Agriculture’s peformance provides food for thought

Investors looking for defensive assets, but concerned about the inflated price of gold and gilts, are now landing on soft commodities.

ETF Securities reports that its exchange traded agricultural commodities have been attracting strong investor interest, second only to gold.

Nicholas Brooks, an analyst at ETFS, argues that this is because agriculture, like gold, is largely uncorrelated to equity markets.

“I think in this economic environment, investors have not been sure where to put their funds,” he says. “Agriculture stands out as a sector that is less cyclical than many others.”

Even so, Barclays Stockbrokers reports that investor interest in agriculture has been limited so far this year, with volumes 75 per cent lower than the same period in 2008. In part, this could be because, like most other asset classes, agricultural commodities suffered steep price falls last year. After a strong bull market in the first six months in soft commodities, agricultural prices went the way of the rest of the markets from early July, with losses of around a third. ETFS Sugar, for example, was down 31 per cent in 2008.

But, in many cases, soft commodities are rebounding better. Sugar is now up nearly 6 per cent this year, compared with double-digit falls in equity markets.

Chady Achkar, a senior portfolio manager on the Ceres Agriculture fund, argues that the falls last year were not driven by fundamentals.

“One thing that a lot of traders were asking themselves at the end of last year was: how will 2009 look like on fundamentals? Will corn prices be driven by supply and demand and no longer by the economic crisis? The answer is yes, fundamentals are back into play.”

And the fundamentals appear strong.

Agriculture investment is based on the idea that demand for food is set to rise, particularly from emerging markets, where consumers are turning away from vegetarian diets and towards meat, which uses up more farmland.

Baring Asset Management launched an open-ended Global Agriculture fund in January, saying that even though prices had fallen 50 per cent in the previous two months, global demand for feed, food and fuel was set to increase dramatically.

“We do not anticipate any significant decline in demand for soft commodities as a result of a recessionary climate,” says Jonathan Blake, the fund manager.

But different soft commodities have different stories, according to Achkar. Sugar has risen about 6 per cent this year, as the market has realised that after three years of surplus, there will now be a sugar deficit. Cocoa, by contrast, is down 15 per cent, in spite of having strong fundamentals, he believes.

However, Achkar warns that agriculture is very volatile at present. Partly, this is because it is now the planting season for a number of crops, and the weather, hardly a predictable factor, can have a big impact.

Consequently, traders, still nervous on the economic outlook, might allow any bad economic news to affect soft commodity prices.

Agricultural produce can also move in line with other commodities. Last year, for example, demand for grain went up because the oil price was so high, because people were buying more corn to use as alternative fuel.

While these prices were rising in the first half of 2008, a number of funds were launched, most by specialist fund houses. But agriculture funds have quite distinct ways of investing.

For example, the Ceres Agriculture fund does not own any equities. It aims to profit from volatility by trading futures contracts on soft commodities, making it a good bet for an investor unwilling to buy for the long term.

Some long-only funds, such as the CF Eclectica Agriculture fund, invest in companies that are involved in farming activities, such as tractor makers and fertiliser suppliers. Eclectica’s fund has lost about 2 per cent this year, but is up 6 per cent over the past three months.

But Mick Gilligan at Killik & Co warns that these funds can be a more volatile way of accessing soft commodities because they are exposed to equity movements in the agricultural companies as well as the underlying commodity prices.

The most direct way to gain exposure to agriculture is through an exchange traded fund. ETFS has a number of funds that track the prices of individual underlying commodities, and of commodities indices in general – removing equity exposure.

“I think it makes sense to get exposure now,” says Gilligan. “The demand side is much firmer than the market is implying. People won’t drive as much, but everyone’s got to eat, so I think demand is much better underpinned than a lot of other commodities.”

But investors are urged to take a long view on soft commodities, as prices could fall further this year.