PORTFOLIO POINT: Food commodities are on the investment menu, and there are plenty of options on the plate for retail investors including pure plays and listed stocks.
Soft commodities – wheat, corn, sugar, soybeans, food stuffs essentially – have become an increasingly popular asset class for retail investors in recent times, including self-managed super funds.
Certainly I am very much in favour of keeping ‘softs’ on the investment radar for active investors – they are an essential part of any diversified portfolio for me, although it’s not a fire and forget investment decision. But for active investors they are a must, as the returns are just too attractive. A large number of high-profile investors have strong buys on soft commodities. That’s because there are enormous structural changes going on around the globe, including population growth, rising per capita food consumption, and climate change, and these cannot be ignored as I discussed in my October 12 note, Swallow the food story. Just look at what the real money is doing. Investors are literally falling over themselves to buy farmland, and there is a reason for that.
For those already invested or others pondering the decision, softs have had a hard time of late – soybeans are off 20% over the last few months, and sugar is not too far behind that, although I don’t see the cost of a soy lattes falling mind you. A casual glance would suggest there seems to be some broader malaise hitting the market – or a positive production shock. Now for commodities like sugar and soybeans, I can understand the moves and they were expected by the market by and large. Sugar, for instance, is actually being hit with record production levels out of Brazil and rapidly rising stocks. Price falls make sense and there is probably more to come. Yet, in the grain space, I’m not really seeing where the renewed production optimism is coming from.
Prices for grains like wheat and corn are still elevated, sure, as you can see in charts 1 and 2. But the recent decline of about 11% and 12% does seem a bit overdone for me. Maybe the prices reflect seasonal trading patterns or technical considerations – I’m not sure. Perhaps some of the price fall at least follows a recent US Department of Agriculture report suggesting that US wheat production would be strong in 2012-13 – up about 14% driven by both higher yield and area planted.
If so, the decline appears premature, as the Department also noted in another report that global wheat production for the 2012-13 year was set to fall almost 45 million tonnes. According to the report: “This is the largest year-to-year drop in world wheat production since 1991-92, and the largest drop for foreign production on record.” For interest, the decline is largely due to production falls in Australia, Russia, Ukraine and Kazakhstan. In Australia alone, production is forecast to fall about 24% (according to government forecasts). I’m not seeing anything too bearish (prices) in that. The net effect of these production cuts is a wheat shortfall for 2012-13 (see chart 2), and a sizeable one at that.
Now consider also that all the risks seem tilted to the downside. In the US recent updates suggest conditions for the winter crop (which accounts for about 75% of all US wheat production) are deteriorating, with only 39% of the crop rated good-excellent. This is the lowest proportion since 1985, and soil moisture continues to dry. This is a problem, as reports suggest that two-thirds of the crop has been planted in drought-affected areas anyway. The Spring crop was less affected by drought as it was either harvested before the drought kicked in or was located outside affected areas.
That’s not the case this time around, and there doesn’t seem to be any let-up in the drought. Take a look at chart 3.
As at November 20, the US Department of Agriculture actually suggested that drought conditions had, if anything, deteriorated and the outlook, shown in chart 4, isn’t great either – until about March 2013.
For Russia, another major wheat producer, there is mixed news on the harvest. 2012-13 production was estimated at 42 million tonnes, down 25% from last year. More recently analysts suggest this could be 34% lower. As yet, it’s too early to determine what sowing conditions are like for the 2013 harvest until this harvest is complete in a few weeks. But again the news isn’t positive at the moment and forecasts have been revised down substantially from October.
So, taking stock for a minute, if recent price peaks (highest since 2008) occurred at a time when production was meeting consumption and stocks were rising, then what’s going to happen in 2012-13 when consumption is set to exceed production and the risks are to the downside? It seems pretty clear-cut to me where prices should be going.
Looking at coarse grains, the outlook isn’t any better – maybe just a little more uncertain given the next harvest is some time away. For now, and as mentioned, the drought doesn’t really seem to be easing any, and at this stage it is expected to persist through to March. This doesn’t leave a lot of time for the drought to break before the main planting period from April to June. Some farmers may have made a decision prior to that about sowing an alternative crop. And as for China, the world’s second-largest producer? It is a net importer despite strong production – ditto Mexico. That leaves Brazil, and it simply cannot make up the shortfall. Indeed production is expected to fall in Brazil anyway.
Russia could be the key short-term risk to this view, although I’m not sure positive news here could really change the underlying story. Reports suggest the outlook is mixed and could go either way at this stage. We’ll know in a couple of weeks, but this is very much worth watching closely.
How to play it? Well Betashares offers an agricultural ETF that does include wheat and corn, but the downside is that it also contains sugar and soybeans. So I don’t think this is the best way to play a grain-only story.
Then ETF Securities has a product (ASX code: ETPWHT). Otherwise , another wheat pure play is Teucrium Wheat Fund (WEAT), which trades on the NYSE. This is probably the better option given greater liquidity. It’s easy now for Australian retail investors to buy into the NYSE, and many brokers offer this service.
Obviously, with a recent unsuccessful takeover attempt on the company, the local market has woken up to the attractions of Graincorp – I mentioned this stock as an attractive option in the October 12 note, Swallow the food story.
There are some listed stock options but these are a more round-about way of playing the grain story and may be less desirable as a pure play on food. But, if you’re interested, Nufarm or Incitec Pivot would be worth a look as well. The idea being that high prices/lower yields or production add an incentive to protect the crop you’ve got. That said I always prefer a pure play.