Fin24

How to invest in food

2011-01-27 14:45

RIOTS in Mexico over pricey tortillas, the cost of European wheat doubling in a year, pasta prices up 20%, onions running out in India, sugar prices rocketing 77% in six months - the bad old days of 2008 are back.

This could be the start of a 20-year bull market in agricultural commodity prices.

The demand for food will be driven by population growth (almost 80 million babies born every year) and consumers changing their diets as they grow wealthier (Chinese dairy sales have doubled in five years).

The demand for food crops as fuel is also expanding rapidly. A fifth of the US maize crop is now going towards ethanol - five years ago, it was less than 5%.

Meanwhile, food supply is being tested by too much water (recent flooding in many key agricultural producer countries) in some parts, and too little (chronic droughts) in others.

Government intervention – India (rice) and Russia (wheat) have banned exports of produce in the past – also drives up prices.

Then there is "financialisation of food" – speculators taking bets on soft commodities (like wheat, maize, cocoa and soy beans) on the financial markets, pushing prices higher artificially.

Already, global food prices - as measured by the United Nations agricultural body - have surpassed the record high levels reached in 2008.

In South Africa, the picture looks a bit different, however. While in countries like India food inflation has topped 14%, the local number is still around 1.5%. The price of a tonne of white maize is around the R1 430 to R1 570 mark – compared to R2 100 in 2008.

This is mainly due to bumper crops and problems exporting a glut of maize out of South Africa.

There are huge backlogs at the ports and rail transport has deteriorated. According to one estimate, only 10% of local maize is now transported by train; 20 years ago it was up to 90%.
 
With traditional African export markets like Zambia also now having their own strong crops, this is keeping local produce in the country and prices low.

It is also not anticipated that local floods will have a major impact on food prices, says the JSE's head of commodity derivatives, Rod Gravelet-Blondin. At this stage, although still early, the floods have mainly hurt the output of small-scale farmers and low-lying fruit farms.

Local agricultural prices, however, do track international ones and may move higher. Rumours that exports out of East London harbour may be ramped up have added to some upwards momentum.

How do you go about investing in food?

Shares:

There aren't that many pure agricultural companies on the JSE to choose from.

However, the index of food producers, which includes companies like Clover, Illovo Sugar [JSE:ILV], Pioneer Food Group [JSE:PFG], Tiger Brands [JSE:TBS] and Tongaat Hulett [JSE:TON], may offer some exposure to higher prices.

The earnings of these companies show a 60% correlation with food inflation, says Schalk Louw, CEO and strategist at Contego Asset Management. This means that 60% of the time, their profits will grow when food prices heat up.

"Currently our best choice for gaining exposure to the food producer sector is through investment in Tiger Brands, AVI or Pioneer Foods."

Since both Tiger Brands and Pioneer Foods are on the acquisition trail (Tiger in Africa and Pioneer domestically), which could have an impact on short-term earnings, Louw chooses AVI as his top pick.

He thinks the company could offer "potential upside surprises on distributions to shareholders".

According to Craig Pheiffer, general manager of investments at Absa Investments, the chicken producers - Country Bird Holdings [JSE:CBH], Astral Foods [JSE:ARL], Rainbow Chicken [JSE:RBW] and Sovereign Food Investments [JSE:SOV] – are probably the "purest" food plays on the market.

However, most of them also have other animal feed businesses, and where sourcing is from offshore, margins will come under pressure as commodity prices rise.

Other options include fishing group Oceana Group [JSE:OCE], with its own risks relating to catch sizes and fishing rights, and agricultural groups like Crookes Brothers [JSE:CKS], which has a wide exposure to different crops.
 
Pheiffer thinks the food retailers, which traditionally sneak in fatter profit margins when food prices are rising, may be in the best position to benefit.

Soft commodities:

The most direct and popular way of getting exposure to food prices is by buying futures contracts on agricultural ("soft") commodities like wheat, maize, sunflower seeds and soy beans.

