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How to Prosper Financially

Investing in Agricultural Commodities as an Inflation Hedge

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Investing in agriculture directly may look like a wise strategic move at first. Regardless of whether the economy is weak or strong, people still need to eat. This is why farming and agriculture are considered recession-proof investments, except when armed conflict or war arises. Furthermore, as the world’s population is constantly growing, we will need even more food to be able to feed everyone.

Buying agricultural land can be a good investment strategy but is certainly not for everyone. Farming not only requires a substantial capital investment but leasing and operating a farm can be a costly and time-consuming endeavor. Fortunately, there are plenty of good ways to invest in agriculture such as mutual funds, ag ETFs, stocks, and farm REITs.

Stocks

Agriculture or farm stocks give investors access to major publicly-traded companies, including those involved in growing crops and businesses supporting farms. Investing in businesses engaged in crop and food production is one opportunity to explore. Examples of such publicly-traded crop production companies include AppHarvest, Adecoagro SA, and Fresh Del Monte Produce Inc.

Another option is to buy shares in various sectors that provide supporting activities. There are hundreds of thousands of companies that specialize in packaging, processing, distribution, and other supporting activities.  Such sectors include crop processors and distributors, equipment manufacturers, and seeds and fertilizer producers. Many businesses are engaged in the production of seeds and fertilizers, for example, including companies such as FMC Corp, Corteva Agriscience, and Scotts Miracle-Gro. The sector was in haywire last year due to severe weather, new export-licensing regulations, and the high cost of natural gas. However, the ongoing conflict in Ukraine has made carriers shun Russia, which is a major fertilizer exporter, causing stocks to rise to record levels.

There are also companies that specialize in supporting activities such as processing, transport, and distribution of crops. Some examples include Bunge Limited and Archer Daniels Midland.

Note that while stocks provide good equity returns, the stock markets can be volatile due to adverse conditions, including economic, market, regulatory, and political developments. Foreign securities, in particular, are subject to multiple risks such as political, economic, and currency exchange rate risks. The agriculture and farming industries can be affected by government regulations, global competition, export and import controls, world events, consumption, and commodity prices. For all the reasons above, stocks are considered one of the riskiest investment products.

Farm REITs

Farm real estate investment trusts invest in a portfolio of farmland and then provide farmer-friendly leases. This is the closest you can get to operating an actual farm with the added benefit of significant diversification. REITs provide investors with the opportunity to own stocks in more than one farm and across geographies. Also, stocks have a better liquidity and can be quickly traded on the major exchanges.  Unfortunately, there are just a few farm REITs to invest in, including Gladstone Land Corporation and Farmland Partners Inc.

Agricultural Mutual Funds

Some mutual funds invest in agriculture and farming businesses as part of their portfolio. The goal is to achieve long-term capital growth by investing indirectly or directly in equity-related securities and equities. Similar to stocks, investing in mutual funds can be risky as the value of securities can fluctuate. Adverse events such as floods, droughts, and fires can affect the commodities and agricultural markets and negatively impact demand and supply relationships.

Soft Commodities

Soft commodities are actually futures contracts whereby the underlying commodities are grown and not mined or extracted otherwise. This category covers a wide range of agricultural products, including livestock, wheat, rice, sugar, cotton, coffee, cocoa, and soybeans. Some exchange traded funds and notes give exposure to a single commodity, whether grains or corn, while others include a basket of commodities. The Invesco DB Agriculture ETF, for instance, specializes in sugar, soybeans, wheat, and corn futures contracts. The fund is only suitable for investors with a high-risk profile as it trades in volatile markets. The iPath Bloomberg Agriculture Subindex ETN also invests in a basket of commodities, including cotton, coffee, sugar, soybeans, wheat, and corn. As the ETNs have no principal protection, they are riskier than other types of debt securities. As unsecured debt securities, ETNs are not guaranteed or an obligation, indirectly or directly of a third party. In general, due to risks associated with pathogens and adverse weather conditions, soft commodity features are riskier and more volatile than other debt securities. Harvesting, seeding, and weather forecasts, for instance, can cause fluctuations in oilseed or grain prices, which can affect contract values based on delivery dates.

Using Agricultural Commodities as an Inflation Hedge

Agricultural commodities can be a good investment when inflation rises quickly. The price of agricultural products, industrial and precious metals, gas, and oil rises with inflationary pressures. Due to the fact that these commodities could be volatile markets, it is important to carefully choose the products you would invest in. Also, solid investment firms can be a good choice in uncertain times but commodities only make for a small percentage of the final product they sell.

Corn, soybeans, and livestock are considered some of the best farm commodities to invest in. Corn, for example, is a staple as livestock feed and in ethanol production. Over 1.2 billion metric tons are produced globally per year.

Investors use a variety of futures contracts and ETFs to trade for profit. When predicting price fluctuations, there are different factors they take into account, including oil and gas prices. When prices increase, the ethanol market sees a surge in demand, which results in a higher demand for corn. Also, there are more price fluctuations during the summer months due to the fact that corn is a warm-season crop. If crop-damaging storms occur, this may impact supply and market prices.

With livestock trading, there are different factors that play a role. One is the cost of feed such as soybeans, wheat, and corn. When prices are high, farmers may choose to shorten the period during which livestock is fed, resulting in excess supply. Illnesses that affect livestock, including outbreaks caused by parasites, bacteria, and viruses, also affect demand and supply.

Finally, soybeans are used in margarine, cooking oils, lumber, and building materials. Due to the fact that they have uses in a variety of food products, any news about adverse health effects could result in a low demand.

What is a commodities super-cycle?

