Friday, January 28, 2011

FIN24: How to invest in food [ADVICE]

The bad old days of 2008 are back, but this time, can you make money out of a global food crisis? - Helena Wasserman

RIOTS in Mexico over pricey tortillas, the cost of European wheat doubling in a year, pasta prices up 20%, onions running out in India, sugar prices rocketing 77% in six months - it's 2008 all over again except this year it's worse.

You may be catching a wave on year one of what, some say, could be a 20-year bull market in agricultural commodity prices.

The conditions are near perfect. The demand for food will be driven by population growth (almost 80 million babies born every year) and consumers changing their diets as they grow wealthier (Chinese dairy sales have doubled in five years).

The demand for food crops as fuel is also expanding rapidly. A fifth of the US maize crop is now going towards ethanol - five years ago, it was less than 5%.

Meanwhile, food supply is being tested by too much water (recent flooding in many key agricultural producer countries) in some parts, and too little (chronic droughts) in others.

Government intervention – India (rice) and Russia (wheat) have banned exports of produce in the past – also drives up prices.

Then there is "financialisation of food" – speculators taking bets on soft commodities (like wheat, maize, cocoa and soy beans) on the financial markets, pushing prices higher artificially.

Already, global food prices - as measured by the United Nations agricultural body - have surpassed the record high levels reached in 2008.

In South Africa, the picture looks a bit different, however. While in countries like India food inflation has topped 14%, the local number is still around 1.5%. The price of a tonne of white maize is around the R1 430 to R1 570 mark – compared to R2 100 in 2008.

This is mainly due to bumper crops and problems exporting a glut of maize out of South Africa.

There are huge backlogs at the ports and rail transport has deteriorated. According to one estimate, only 10% of local maize is now transported by train; 20 years ago it was up to 90%.

With traditional African export markets like Zambia also now having their own strong crops, this is keeping local produce in the country and prices low.

It is also not anticipated that local floods will have a major impact on food prices, says the JSE's head of commodity derivatives, Rod Gravelet-Blondin. At this stage, although still early, the floods have mainly hurt the output of small-scale farmers and low-lying fruit farms.

Local agricultural prices, however, do track international ones and may move higher. Rumours that exports out of East London harbour may be ramped up have added to some upwards momentum.

How do you go about investing in food?


There aren't that many pure agricultural companies on the JSE to choose from.

However, the index of food producers, which includes companies like Clover, Illovo Sugar [JSE:ILV], Pioneer Food Group [JSE:PFG], Tiger Brands [JSE:TBS] and Tongaat Hulett [JSE:TON], may offer some exposure to higher prices.

The earnings of these companies show a 60% correlation with food inflation, says Schalk Louw, CEO and strategist at Contego Asset Management. This means that 60% of the time, their profits will grow when food prices heat up.

"Currently our best choice for gaining exposure to the food producer sector is through investment in Tiger Brands, AVI or Pioneer Foods."

Since both Tiger Brands and Pioneer Foods are on the acquisition trail (Tiger in Africa and Pioneer domestically), which could have an impact on short-term earnings, Louw chooses AVI as his top pick.

He thinks the company could offer "potential upside surprises on distributions to shareholders".

According to Craig Pheiffer, general manager of investments at Absa Investments, the chicken producers - Country Bird Holdings [JSE:CBH], Astral Foods [JSE:ARL], Rainbow Chicken [JSE:RBW] and Sovereign Food Investments [JSE:SOV] – are probably the "purest" food plays on the market.

However, most of them also have other animal feed businesses, and where sourcing is from offshore, margins will come under pressure as commodity prices rise.

Other options include fishing group Oceana Group [JSE:OCE], with its own risks relating to catch sizes and fishing rights, and agricultural groups like Crookes Brothers [JSE:CKS], which has a wide exposure to different crops.

Pheiffer thinks the food retailers, which traditionally sneak in fatter profit margins when food prices are rising, may be in the best position to benefit.

Soft commodities:

The most direct and popular way of getting exposure to food prices is by buying futures contracts on agricultural ("soft") commodities like wheat, maize, sunflower seeds and soy beans.

On the JSE's Commodity Derivatives market, you can buy a contract to sell or buy a specific amount of a commodity at a specific date in the future.

For example, you expect the price of yellow maize will rise in the next few months. Currently you can buy a contract which commits you to buy a tonne of yellow maize for R1 550 by May. This is called a "long" position.

If the price of the contract rose to R1 650 by May, you will have made a profit of R100. But if the price falls from current levels, you will make a loss.

Going short entails buying a contract that entitles you to "sell" maize at a specific price in the future. If prices go lower than your entry level, you will make a profit.

To start investing in these futures, you need to open an account with a registered broker and pay a deposit (initial margin) for a trade.

One contract is made up of 100 tonnes for maize, 50 tonnes for wheat and sunflower seeds and 25 for soy beans. You usually need to put down about 10% of the value of the contract as a deposit or initial margin. (The margin will depend on the specific contract and other factors.)

If the price of maize starts to move against you, more money will need to be deposited as variation margin to offset the losses. Your initial margin must be maintained and will be returned to you with interest when your position is closed out.

You can also trade in overseas commodities – like the maize and soybean contracts traded in Chicago – through the JSE.

Trading in commodities futures has again picked up speed and is close to 2008 levels, with interest in soybeans, key to the production of feed and protein, at record highs, says Gravelet-Blondin.

But trading in futures is not for beginners and small investors need to take care; if they are not watchful, losses can quickly add up. Unlike an investment in shares, you can easily lose all your money – and then some.

One broker at a large financial institution, who declined to be named, also warned that agricultural prices are not a one-way street. He expects maize prices to be lower in six months' time. "SA's export infrastructure problems are not going away."

Spread trading

Spread betting is basically a cheaper way to take a view on the direction commodities will move. You can also get exposure to a number of products not available in SA.

For example, you expect cocoa prices will rise. Cocoa for March delivery is currently around $3 340 per tonne. You decide to bet R10 for every dollar that the price moves higher. If the price moves to $3 350, made a profit of R100.

However, should the price fall to $3 330, you would lose R100. A sudden, big drop can be devastating.

It is extremely important to do your homework; you should spend hours on simulating trading (most spread trading firms offer these accounts) and have strict stop loss orders on price. A stop loss will automatically sell your position if it breaches a specific level.

One of the most popular spread trading firms, Global Trader, prefers offering products based off international commodities.

According to Global Trader head of trading Nilan Morar, there has been growing interest in the group's products based on international commodity markets as they offer long trading hours and deep liquidity. The JSE Commodity Division only trades between 9:00 and 12:00.


Another option is to use your foreign exchange allowance to invest in the vast array of agricultural investments overseas. These include shares in global agricultural and food conglomerates listed in foreign markets – like Monsanto, Deere & Company, Syngenta, Asian Citrus and MP Evans.

There are also a number of agricultural exchange-traded funds – which can track the performance of an index of agricultural shares or commodities – on the market.

But currency risk is key, says Pheiffer. A strong rand can wipe out any of your overseas gains.

No comments: