Asset Allocator’s Soapbox: Dr. Ana Armstrong

Dr. Ana Armstrong, chairman of Distinction Asset Management, takes a closer look at the agricultural sector.

We have rebuilt positions in agricultural commodities in our Multi-Asset Real Return funds following the broad-based commodity sell-off. Worsening crop conditions and adverse weather are constraining supply while shrinking US and global stockpiles have reduced the inventory buffer.

The long-term demand case is driven by population and income growth, with increased purchasing power from emerging markets consumers, plus supply constraints.

We had been nervous about a positive supply response due to higher prices and still expect one of the largest plantings of corn and soybeans in history this year. However, we expect that demand for corn, soybeans, sugar will continue to be driven by imports from emerging markets. For example corn inventories have fallen by 35% from December to March, and we expect Chinese imports of corn will rise from 1.5 million metric tons (MT) to well over 10 million MT in the next three years.

Last year’s drought destroyed one-third of Russia’s wheat harvest. Recent bad weather has also reduced the expected yield in both Europe and North America. According to the United Nations, food costs have advanced in nine of the past ten months and, given the growing demand and falling inventory levels, demand will need to be met through increased yield and near record plantings. Weather is a wild card in this situation and unless everything is near perfect weather-wise we expect inventories to continue to be drawn down and this will support further price rises.

Over the longer term, population growth will continue to provide significant support for soft commodity prices. The world’s population currently stands at just under seven billion and will rise to 9.5 billion by 2050, according to the UN. Deutsche Bank believes that this rise in population alone will lead to an additional one billion tons of soft grain consumption.

Meanwhile GDP per capita is rising fast in the developing world and this new discretionary wealth is initially spent on introducing higher protein foodstuffs like meat into the diet. Meat production is grain (and water) intensive. It takes 8kg of grain to produce 1kg of beef (and 3,680 litres of water).

Bio fuels also boost the demand story, with 30% of US corn harvest used to make ethanol. Oil prices above $100/barrel will likely increase demand for blended fuels.
The supply side of the equation makes for an equally compelling case. Since the 1960s the area of agricultural land per capita globally has halved, according to the USDA and IMF. This has primarily been caused by urbanisation, which will not slow.

It is expected that 318 million workers will move to urban areas in next 20 years in China – more than the current population of the US.

Clearly there are under-utilised parts of the world in terms of crop production but there are significant costs involved in turning pastoral land into productive arable land, plus environmental, regulatory and logistical issues. Without sufficient water or an efficient transport network farming is not economically viable.

Other issues concern supply concentration (Malaysia and Indonesia together account for almost 90% of global exports of palm oil) and political risk. Export bans such as those seen in Russia last year and stockpiling are regular occurrences in times of trouble. For many regimes, food price stability is of paramount importance, particularly in light of ongoing events in North Africa and the Middle East.

Finally, climate is all important. Whether or not one believes in man-made climate change it is clear that the world experiences frequent and significant weather-related crop disruptions. If supply is already tight – which it is – this inevitably causes prices to spike.

Over the longer-term, soft commodities, however, tend to be mean reversionary. This is because farmers tend to plant the crops that attract the highest prices thereby producing a glut in supply and subsequently depressing prices. Therefore, investors should be active and tactical while trying to benefit from this long-term theme.