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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.

Inflation in Canada

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Inflation rates are record high around the world, and Canada is no exception, with an 18-year high of 4.7 percent in November. Prices rose across sectors, ranging from bakery, dairy, and meat to furniture, household products, energy, and transportation.  A combination of factors is driving inflation, the main being money printing, high oil prices, product shortages, supply chain disruptions, and pent-up consumer demand.

Reasons for Record High Inflation

Whether high inflation rates are driven by global supply chain issues or money printing is a hotly debated issue at the moment. In the view of some academics and finance experts at the Bank of Canada, it is supply chain disruptions that cause inflationary pressures and drive food and energy prices up. According to a second group of academics, monetary printing creates an overabundance of demand while supply would not always catch up. The result is inflation whereby prices rise and purchasing power declines.

If we take the monetarists’ argument, inflation is not a temporary phenomenon and requires a tight fiscal policy and interest rate hikes. Such policies would involve tax increases, spending cuts, unemployment, and recession. Recession is generally a period of economic decline marked by substantially lower levels of industrial and economic activity. Businesses see less demand and are forced to lay off workers to cut costs, generating unemployment and insecurity.

As prices rise, inflation also eats away at our money and savings. Inflationary pressures not only result in an overall decline of purchasing power but affect the performance of companies and interest rates on savings accounts. When inflation is high, central banks would typically raise interest rates to discourage consumers from borrowing and buying and keep the cost of goods and services stable. The Bank of Canada recently signaled that interest rate hikes cannot be ruled out as a way to keep inflation under control. The current situation, however, is high inflation and low interest rates on savings whereby the value of your money declines. Fortunately, there are plenty of things to do to protect your savings, like investing in real estate, precious metals, commodities, crypto, and defensive stocks.

Investing in Real Estate

As the value of real estate rises with inflation, rental income can be a potential hedge, especially when it comes to short-term leases such as multi-family properties. Investors who are able to keep their mortgage terms the same and adjust their rent up benefit from inflation. Investing in real estate also provides recurring income that either exceeds or keeps pace with inflation.

Precious Metals

Precious metals such as platinum, silver, and gold are known to be a hedge against inflation as well as a portfolio diversifier. Each precious metal, whether palladium or gold, has its own unique specifics, benefits, and risks. Gold, for example, is less affected by demand and supply, making it easy to sell and buy. An added advantage is the fact that there are different investment options to choose from, including numismatic coins, bars, and proof and bullion gold coins. The downside is that it doesn’t produce passive income the way real estate does.

Commodities

When inflation is high, commodity prices also rise and offer a good return potential. Unlike financial assets such as bonds and stocks, commodities are one of the few investment classes that actually benefit from inflationary pressures. The rationale is that rising demand for services and products results in price increases and hence, the value of the commodities that go into producing goods and services also increases.

Bonds and stocks, on the other hand, tend to perform better when the inflation rate is either slowing or stable. When inflation picks up, it reduces the interest rate that bonds pay while high-dividend and income-oriented stock prices fall. This is why returns from commodity indexes like the S&P Goldman Sachs Commodity Index, Credit Suisse Commodities Benchmark, and Bloomberg Commodity Index are independent of bond and stock returns.

Defensive Stocks

Defensive stocks offer stable earnings and dividends regardless of market conditions and typically outperform other investments in periods of economic decline such as recession or stock market crash. The reason is that they belong to sectors of the economy where there are only minor changes in demand. Such sectors are, for example, healthcare, utilities, and food and beverages. The consumer defensive sector includes businesses engaged in the production of packaging, personal and household products, food and beverages, and tobacco. The sector also includes companies offering services such as training and education. Organizations providing healthcare services fall in this category, including medical supplies and equipment, long-term care facilities, hospitals, home health care, research services, and pharmaceuticals. Examples are also life science development and biotech, vaccine developers, and medical device manufacturers. A third sector is utilities, comprising independent power producers and water, gas, and electric utilities and a fourth – communication services such as media and advertising, 5G network, and telephone and broadband.

Crypto Currencies

Investing in crypto currencies can be a viable alternative to stocks and bonds, with a return of over 6 percent. Proponents point to the fact that bitcoin is not tied to a particular economy, fiscal policy or currency and cannot be devalued by a central bank or government printing money. Not only is bitcoin a digital currency but it has a limited supply and is secure, interchangeable, and durable. Finance experts, however, warn that crypto is a highly volatile asset and one tied to speculative trading. Also, cryptocurrencies have been around for a relatively short period to establish whether they can really act as a hedge against inflation.

Gold, on the other hand, has held its value for centuries. Academics at Duke University also note that bitcoin is vulnerable to crashes and manias over relatively short periods, which makes it a risky asset. Its value is tied to two factors – speculative trading and supply. All in all, bitcoin may have a limited value in developed postindustrial countries with stable fiat currencies. Crypto currencies may have a more practical use in countries prone to political instability and turmoil and hyperinflation.

Summing Up

Inflation is currently higher than normal in Canada, primary drivers being money printing, pent-up demand, and supply chain bottlenecks. Droughts affecting agricultural produce across the country are only making things worse.

Global supply chain disruptions are likely to continue in 2022, mainly due to China’s Covid-19 zero policy, resulting in delayed ships and overwhelmed ports. Inflation rates of 4 – 5 percent could also be with us until 2024. While these changes are temporary, a shift in Canada’s monetary policy may not have the desired effect. Hiking interest rates would result in economic slowdown at a time when governments around the world are withdrawing emergency support and fiscal stimulus.

What Canadians can do to protect their savings is invest in precious metals, real estate, defensive stocks, or commodities, all of which acting as a hedge against inflation. Other assets that offer protection against inflation are leveraged loans, real estate investment trusts, and mortgage-backed securities and corporate bonds.