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A commodities supercycle or boom is a period of sustained and continued expansion due to increased demand for goods and products. Such supercycles are driven by economic growth and demand for energy sources, manufactured materials, and raw materials.

In-Demand Commodities during a Supercycle

Commodities that are in high demand include natural gas, coal, crude oil, aluminum, copper, and iron ore.

Natural Gas and Oil

Natural gas is used to manufacture iron, steel, bricks, glass, and paper. It is also used by utilities companies for electricity generation and by the commercial sector for metals preheating, incineration, and waste treatment. Crude oil is refined to produce diesel, jet fuel, and gasoline which are used to power equipment and for transportation.

Global political tensions, conflicts, and sanctions as in the case of the Russia/Ukraine conflict push up natural gas and oil prices. Gas prices have already doubled while oil prices have recently reached $139 a barrel, the highest we have seen in about 14 years.

Russia is the world’s biggest exporter of natural gas and the second biggest crude oil exporter. If one country relies on Russia for gas and receives less, it has to find an alternative source, thus impacting supply elsewhere.

Industrial Metals

Coal is used by steelmakers to produce steel and by utilities companies to generate electricity. Aluminum is a key component of airplane parts, electrical transmission lines, window frames, and other goods. Copper is used as a construction material for plumbing and roofing and for the manufacturing of industrial machinery and electrical equipment. Iron ore has many applications such as manufacturing catalysts, auto parts, magnets, and steels and construction of bridges and commercial buildings.

Demand for industrial metals has been high during all commodities supercycles. In 2008, for example, China’s demand for industrial metals, including aluminum, coal, and steel, resulted in record-high prices in 2008 and kept prices on the rise until 2014.

When it comes to precious metals, we have seen an increasing demand for silver and gold. Commodity supercycles have no effect on the industrial use of specialty metals but they become more attractive as an investment tool and a hedge against inflationary pressures.

Why Commodity Supercycles Occur

Commodity supercycles occur in response to profound changes in how societies and economies function. Such changes increase demand for a wide range of commodities. History has witnessed 4 supercycles over the past 120 years. The first such cycle occurred during the US mass industrialization in the 1890s and continued until 1918, driven by an increased demand for weapons and armaments during World War 1. The most recent commodities supercycle occurred in 2001, with China joining the World Trade Organization. China’s large-scale urbanization and economic reforms increased demand for commodities. The fourth supercycle ended with the onset of the global financial crisis in 2008.

New Supercycle on the Horizon

There are some signs that we are witnessing a fifth supercycle driven by the energy transition and global health crisis. Metal and oil prices have skyrocketed recently, and producers find it increasingly difficult to meet demand. In fact, the China – United States trade war and Covid-19 pandemic forced many producers to reduce capacity while there has been little investment in new coal, gas, and oil supply projects.

In addition, the current commodity supercycle is marked by a growth in demand for agricultural products and specialty metals such as silver and gold. Agricultural commodities, in particular, are expected to increase in value due to demand for biofuels and demand from China. As air quality, water, and land are at a premium, demand for agricultural products will remain high in China for the next 5 – 10 years.

The conflict in Ukraine is also pushing up agricultural commodities prices, with over 17 percent increase in the price of corn, barley, oats, and other grains. Vegetable oils have seen the biggest price hikes (23.2 percent) as Ukraine is the biggest sunflower oil exporter while Russia is the world’s second biggest.  Skyrocketing prices for grains, corn, vegetable oils, and wheat are already threatening food shortages around the globe.  Shortages are mainly caused due to disruptions in export flows, with large quantities of produce still sitting in Ukraine because of the blockage of major ports. There is also a risk that some crops would be damaged or destroyed, including spring crops such as soybeans, barley, and corn.

Demand for commodities is expected to increase further as economies around the world are gradually reopening after a significant rise in vaccination rates.

How Is the New Supercycle Different?

When a new supercycle is to occur, we are likely to see some differences. One is the green fiscal stimulus that couples up environmental objectives with crisis spending and efforts to restart the global economy. This transition to a system that is more efficient and cleaner is expected to give rise to new emerging sectors and new jobs and opportunities. The American Jobs Plan, for example, includes a proposed $174 billion investment to accelerate the domestic electric vehicle industry, coupled with commitments to green infrastructure and clean energy. The European Union also agreed a massive green stimulus, with funds to be invested in alternative fuel projects that support climate action. China has announced plans to reduce emissions and achieve carbon neutrality by 2060. In Canada, Covid-19-related spending was the main focus of the previous two budgets but in 2022, the federal government announced a comprehensive package of measures aimed at reducing greenhouse gas emissions. Under the 2030 Emissions Reduction Plan, Canada is taking action to promote clean industrial growth, create sustainable jobs, and achieve zero-net emissions by 2050.

This focus on clean energy means that if a new commodity supercycle is to occur, it will be driven by an increased demand for copper. Copper prices already increased by 17 percent in 2021 amidst sustainable and green initiatives. Copper has a wide range of applications such as high conductivity wires, electrical cables and wiring, and power transmission lines. It is used in green and traditional infrastructure and is a major component in electric vehicles, including charging stations, wiring, inverters, batteries, and electric motors. At the same time, shortages are expected to occur due to pandemic-related disruptions of mining operations in Peru and Chile and an increased demand in China. While demand from China is expected to gradually moderate, it will not do so in many parts of the world.

It is clear that the various green stimulus packages and climate change plans will not drive demand for fossil fuels down, at least not in the short run. After all, if we want to build green infrastructure, we will need traditional fuels. Long-term implications, however, are far from clear.