Investing

The dynamics around food are pretty straightforward: there are more and more people to feed, with less and less land available to grow food on. It’s a classic supply and demand imbalance. It is also an investment opportunity – but how to approach it?

Until recently, it has been difficult for Australians to play the food industry, whether through soft commodities such as wheat and sugar, or through meat or fish. Oddly, for a country that is a major producer of agricultural products and livestock, there is a paucity of food and agriculture stocks listed on the Australian Securities Exchange.

But first, the big picture: the long-term case for food investment is strong. The world’s population is today about 7 billion, having only passed the 3 billion mark in 1960. Moreover, many of those people are living longer.

More demanding tastes

Besides an ageing population, eating patterns are also changing – particularly in emerging markets – as are attitudes to self-sufficiency.

“There are not only more people but those people are getting wealthier, and there is a strong correlation between wealth and diet,” says an executive director of Macquarie Group’s agriculture division, Tim Hornibrook.

“As you get wealthier, you tend to consume more proteins, and that once again puts pressure on demand and supply.”

As always, China is a huge driver. The growing use of fish, meat and dairy products in the Chinese diet has had ripple effects all the way to Australian and South American pastoral businesses. China’s decision to be self-sufficient in wheat and corn has had knock-on effects, too.

Land ... they’re not making any more

Then there is the issue of the scarcity of land.

“The investment case is a fairly simple one: we’ve got more people in the world eating more food, but less land to produce that food on,” Hornibrook says.

“That is causing a structural imbalance between demand and supply, causing a shift in agriculture prices above their long-term average.

“Over the last 40 years, arable land available for agricultural production has basically halved.”

As a result, precious resources will increasingly come under pressure.

“The increased size and age of the population means we see additional demands for food, water, resources and everything else,” says the chief executive officer for the Middle East at European fund manager Robeco, Douglas Hansen-Luke. His firm is known for work on the so-called megatrends shaping the world in coming decades.

“It leads to scarcity,” he says.

Shortage = opportunity

Food shortages could ultimately result in civil unrest and prompt economic migration. More pragmatically, that shortage suggests an investment case.

Soft commodities are a way of diversifying a portfolio, and since food is usually a core part of inflation, they work as a hedge.

Shorter term, it’s harder to determine the direction of any commodity in these uncertain times. Price movements can depend on imbalances in short-term supply and demand, and on weather.

The head of global commodities research at Credit Suisse, Ric Deverell, a former Reserve Bank of Australia economist, points out that corn is “fundamentally very tight, while wheat is nowhere near as tight”.

But he says “the central tendency in most of these markets will be for markets to move sideways for the next year”.

That said, corn is “the tightest market we have seen since the 1970s”, he says. “When it’s that tight, it only takes small changes in supply and demand to have very large movements in prices.”

And on top of that, he says the incremental global rate of corn consumption has doubled since 2003, partly because of its use in making ethanol fuel – 40 per cent of the US corn crop will be used in this way in 2012.

New instruments

So how to play it? Late in 2011, it became much easier to invest in soft commodities when a series of new exchange-traded funds (ETFs) was launched by BetaShares.

Exchange-traded funds behave like shares, in that you buy and sell them on a stock exchange, but they give you exposure to an index or an asset class, and tend to be low cost.

BetaShares has two food-related ETFs: an agriculture product and a commodities basket. The agriculture one tracks the performance of the S&P GSCI Agriculture Enhanced Select Index, which is made up of the big four commodities in agriculture – corn, wheat, soya beans and sugar.

The commodities basket is broader, covering 24 separate commodities including energy and metals, but it also includes a wider range of food-related commodities – eight agricultural (the big four plus cotton, coffee, Kansas wheat and cocoa) and three livestock (live cattle, feeder cattle and lean pigs).

All of these commodities are established markets, with a long trading history in the United States.

Drew Corbett at BetaShares feels the new products fill a gap.

“We’re trying to allow people access to different asset classes,” he says.

“People have been able to invest in soft commodities overseas for 10 years now through access products [such as ETFs], and now people here can access some assets they previously didn’t have a low-cost solution to invest in.” He notes that among overseas private investors, asset classes such as these can account for up to 10 per cent to 15 per cent of an overall portfolio, and argues retail investors in Australia should be allowed the same opportunity to diversify.

One point to note about ETFs like this is that, unlike a share index ETF, these can’t be backed by the underlying investments.

You would need to have a vast warehouse full of corn and wheat that couldn’t be used (or, in the case of the oil ETF, a tanker) to back the fund. Instead, BetaShares backs its ETFs with cash in order to reduce counterparty risk.

Time to look at CFDs

Providers of contracts for difference (CFDs) have watched the emergence of these ETFs with some interest, since they have provided the opportunity for investors to trade soft commodities for years without receiving a huge amount of take-up.

At IG Markets, for example, you can trade cocoa (London or US), coffee (robusta or arabica), orange juice, two kinds of sugar contract, cotton, lumber, oats, corn, soya beans (including meal and oil), wheat (London, Chicago or milling), rough rice, live and feeder cattle, lean hogs or rapeseed. But, by and large, people don’t.

“It’s not one of our most traded products,” says Chris Weston at IG Markets. “But more specialised investors will use it – we get a lot of farmers who trade these products, for example.”

He says that anyone looking at ETFs should take a look at CFDs first, on the grounds that they are more cost effective and that prices track the spot and futures markets more accurately. CFDs allow significant leverage, which magnifies both gains and losses.

Don’t forget currencies

Anyone investing in commodities needs to think about currency too. Commodities are generally quoted in US dollars, and as anyone who’s invested in gold in recent years will know, that can make all the difference if you have made your investment in Australian dollars.

The BetaShares products hedge for the currency. People using CFDs can add a currency hedge in a separate contract if they wish.