Canadian Guide to Protecting Your Wealth from Inflation

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Inflation is on the rise in Canada and rose to 3.7 percent in July, 2021. This is the biggest jump since May, 2011 and is mainly due to more sectors of the economy reopening and consumers having where to spend their money. While pay rates are set to trail inflation, salary increase budgets are unlikely to catch up with inflationary pressures in 2021. Plus, it is not guaranteed that salaries will go up across all sectors of the economy. Inflation is robust but fortunately, there are ways to protect your wealth and fight the effects of inflation. From buying real estate and investing in stocks to alternative investments and portfolio diversification, there are time-tested strategies to protect your money.

1. Buying Real Estate

Investing in real estate may sound counterintuitive given that the average selling price is $688,000. Prices rose by 38 percent in 2020 alone. In most cases, Canadians looking to buy a home need to apply for a loan. As it turns out, however, the cost of borrowing decreases when wages increase and prices are on the rise. Average home prices are also rising faster than the consumer price index which makes investing in real estate a good hedge against inflation.

Additionally according to the Canadian Real Estate Association, home prices tend to be skewed by listings in expensive metropolitan markets such as Vancouver and Toronto. CREA tracks the house pricing index which gives a more accurate picture in terms of the types and number of properties sold.

2. Investing in Stocks and Bonds

There are investments that actually benefit from inflation, such being energy and retailers stocks. Energy companies profit when inflationary pressures are driven by oil price increases. Retailers also hike prices and considering the pandemic e-commerce boom, investing in e-commerce stocks can be a good idea.

Some equities both benefit and contribute to inflationary pressures, for example, metals, grain, lumber, and crude oil. It makes sense to buy shares in commodity companies either through mutual funds and exchange-traded funds or directly.

Investing in government bonds is yet another way to protect your money from inflation. What portion to dedicate to fixed income depends on how soon you will need cash and your risk tolerance. As a rule, government bonds offer income and security but the shorter the maturity, the lower the yield. That is because investors face less risk of interest rate increases. Bonds with longer maturity are more sensitive to interest rate fluctuations. The choice of shorter maturity depends on factors such as income requirements, nearing retirement, and the need to diversify investments.

3. Alternative Investments

The price of alternative investments such as silver, gold, and cryptocurrencies is also rising in the long run. As they are risky, dedicating a small portion to alternative investments only makes sense. At the same time, they are thought to not only retain their purchasing power but to outperform when inflationary pressures arise.

Also, there is a wide array of investment options to look into, besides bonds and stocks, each with its proposition, value, and risk factor. The range of solutions includes derivative contracts, commodities, antiques and art, managed futures, hedge funds, venture capital, and private equity.

The category of alternative assets is vast, indeed, but there are some factors to consider when building a portfolio. First, investors can choose to own assets such as farmland, commodities, precious metals, and real estate indirectly or directly. They can either buy physical assets or shares like, for example, invest in shares of gold or gold bars. The same is true for other assets such as real estate or farmland. When buying shares, the asset is tied to physical property, thus giving investors a choice between financial and physical assets.

Some alternative investments are classified as risky, such being the case with farmland. The value of farmland has steadily risen on an annual basis over the last three decades. There are no signs of slowing down in the short term, given the demand for commodities and agricultural products. In fact, farms will need to significantly increase production to meet growing demand as global population growth continues.

An alternative solution is to invest in inflation-linked bonds which are pegged to the consumer price index. In this case, the interest and principal rise and are adjusted for inflation. There are many benefits to investing in inflation-linked bonds such as less risk and volatility and higher returns compared to conventional bonds. A word of caution should be mentioned here, however. When deflation occurs, the bond principal will fall below par value, with interest due on the inflation-adjusted principal. Investors are likely to incur capital losses if deflationary pressures persist. The longer the maturity, the more vulnerable bonds become to interest rate fluctuations.

4. Portfolio Diversification

Building a diversified portfolio is an excellent hedge against inflation. The types of assets that can protect an investment portfolio against inflationary pressures include US stocks and REITs, treasuries, TIPS, commodities, emerging stocks, gold, European and Pacific stocks, and international REITs. Real estate investment trusts, for example, buy a diverse range of real estate that is rented out and produces solid returns. There is also an option to invest in international and US REITs and many have done so since the 2008 US market crush. The fact is that REITs invest in both commercial and residential real estate and are more diversified than conventional real estate portfolios. This means that they are more stable and less risky in case of rising inflation and economic shocks.

5. Consider a Fixed-Rate Mortgage Loan

There are currently variable-rate mortgages offered at about or even less than 1 percent. Getting a variable-rate mortgage sounds tempting as it looks like borrowing for nothing but it comes with a hitch. The fact is that a significant increase in mortgage rates could translate in hundreds and even thousands of dollars in interest over the loan term.

In comparison, five-year fixed-rate mortgages are currently available at about two percent. Regardless of inflationary pressures and rate fluctuations, borrowers pay two percent over the course of the mortgage. Locking in a variable-rate loan is a good idea when inflation is rising.

Investing in stocks, alternative assets, and real estate is worth considering given that high inflation could last for years. According to chief economist with Bank of Montreal Douglas Porter, inflation rates could remain at 3 – 5 percent for a year or even two. The outlook for the U.S. is similar, with prices and inflation rising until 2023. In fact, inflation south of the border is higher than in Canada, reaching 5.4 percent in June. Canada, however, is behind the U.S. on the path to economic recovery which is a red flag when it comes to recessionary pressures. Investing in physical and financial assets now can help mitigate the effect of expected rising inflation. With a variety of inflation-proof stocks such as energy and utilities and exchange traded funds, there are plenty of options to hedge against inflation.