Time to revive appetite for grains

Agricultural commodities are well below heady highs reached this summer -- and poised to rally again

By Darcy Keith

Globe Investor Magazine online, Dec. 11, 2008

No matter how deep or protracted the economic downturn becomes, the world's population will still need food on the dinner table each night. So, for some, it's been a bit of a curiosity that grain prices have been halved in recent months as equities tanked and economies contracted.

Tight bank credit and a splurge of investor redemptions forced many hedge funds and other speculators to quickly liquidate their futures positions in the sector. But the supply and demand fundamentals that drive these markets remain largely intact.

Unlike other commodities, such as copper and oil, the agriculture sector feels little impact from gross domestic product fluctuations, because consumption depends more on factors such as population growth and biofuel development.

Some analysts suggest grains and oilseed prices may have fallen victim to a herd mentality of selling commodities across the board. And many believe the commodities are poised for a rebound.

THE CASE FOR A RALLY

Investment guru Jim Rogers left little doubt that he is firmly in the bull camp during a recent investor presentation in the Netherlands: "In a little while, farmers will drive Maseratis and all stockbrokers will be driving a cab," he quipped.

Analysts point to the fact that the amount of wheat, corn and soybeans left unconsumed at the end of the crop year is at historically low levels at a time when the world's population is growing.

While the world wheat crop was the largest ever this year, surplus stocks are the fourth-lowest in 50 years, notes Don Bousquet, a grains market analyst and the host of the long-running Farm Market News broadcast heard on rural radio stations across Western Canada. Farmers next year are expected to cut back on wheat acres planted, given the recent price decline and the high cost of fertilizer, he said.

Meanwhile, the U.S. corn crop is expected to be the second-largest on record this year, but surplus stocks should be among the lowest, according to the U.S. Department of Agriculture. It's a similar case with soybeans.

Chalk it up to strong demand, which is also likely to spur further growth. A surge in the middle-class ranks in the developing world, especially in India and China, has meant more dietary meat consumption, and in turn, a need for more animal feed. At the same time, cultivable land is being gobbled up by urban sprawl.

"Expanding demand out of Asia will be a driver in the market well into this century," said Mr. Bousquet. Chinese per capita meat consumption is still less than half of North America's, but it is catching up quickly, he noted.

Another source of strong demand - the push for renewable fuels. In mid-November, the U.S. Environmental Protection Agency raised the 2009 renewable fuel standard to 10.21 per cent to ensure at least 11.1 billion gallons of renewable fuels are blended into transportation gasoline. That calls for about 500 million gallons of biodiesel and renewable diesel.

Nearly 40 per cent of the U.S. corn crop this year will go towards making ethanol for gasoline, and that percentage will increase in coming years, according to Patricia Mohr, vice-president of Scotia Economics in Toronto.

"I would say corn prices will probably rally at some point in the next few months, and the new Obama administration is going to be even keener on renewable fuels than the Bush administration," said Ms. Mohr. She expects similar rises in many other agriculture prices.

"Typically, grain prices tend to move higher over the winter months," she noted.

Donald Coxe, global portfolio strategist for BMO Capital Markets, says investment managers tend to buy commodities as a class. As a result, when oil prices tumbled, grains and oilseeds were caught in the collapse.

"On a supply-demand basis, grains are now greatly under-priced," Mr. Coxe wrote in a recent report.

JPMorgan Chase & Co. said it believes agriculture is the best bet in commodity investing right now.

"In agriculture, not only is there less sensitivity of demand to economic pressures, but there may be other constraints that limit yield growth," the bank said in a recent note. For instance, adverse weather conditions could suddenly erupt in a key-growing region.

JPMorgan is particularly bullish on corn and soybeans. It expects corn prices to average $4.20 (U.S.) a bushel in the fourth quarter, and rise to an average of almost $5 next year. It sees soybeans rising from $9.40 a bushel this quarter to just over $10.70 in 2009.

European bank UniCredit Group forecasts that wheat may reach $10 a bushel in 2009 as global production falls 7 per cent.

A MATTER OF PERSPECTIVE

While many tend to think agricultural commodities are ripe for a rebound, it's also important to put recent performance in some perspective.

Commodities such as corn, wheat and soybeans all reached multiyear or record highs this summer prior to the meltdown in capital markets. The rally in wheat was particularly eye-popping, with prices reaching $12 a bushel.

While prices may appear to have fallen off a cliff this fall, they are still well above long-term trading ranges, noted Mr. Bousquet.

The 30-year average price for wheat is $3.50 a bushel, well below its current price of around $5. Corn rallied to near $7.50 a bushel this summer and has since fallen back to near $3, but that's still above the 30-year average of $2.00.

Prices for soybeans have been halved since peaking at near $16 a bushel in July, but they are still trading well above the 30-year average of $5.50. Canola, after rallying to $700 a tonne this summer, is trading near $400, $100 more than its 30-year average.

"We went through a phenomenal spring rally, reaching lifetime highs where we didn't even realize we could have gotten to," said Tony Tryhuk, branch manager of the commodity trading division of RBC Dominion Securities in Winnipeg. "I think that our prices are still historically speaking quite robust."

For Mr. Tryhuk, it's more difficult to predict where prices head from here. Returns to farmers at current prices don't appear all that favourable because fertilizer and other input costs have also been high. Last year, farm operating expenses rose 8 per cent as seed and fertilizer prices soared, according to Statistics Canada. But advances in technology are allowing farmers to achieve record-breaking yields, said Mr. Tryhuk.

Some market observers also suggest demand for corn in the ethanol industry may wane in the future as more cost-effective sources of energy are found.

WAYS TO INVEST

Investing directly in commodity futures is a risky game that may require considerable initial investment. Buying shares in corporations involved in agriculture, such as fertilizer, farm equipment and genetically modified seed stocks, would be a simpler way to go.

Mr. Bousquet suggests buying stock in grain companies.

"Look for a diversified company that works in both grains and oilseeds," he said, such as Archer Daniels Midland Company and Bunge Ltd.

To diversify further, you could invest in an exchange-traded fund. The one-year-old Claymore Global Agricultural ETF (COW-TSX), for instance, holds shares in a broad array of companies involved in fertilizers, chemicals, construction, farm machinery, and packaged foods and meats. It's trading at about half of its 52-week high.

There's also a selection of U.S.-traded ETFs. Listed on the American Stock Exchange is the Market Vectors Agribusiness ETF (MOO-A), which tracks an agribusiness index in Germany. There are also ETFs that give you a direct play in the futures markets. The PowerShares DB Agriculture Fund (DBA-A), for instance, buys futures contracts in soybeans, corn, sugar and wheat.

Toronto-based BetaPro Management Inc. also this year launched bull and bear versions of agriculture-focused ETFs (HAD-TSX, HAU-TSX). These leveraged investment products offer double the daily return when either going long or short the market. You'll need a strong stomach to ride out the volatility.

Special to the Globe and Mail