Monday, January 5, 2009

The Agricultural Commodities Boom

For global-macro investors, the agricultural commodities market has been of keen interest lately, and even more so now that prices have declined. The general outline of macroeconomic factors that are at play can be found in this Bloomberg News article:

As the article states, there is a strong probability that we might see the biggest rally ever in agricultural commodities in the near future, due to a fragile supply-demand situation.

But, as always, it is important to have a healthy degree of skepticism in approaching the situation. For example, similar to their call on $200 per barrel oil, Goldman Sachs made lofty predictions on agriculture in the above article at the apex of the market.

Here is another interesting take on the issue, from today's
New York Times:

This is a particularly chilling passage:

"For 50 or 60 years, we have let ourselves believe that as long as we have money we will have food. That is a mistake. If we continue our offenses against the land and the labor by which we are fed, the food supply will decline, and we will have a problem far more complex than the failure of our paper economy. The government will bring forth no food by providing hundreds of billons of dollars to the agribusiness corporations."

For those who want to read more about agricultural commodities, here is a great overview with links to more extensive USDA reports:

When paired with the most pressing global issues such as water shortage, global warming, the energy crisis, population growth, low global food stocks, governments printing money and so on, investing in agricultural commodities, via futures contracts or ETFs (such as DBA or RJA), seems like a one-way bet.

But, before getting too giddy over such an investment, I refer you to one of my older posts:

The human record on lofty macro predictions ranges from abysmal to comical. Yet, with the many recent successes in global-macro speculation – short-selling financials and the dollar, riding the commodities and globalization boom – it becomes easy to forecast these trends far into the future. Lo and behold, the Bloomberg News article above quotes a commodities investor who makes the claim that "we are in the early stages of a rally that could last 20 years."

Maybe so.

But it is very easy right now to be fearful of a second Great Depression or sell stocks at deep losses. This is simply the mirror image of what people felt at the apex of the stock market.

Back then, they could have produced a list of reasons why stocks and the economy would continue humming along nicely. In fact, I recall that Robert Hormats of Goldman Sachs made such an erudite forecast
and it was precisely wrong, right at the top of the market.

Thus, while I do believe that agriculture is a very attractive investment, one caveat is that individual commodities will be highly volatile and spike up only for short periods of time, as they did in the 1970s and have throughout their history. Supply and demand can shift quickly, as producers respond to high prices; and the shortage scenarios simply might not materialize.

In other words, it strikes me that the best approach to commodities investment is a very conservative one. While the inflation-hedge characteristics are attractive, commodities might be more suited to short- and medium-term traders, not long-term index investors.

Land, labor, capital and commodities are combined to create businesses that increase productivity. And while any one of these factors may become relatively attractive during a boom, owning excellent businesses is the best investment over the long haul.

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This work by Nicholas E. Radice is licensed under a Creative Commons Attribution-No Derivative Works 3.0 United States License.