July 29, 2012
With food prices set to rise, it's time to sow the seeds of soft commodities, writes David Potts.
Food prices are about to take off again but you don't have to starve to get the better of them.
The early wheat harvests of Russia and Ukraine are estimated to be down 40 per cent, but the drought in the midwest of the US is the clincher because it produces 38 per cent of the world's corn crop.
At the bottom of the feed chain, corn lifts the prices of everything above it.
The price of internationally traded corn has jumped 60 per cent to a record since June. The Australian wheat price is already up 30 per cent.
Both grains are essential feedstock for cattle, pigs and poultry - their main purpose, in fact - and normally one is a buffer against the other.
''The US drought is a global issue. A US corn shortage means a global grain shortage,'' the agricultural commodity strategist at the Commonwealth Bank, Luke Mathews, says.
''Feed grain users around the world will be less likely to differentiate between grain types this year. Rather, they will be more concerned with securing whatever supplies are available,'' he says.
Not that you can do much about it, apart from tightening the belt or stocking up, but even then there's a limit to how much the freezer holds.
THE BIGGER PICTURE
There is a way to make hay out of food prices, so to speak, at least if this proves to be more than weather related, but rather the beginning - if not continuing - of a longer-term trend. After all, when it's not the weather it's hedge funds and other smarty-pants speculators playing with the US dollar, from which commodity prices are set.
But you don't have to fear global warming - though really you should - or be pessimistic about the US dollar to be convinced that food prices can only rise faster than ordinary inflation.
There are other reasons agflation is here to stay, not least being the world's growing population. On current projections there will be 1 billion more mouths to feed in 20 years, which will require a 45 per cent lift in food production.
But get this: the amount of land dedicated to growing soft commodities, as economists call food, has been stagnant for years and is starting to fall.
The land grab is due to the industrialisation of developing countries, most notably China, and the diversion of corn into biofuels, especially in the US.
A new interloper is coal-seam gas mining, which not only takes up arable land but, by polluting the water supply, can affect paddocks downsteam.
Fortunately, technology, fertilisers and insecticides have increased farming productivity around the world, but at some point, if not already, diminishing returns must set in.
There are more mouths to feed and more demanding better, higher-protein food. The growing middle classes in China, India and south-east Asia are eating more meat and dairy products.
My beef is there's only one, uh, beef stock on the ASX, the live cattle exporter Australian Agricultural Company (AAC).
Even then, as for food manufacturers such as Goodman Fielder, agflation is a mixed blessing for AAC, because it has to pay higher feed prices. Worse, it's suffering the fallout from the drought that forced it to borrow more.
But it might have been marked down too far, because its shares are worth less than half the properties it owns and few brokers bother to follow it.
So how about wheat, then? There's GrainCorp (GNC), but it handles grain and bulk commodities, so, strictly speaking, isn't a play on rising prices.
It's all about volumes and so must be one of the most weather-wary
stocks of all. Still, high prices encourage more planting, so there's an indirect benefit.
Trouble is, it's one of the few stocks that's had a good run in the past year and is liked by analysts, so the market has probably got in ahead of you. It's also the only agri-stock that pays a decent dividend.
There's always the out-of-favour AACL Holdings (AAY), which runs an investment scheme or what it calls a ''grain co-production project''.
You can either join the scheme directly (see aacl.com.au) or invest in the stock that runs it. But the shares have been hit hard by the Tax Office's clampdown on managed investment schemes and are trading at only 2¢ or 3¢ each.
Toowoomba-based PrimeAg (PAG), which invests in rural properties, often with the bonus of water entitlements, has planted more wheat this year to take advantage of the higher prices.
It has no debt and it trades about 20¢ below the value of its properties, though with the planned buyback of 10 per cent of its stock, that might be short-lived.
But here's a warning for investors in agri-stocks. The price of cotton, one of its crops, has dropped because of more global supply.
''We saw crazy prices for two years, so there was a huge increase in production globally. Now we're paying for it,'' the managing director of PrimeAg, Peter Corish, says.
RBS Morgans rates the stock a hold. ''Value is there but its structure is complicated by the agri fund,'' an RBS Morgans analyst, Belinda Moore, says.
This is a separate unlisted fund it manages, boasting the Future Fund as a key investor and has first dibs for two years on large property acquisitions.
Then there's Ridley Corporation (RIC), which supplies feedstock, but it's mainly a salt miner.
Mind you, it doesn't have to eat or grow for you to make the most of rising soft commodity prices. It all comes down to dirt, and the quality of it, in the end.
''Higher grain prices are more incentive for farmers to add chemicals and fertiliser to improve yields,'' Moore says.
Ah, now that opens up possibilities. Nufarm (NUF), producer of Roundup weed killer, has been through a torrid time, not least with its own shareholders.
But chemicals controlling pests and disease are essential to increasing yield and the company has reined in its debt and improved earnings.
Fertiliser is supplied by Incitec Pivot Limited (IPL), but ''it's becoming more an explosives company''.
''Fertiliser is becoming a lesser proportion of its business, though it's still the market-leader along the east coast,'' Moore says.
It should be a good year for cotton after rain replenished dams, but Tandou (TAN) is especially attractive for its large water entitlements in the Murray-Darling Basin.
It's another agri-stock that trades below its asset value, is debt free and, judging by the low price-earnings ratio it trades on is, uh, dirt cheap.
But it does seem to eat a lot of cash.
There are two dairy stocks - Warrnambool Cheese & Butter (WCB) and Bega Cheese (BGA) - but milk products are one of the few commodities where the price is dropping.
Still, with the growing market for more protein in Asia, that's bound to be temporary.
OTHER AGRI PLAYS
A great virtue of soft commodities is that they aren't tied to the sharemarket, which is handy for diversifying. Don't let that fool you. They might run their own race, but they're even more erratic.
Or you could let somebody else worry about the volatility. Colonial First State (which isn't hedged against currency fluctuations) and DWS (through Ironbark and is hedged) sell global soft commodity share funds.
But if you don't mind the thrills and spills and potential riches then you could have a go yourself through BetaShares' agricultural exchange-traded fund (QAG).
This tracks corn, soybeans, sugar and wheat. It's hedged, so you're protected against currency changes.
Even more direct is Rural Funds Management's StockBank, which buys sheep and cattle, fattens them up and sells them. It boasts a six-month return of 8.75 per cent, but the minimum investment is $50,000.