Tucking into the commodities story

The traditional Sunday roast may be a staple of the British diet, but if forecasters are to be believed more people around the world will be tucking into their meat and two veg over the coming decades.

Global meat consumption is expected to rise steadily over the next decade as the populations of emerging countries like China become wealthier and adopt a more protein-rich diet.

“As incomes rise worldwide, the race is on to meet the changing nutritional needs of an increasingly affluent population,” says Ralf Oberbannscheidt, manager of the DWS Global Agribusiness fund.

“This holds true particularly in the world’s most populous countries in Asia, where higher protein foods will be [increasingly] consumed.”

Growing demand for meat is just one of the themes underpinning a small number of agricultural funds that have hit the retail market recently.

These funds aim to exploit the idea that as the global population grows – the United Nations expects the number of people in the world to swell from 6.3 billion in 2004 to 9.3 billion by 2050 – so too will demand for food.

Also strong growth in the bio-fuel and ethanol market is driving demand for soft commodities used to make alternative energy like corn, palm oil and sugar. Latest figures indicate that in the US around 20% of maize production is currently put aside for bio-fuel manufacturers.

George Lee, portfolio manager on the Eclectica Agriculture fund, which launched on the London stock exchange last June, believes the agricultural sector is at the beginning of a 10-year bull market.

Lee argues that agriculture, like oil and hard commodities, moves in a 25-year super cycle. Agriculture has been in a decline since the mid 1970s, with the price of commodities like wheat and corn falling each year on an inflation adjusted basis. Recently, however, the prices of agricultural commodities have risen sharply. Lees says this could signal the start of a five to 10 year “investment frenzy” in the sector and that commodity prices could rise several times further from here.

He likens the current situation to the North Sea oil boom of the late 1970s and early1980s, which saw Scottish city Aberdeen ride high on the back of the soaring oil price.

“The same thing will happen in agriculture and we will see booms in countries like Brazil, Argentina, Russia and the Ukraine,” Lee says.

Influential forecasters like the OECD (Organisation for Economic Co-operation and Development) and the UN’s Food and Agriculture Organisation appear to agree.

In a recent report, they noted that although the rally in agricultural commodities was due in part to temporary factors like drought – Australia, a major wheat producer, has suffered drought for the last two years - structural changes such as increased demand for bio-fuel plus a fall in food surpluses due to past policy reforms could keep prices above historic levels for the next decade.

DWS’s Oberbannscheidt says: “The trend is a long-lasting one. Of course, markets have seen some sort of a rally already, mostly due to extreme weather conditions such as droughts, flooding and hailstorms, all of them resulting in crop failures and consequently short-term price increases. But the general trend is upwards.”

Climate change is having a big impact on the agriculture sector. One area that agricultural investors are particularly interested in is the world’s dwindling water supplies.

Jim Wood-Smith, head of research at stockbroker Williams de Broe, says water shortages are having a big impact on both agriculture and development.

“There is not enough drinking water to support the urbanisation of China or enough water in the right parts of the world to grow enough food,” he says.

Lee agrees that water poses the biggest threat to production. He looks to exploit this difficult area to invest in by for example buying companies that make efficient irrigation systems like US stock Lindsay.
“The main constraint on supply is not land but water,” he says.

But, not everyone is confident the upswing in agriculture is a long-term trend. Cynics argue that arable land is not in short supply and that recent price rises have been prompted by erratic weather, which cannot be guaranteed going forwards.

Although Wood-Smith thinks the water theme is interesting – he and his team are looking to launch a water fund shortly - he is concerned that the broader agricultural trend could be a short term fad. However, he admits he could be proved wrong.

“I have a nagging suspicion agriculture funds are now where commercial property funds were 18 to 24 months ago"

1 March 2008