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Agricultural Commodities The Next Great Inflation Hedge

Commodities / Agricultural Commodities Jul 24, 2007 - 03:08 PM GMT

By: Michael_Pento

Commodities The best way to protect your wealth from the ravages of inflation is to invest in a tangible asset whose supply cannot be increased at the same rate as the currency it is being measured in. Even better is to invest in an asset with growing demand and limited supply whose intrinsic value is increasing.

Some traditional inflation protection vehicles include precious metals, crude oil, real estate and Treasury Inflation Protection Securities (TIPS). A quick comparison shows that oil, for example, has been an excellent hedge against inflation a 37-year compounded return of 8.5%. Real estate, meanwhile, has returned 6.15% over that same span since 1970.

Even worse inflation protection are TIPS, which have provided and average compounded yield of just 5.4% since their inception in 1997. By comparison, gold's return over that same ten-year timeframe has been 8.7%-- no contest.

Despite the multi-year rally we've seen across most of the commodity spectrum, only recently have investors looked to agricultural commodities as another inflation hedge. Due to several watershed macroeconomic factors, this asset class may be entering into a secular trend which will cause it to be a leading provider of real returns. Some of the macroeconomic trends are:

World population to reach 7 Billion by 2013 source: United Nations information service

  • Global GDP to remain above trend through 2016/17 leading to improving dietary trends source: FAPRI
  • Global grain demand to increase 40% by 2020 source: World Resource Institute
  • By the year 2009/2010 fuel is expected to consume 30% of maize crop source: FAPRI

The Agriculture Story

Global money supply is growing at approximately 15%, far above the production rates of most commodities. Like gold, the increase in the supply of agricultural commodities is also running far below the rate of global money supply growth. Unlike gold, however, the intrinsic value of agricultural commodities is increasing because of their burgeoning use in energy production, the shrinking of available hectares devoted to crop production and growing demand from an increasingly wealthy world population.

Not only is the supply and demand balance for these commodities favorable today, but estimates from the Food and Agricultural Policy Research Institute (FAPRI) suggest the supply/demand balance will remain tight for the foreseeable future. Evidence of today's tightness is the fact that current stock-to-use ratios for many agricultural commodities are at historic lows.

Higher Prices to Continue

Prices should remain elevated as productivity struggles to keep up with surging demand. According to FAPRI, prices of course grains (corn, sorghum and barley) should remain 50% above their 10 year average until at least 2016/17. And over the next 10 years sugar and wheat should be 26% and 39% higher, respectively, than their averages.

In conducting our research while consulting on the Delta Global Agriculture UIT , we were convinced that investors interested in gaining agriculture exposure through equities should focus on agriculture producing companies (i.e. growers) or those who are closely related to them, such as seed and agricultural chemicals companies. Amazingly, there are those who consider a company such as Kellogg's to be an agricultural stock; in our opinion, it isn't. In fact, such packaged foods producers likely stand to be harmed by the trend of rising agricultural commodities prices, as a few high-profile earnings warnings have recently highlighted.

Finally, it should be noted that agricultural commodities have not historically been an effective inflation hedge, as they are still 60-90% below their inflation-adjusted highs in some cases. However, due to the above-mentioned macroeconomic changes that are in still in their infancy, I believe we may be in the early stages of a long-term secular trend in which these commodities will far outpace the rate of inflation.

Although this sector is starting to get noticed, we think it is still a little-known story. In the very near future, however, owning agricultural commodities may be broadly viewed as an excellent hedge against inflation and a necessary component of a well diversified portfolio.

By Michael Pento
Senior Market Strategist
Delta Global Advisors, Inc.

A 15-year industry veteran whose career began as a trader on the floor of the New York Stock Exchange, Michael Pento served as a Vice President of Investments at Gunn Allen Financial before joining Delta Global. Previously, he managed individual portfolios as a Vice President for First Montauk Securities, where he focused on options management and advanced yield-enhancing strategies to increase portfolio returns. He is also a published theorist in the field of Austrian economics.

Michael Pento Archive

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Agcapita Farmland Investment Partnership
28 Sep 08, 19:49
Inflation, Rotation, Hard Assets

The equity and bond markets have benefited from a long period of low inflation, but ongoing and massive central bank liquidity injections point to a far less benign environment of elevated inflation ahead. Research by our firm, Agcapita Farmland Investment Partnership (Calgary, Canada based agriculture private equity firm) shows investors must be prepared to rotate into asset classes with different characteristics.

During the last commodity bull market & high inflation period in the 1970’s, equities materially underperformed farmland. Western Canadian farmland went from around $100/acre to $550/acre (550% total return and 176% in inflation adjusted terms), cash held in a money market account barely kept ahead of inflation (6% inflation adjusted return) and the S&P 500 index returned less than 2% per year (a loss of almost 50% in inflation in adjusted terms)

We believe the world is still in the early stages of this current commodity bull market. When agriculture commodities prices are compared against their previous inflation adjusted highs they are significantly discounted implying scope for further increases:

 Corn is US$ 5/bushel currently compared to US$16/bushel in 1974,

 Wheat is US$ 7/bushel currently compared to US$27/bushel in 1974

 Canadian farmland is C$ 660/acre currently compared to C$1,100/acre in 1981

Agcapita’s investment team has over 40 years private equity and fund management experience and over $1 billion in total career transactions. The team currently manages a group of private equity funds with almost CAD$ 100 million of assets under management and previously managed a group of emerging market funds with almost C$500 million in assets for one of the largest banks in Europe.

The Canadian farmland investment premise is driven by several key points:

1. Canadian farmland is high quality: Canada is the third largest wheat exporter in the world and in aggregate one of the largest agricultural producers in the world. The three western Canadian provinces alone have approximately 135 million acres of farmland and produce approximately 20 million tons of wheat a year.

2. Canadian farmland is low cost: Agcapita believes Saskatchewan farmland in particular is an undervalued asset. With an average price of $390 per acre, Saskatchewan farmland is some of the least expensive in the world. The prices in Alberta are almost 3 times higher than Saskatchewan at an average of $1,000.

3. Canada has world class farming infrastructure: Unlike investing in farmland in emerging markets such as Argentina, Brazil or Russia, Canadian farmland is supported by first world storage, processing, and shipping infrastructure. This infrastructure is extremely costly to reproduce.

4. Canada has low political risk: Unlike emerging markets, Canada lacks significant political risk. Canadian farmland owners benefit from a transparent and enforceable title system with no material risk of de jure or, worse yet, de facto expropriation. See recent agriculture export tariffs in Argentina.

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