than it was 20 years ago. So there is scope for higher food production in China, India, Indonesia and other countries. And Russia and Ukraine - the breadbaskets of Europe - are still producing less now than in their Soviet heyday.
While investing in commodities and resources is appealing on a long-term view - it’s definitely the right idea for your pension fund - there is a big difference between the ‘soft’ commodities like wheat, corn, soybeans and cotton, and the minerals and energy.
Improvement in harvests
Creating new mines to add supplies of copper or nickel takes anything up to ten years and getting oil out of a new field at least five years. But in response to price rises like those we’ve seen recently, you can be sure that farmers worldwide will be planting as much more wheat and corn as they possibly can.
Last year’s harvests - hit by bad weather everywhere - were well below average, but this year’s could be far larger. So while we may have a 20-year uptrend, there could be periods of a year or two in which ‘soft’ prices stay stable or fall. In fact, some of the smarter commodity traders have been selling out of ‘softs’ in recent weeks in expectation of a setback after the strong rise of the past 12 months.
But one thing you can be sure of is that if something goes up in price, the promoters of investment products will offer you a way of buying it. In the case of food, there are three ways: buying shares, buying commodities or buying a mixture of shares and commodities.
Three ways to invest
In the past, the only way you could get on the bandwagon was through funds investing in shares. There are such funds today - a new one is Allianz RCM Agricultural Trends Fund - but the problem is that the shares they invest in tend to be affected by trends in stockmarkets as much as by trends in the food industry.
So they don’t provide as much of a ‘diversification benefit’ as investing in commodities. Two other funds that invest more widely in natural resources shares are JP Morgan Natural Resources and First State Global Resources.
A newer fund vehicle, Exchange Traded Commodities (ETCs), allows you to buy into the commodities directly. ETCs are created by promoters who buy baskets of commodity futures. The assets are held by an independent custodian and the ETC is traded on the London Stock Exchange, so ETCs are easy to buy through any type of sharedealing account.
Their costs are low, too, about an annual 0.5% compared with over 1.5% for share-investing funds. Two agricultural ETCs are ETF Securities Agriculture and Powershares DB Agriculture Fund.
Best of both worlds
The latest thinking is to combine the two forms of investing. Sarasin, part of the Dutch agri-bank Rabobank, has just launched Agrisar, which will invest in commodity futures and in shares and will also use modern portfolio management techniques to limit downside risk.
Sarasin have a decent record with their other ‘thematic’ funds, but I don’t like the fact that Agrisar has a 15% performance fee as well as a 1.5% annual management charge.
A better option, in my view, if you like the food and commodities story, is to buy a general commodities fund and leave it to the managers to decide when and whether to be in metals, minerals and energy or in softs. Schroders run such a Commodity Fund (Schroder AS Commodity, based in Luxembourg), which is only available through investment advisers.
The fund was launched in 2005 but Schroders has been managing money for institutions in this way for much longer and has a dedicated team of managers and analysts- probably only Rabobank has an equivalent skill base in Europe.
You can see these agriculture and commodities funds as a reactive form of investment designed simply to profit from rising prices. There is another set of ‘green’ funds that take a positive and proactive stance on the food, energy and climate change story, and I’ll review these ‘green’ funds another time.
