Monday, July 11, 2011

A Long-Term Opportunity in Agricultural Commodities

Market participants seem to be taking shorter and shorter perspectives, especially concerning agricultural commodities.   For example, periodic crop forecasts by the U.S. Department of Agriculture often cause sharp swings in commodity prices, regardless of broader supply and demand factors.  I think this is the case now.

A recent USDA report showed that corn and wheat plantings were larger than expected, as were inventory stockpiles.  In response, Goldman Sachs cut its corn and wheat price forecasts by 26%.  In the two days after the USDA report was released, corn and wheat futures prices fell by 8-9%.

According to a Bloomberg News story, U.S. farmers planted 1.8% more corn than projected by analysts, which is the second-highest amount of acreage since 1944.  Inventory stockpiles as of June 1 were 12% higher than forecast.

I think this recent price drop was an overreaction.  I have seen repeated instances of such short-term forecasts of agricultural prices that are soon made irrelevant—and wildly erroneous—by news of drought, or greater than expected demand, for example.  As with investing in general, the odds for success increase with the length of one’s time horizon (and decrease with one’s portfolio turnover).  This is particularly true for agricultural commodities.

The long-term factors driving agricultural commodity prices remain exceptionally positive for prices—though negative for the world’s poor.  The World Bank estimates that higher food prices have pushed 44 million more people into poverty.  It would be hugely positive if major crop producers would emulate what leading pharmaceutical companies do in providing their product either free or at sharply reduced rates to the poorest countries.

Global stockpiles of corn, the most-consumed grain, are forecast to drop to 47 days of use, the fewest since 1974.  Inventories are declining as demand continues to exceed supply (for a fifth straight year of record production).  Wheat inventories will drop to a three-year low, according to USDA estimates.

As for market participants, the 20-25% price drop in recent weeks for corn and wheat present an opportunity for long-term investors who are interested in protecting the purchasing power of their savings.  I expect agricultural commodity prices to rise over time at least as fast as inflation.  There are exchange-traded funds and exchange-traded notes that provide participation in agricultural markets, and particularly for investors who have no exposure to this area, I suggest building a position at current levels.

Steve Lehman

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