Look to agricultural commodities for nourishing investments

Prices will continue to soar as populations in the “BRIC” countries of Brazil, Russia, India and China become wealthier, says Jim Rogers, chairman of Singapore-based Rogers Holdingsand author of Hot Commodities: How Anyone Can Invest Profitably in the World’s Best Market: “As prosperity in these regions grows, people will [be able to] eat two or three meals a day instead of one.”

And with this ability to afford more food, the demand for meats, vegetables and grains will rise.

Not only will people in these regions eat more, their dietary preferences are also shifting, says Prakash Hariharan, portfolio co-manager of Toronto-based Front Street Capital‘s Diversified Income Fund and Ceres Global Ag Corp., a Front Street subsidiary that specializes in public and private agriculture-related investments.

“The growing middle class in India and China are consuming more protein in their diets,” says Hariharan, who explains this has provided a boost for demand and, subsequently, the prices of beans, meats and grains.

As people in these regions eat more, they are also cooking more. As a result, says Hariharan, “There has been a huge shortage of cooking oil in India” — causing the price of soybean oil, for example, to shoot upward. Soybean oil had risen to $838.37 a tonne as of Jan. 31 compared with $754.73 a year earlier.

This increases demand for soybeans, which are also used to make soy milk and tofu, says Matthew McCall, president of Ridgewood, N.J.-based Penn Financial Group LLC, an investment advisory firm that specializes in researching exchange-traded funds: “When it comes down to it, soy is used in many different food sources throughout the world.”

Despite the increased demand for soybeans, there isn’t a related increase in global supply, McCall points out: “Supply has come off-line during the recession since a lot of farmers couldn’t get the financing to keep up their crops.”

Soybean futures for March delivery closed at $9.52 per bushel ($349.80 per tonne) on Feb. 22 on the Chicago Mercantile Exchange. McCall expects the price of a soybean futures contract to rise to $11 per bushel by the end of 2010 and as high as $13 per bushel by 2011.

Sugar is another agricultural commodity that managers are bullish on. Thanks to India’s and Brazil’s growing middle classes, more people are demanding refined sugar instead of cheaper, alternative sweeteners. Meanwhile, there is also a limited supply of sugar in both these regions due to bad weather. India, for example, suffered a massive monsoon last year that wiped out crops. Considering that India is the world’s second-largest producer of sugar, this had a substantial impact on the supply of the commodity.

“Farmers in India didn’t plant enough sugar cane crops [to compensate], and now they have to rely on imports,” says Hariharan, which has pushed up prices even further.

Although a sugar futures contract for March trades at about 27¢/lb. on the CME, McCall expects the futures to reach as high as 32¢/lb. by the end of 2010 and 35¢/lb. by 2011.

As for livestock, the spotlight is on pork, says McCall, with China being the world’s largest growing consumer of hog meat. China is expected to consume roughly half of the forecasted global supply of pork, or 50.3 million tonnes, by October, according to the U.S. Department of Agriculture. In 2009, China consumed 48.3 million tonnes of pork, up from 45.8 million tonnes in 2005. In comparison, the U.S. makes up roughly 8.5% of the world’s demand, having consumed 8.9 million tonnes in 2009.

Although the impact of swine flu and a subsequent Chinese ban on U.S. pork imports had caused global pork prices to decline heavily in 2009, a turnaround is expected, says a recent report from BMO Capital Markets Corp. : “The modest recovery in hog prices likely reflects the expectation of higher export volumes, especially to China, following the announcement it will remove its ban.”

@page_break@Pork prices had recovered to 67.50¢/lb. as of Jan. 31 from 55.99¢/lb. a year earlier.

Despite the appetizing prospects for these agricultural commodities, it’s best to stay away from the futures market if you don’t have specialized knowledge of a commodity’s track record, advises Rogers: “You can go into commodities futures [only] if you know what you are doing. For most people, an exchange-traded fund with a wide exposure to agriculture is the best way of accessing this market.”

One such option is Power-Shares DB Agricultural ETF, issued by New York-based DB Commodity Services LLC, a subsidiary of Germany-based Deutsche Bank AG; it trades on the New York Stock Exchange. Although McCall says this agriculture-related ETF is the most liquid among its peers by far, it exposes unitholders to only four commodities: corn, soybeans, wheat and sugar.

For clients looking for more diversification, McCall suggests looking at exchange-traded notes, which are debt instruments that promise to pay a return on an index. Like most debt instruments, they are issued by a bank; however, unlike ETFs, they carry credit risk.

McCall says one ETN worth looking at is iPath Dow Jones AIG-Agriculture ETN, issued by London-based Barclays Bank PLC and trading on the NYSE. It is based on futures contracts that trade on U.S. exchanges and is a little more diversified, offering exposure to about seven commodities.

For those looking to invest in meat products, McCall suggests Barclays iPath Dow Jones Livestock ETN, which invests primarily in cattle and pork.

Another way to play the agricultural commodities market — albeit indirectly — is to invest in a company that manufactures crop fertilizer or in an animal-feed producer.

“Companies that produce the nutrients that enhance crop yield will give you exposure to a wide number of areas,” says Hariharan, who offers Potash Corp. of Saskat-chewan Inc. as an example.

Although all these plays look attractive, the evolution of genetically modified seeds could throw the supply/demand balance out of whack, warns Hariharan: “If you look at five years back in the U.S. Midwest, for example, you got corn yields of 100 bushels per acre; now, with genetically modified seeds, you can get corn yields of 170 bushels per acre.”

Scientists are improving the technology in genetically modified seeds each year, and that can greatly impact supplies on the upside, which can lower prices.

A higher US$ can also have a great impact on global demand for agricultural commodities, McCall says, as demand for food commodities shrinks because U.S. exports are pricier. That said, the damage from a rising US$ can hamper prices only so much, he adds: “It’s food and, at the end of the day, people are always going to need to eat.” IE