Why you should look at soft commodities

As rising food prices make headlines, Parmenion’s Simon Brett explains why soft commodities are providing opportunities for investors.

Soft commodities generally refers to commodities that are grown, rather than mined. They play a key role in the futures market as they are often used to lock in the future price of crops and offer significant potential gains to speculative investors.

Not so long ago it was rare to see anything written about them, it tended to be the rising price of gold, copper and silver. But these are now being matched by stories appearing in the media of rising food prices or “soft commodities”. The effect on the family budget of a rising weekly food bill is now an item on the main national news.

Affordable food is important. In the past, rapid rises in the cost of food have led to revolutions, war and immigration. The unrest in North Africa during the past six months can be partly explained by higher food prices. Food is a necessity; rising prices in staple goods are therefore unavoidable.

Rising demand

The headlines currently being written are a product of a long-term investment story; a secular rise in the demand for foodstuffs being driven by long-term population growth, changing consumption habits and the increased demand for biofuels. It is anticipated the world’s population will rise to nine billion by 2050 from the current level of approximately six and a half billion. Most of that rise will be in developing countries, with 60% of the world’s population being located in Asia by 2050.

However, this population growth of nearly 30% would result in a rise of 70% in food production, as increasing prosperity in developing nations leads to a change in dietary habits – people will eat more and they will want more variety in what they eat.

As Japan witnessed after World War Two, increased wealth leads to a switch towards a Western diet with more protein, such as chicken and pork, and less staples like rice. This change has important implications for the demand for cereals. For example, it requires 2kg of grain to produce 1kg of chicken and 7kg of grain to produce 1kg of beef. This will have a significant impact on the use of cereals as feed for livestock as protein demand increases.

Oil prices have also risen dramatically over the past year. Oil is a key ingredient in fertiliser, which leads to higher corn and wheat costs. More than 30 nations now have targets to increase the use of biofuels (liquid fuels derived from sugar and corn) to lessen their dependence on imported oil. Farmers in the US have been encouraged to grow maize, not for food but as a feedstock for biofuels, which reduces the land available for crops. Although perhaps not as important as a driver of soft commodity prices as food and diet, it is nevertheless another component of demand for “softs”.