Snub This Much-Misunderstood Market At Your Peril

Snub This Much-Misunderstood Market At Your Peril
Stéphane Renevier, CFA

about 3 years ago3 mins

What’s going on here?

After a multi-year bear market in which it lost two thirds of its value, the Bloomberg Agriculture Subindex of commodities (ticker: BCOMAG) is showing signs of life – rising 50% from the all-time lows experienced in June. And this may offer the forward-thinking investor both clues and opportunities…

Agricultural commodities have risen sharply in price
Source: TeleTrader

What does this mean?

There are two timeless factors contributing to this rally in prices of the subindex’s constituent commodities – which include coffee, corn, cotton, soybeans, sugar, and wheat.

Supply-side constraints

Logistical bottlenecks arising from anti-coronavirus measures have conspired with dry weather caused by the atmospheric phenomenon known as “La Niña” to threaten global access to wheat, soy, and corn in particular

Demand pull

Fearing food shortages, many countries have been actively stockpiling since the beginning of the pandemic – with China, unsurprisingly one of the largest consumers of agricultural commodities, an especially potent force in this regard.

But the repercussions of the recent rally extend far beyond the cost of your morning coffee. If history is any guide, this spike in prices could have significant consequences for the wider macroeconomic picture.

Higher inflation

Food prices are an important part of consumer price indexes (CPIs), particularly in emerging markets – so when the things used to make foodstuffs get more expensive, inflation (all else equal) increases. And the full effects of this may not be felt immediately. Corn, for example, is an “input cost” for a wide range of complex products, used in everything from pig feed to ethanol production. As higher prices for producers take time to filter through to consumers, sharper commodity costs today might lead to even higher inflation tomorrow.

Social unrest

Food insecurity is a big and growing issue – and not only in developing countries. With unemployment also widely projected to rise once economic stimulus packages wind down, disaffected citizens could destabilize or even topple administrations in some parts of the world, potentially with major consequences for investor confidence in, say, government bonds.

Geopolitical risk

Actions speak louder than words – and monitoring agricultural stockpiling activity and export restrictions can give you strong clues about the strategic priorities of governments. These often have geopolitical (and therefore investment) ramifications: witness the Arab Spring, possibly prompted in part by a Russian wheat export ban sending local food prices soaring.

Why should I care?

As we’ve seen, higher agricultural commodity prices can have a significant impact on the macroeconomic landscape – and ultimately on your portfolio. It’s therefore worth watching this space closely. Try to anticipate some of the different scenarios that could unfold should commodity costs continue to creep up, and prepare a few trade ideas for each. Although my own medium- to long-term view is that agricultural prices will actually fall – as I’ll explain in an upcoming Insight – I think it’s nevertheless worth exploring how you could put in place a hedge against a further sharp spike.

There are a few options here. Investors with a particularly targeted view could seek to benefit by buying bite-sized futures contracts on individual commodities such as corn, soybeans or wheat. “E-mini” futures offer even investors with modestly sized portfolios the opportunity to make such trades. For those without access to futures, meanwhile – or without time to research the ins and outs of individual crops – simple exchange-traded funds (ETFs) can get the job done. As well as playing each commodity on its own through ETFs like CORN, SOYB, or WEAT, you can also buy diversified funds which track a wide range of prices – such as DBA (in the US) or AIGA (in the UK).

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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