On the JSE's Commodity Derivatives market, you can buy a contract to sell or buy a specific amount of a commodity at a specific date in the future.

For example, you expect the price of yellow maize will rise in the next few months. Currently you can buy a contract which commits you to buy a tonne of yellow maize for R1 550 by May. This is called a "long" position.

If the price of the contract rose to R1 650 by May, you will have made a profit of R100. But if the price falls from current levels, you will make a loss.

Going short entails buying a contract that entitles you to "sell" maize at a specific price in the future. If prices go lower than your entry level, you will make a profit.

To start investing in these futures, you need to open an account with a registered broker and pay a deposit (initial margin) for a trade.

One contract is made up of 100 tonnes for maize, 50 tonnes for wheat and sunflower seeds and 25 for soy beans. You usually need to put down about 10% of the value of the contract as a deposit or initial margin. (The margin will depend on the specific contract and other factors.)

If the price of maize starts to move against you, more money will need to be deposited as variation margin to offset the losses. Your initial margin must be maintained and will be returned to you with interest when your position is closed out.

You can also trade in overseas commodities – like the maize and soybean contracts traded in Chicago – through the JSE.

Trading in commodities futures has again picked up speed and is close to 2008 levels, with interest in soybeans, key to the production of feed and protein, at record highs, says Gravelet-Blondin.

But trading in futures is not for beginners and small investors need to take care; if they are not watchful, losses can quickly add up. Unlike an investment in shares, you can easily lose all your money – and then some.

One broker at a large financial institution, who declined to be named, also warned that agricultural prices are not a one-way street. He expects maize prices to be lower in six months' time. "SA's export infrastructure problems are not going away."

Spread trading

Spread betting is basically a cheaper way to take a view on the direction commodities will move. You can also get exposure to a number of products not available in SA.

For example, you expect cocoa prices will rise. Cocoa for March delivery is currently around $3 340 per tonne. You decide to bet R10 for every dollar that the price moves higher. If the price moves to $3 350, made a profit of R100.

However, should the price fall to $3 330, you would lose R100. A sudden, big drop can be devastating.

It is extremely important to do your homework; you should spend hours on simulating trading (most spread trading firms offer these accounts) and have strict stop loss orders on price. A stop loss will automatically sell your position if it breaches a specific level.

One of the most popular spread trading firms, Global Trader, prefers offering products based off international commodities.

According to Global Trader head of trading Nilan Morar, there has been growing interest in the group's products based on international commodity markets as they offer long trading hours and deep liquidity. The JSE Commodity Division only trades between 9:00 and 12:00.

Overseas

Another option is to use your foreign exchange allowance to invest in the vast array of agricultural investments overseas. These include shares in global agricultural and food conglomerates listed in foreign markets – like Monsanto, Deere & Company, Syngenta, Asian Citrus and MP Evans.

There are also a number of agricultural exchange-traded funds – which can track the performance of an index of agricultural shares or commodities – on the market.

But currency risk is key, says Pheiffer. A strong rand can wipe out any of your overseas gains.

 - Fin24

Comments
  • richard - 2011-01-28 08:16

    This article offers great advice for an investor without any ethics, it describes how to profit from others' misfortune and add to the problem. The article talks about the "financialisation of food" contributing to higher global food prices and then goes on to suggest buying futures contracts for food commodities! This just drives the prices up higher as more people speculate on food, leading to political instability and food shortages in poorer countries, including south africa. The article then goes on to suggest investing in companies like pioneer foods who have recently been involved in large scale price fixing in south africa as well as monsanto and syngenta who spend millions of dollars every year to roll back environmental and food safety legislation worldwide. Maybe if food shortages were really bad, the author would have also suggested investing in arms manufacterers and private security comanies.

  • eddy - 2011-01-28 10:09

    hi can you advise how i can buy shares direct without going through a third party thanks regards eddy

  • Caroline - 2011-01-28 10:35

    Richard, I read the article with horror and thought, "this time, I have to comment" - and you took the words out of my mouth. Trading on food prices as commodities means food prices move in response to a market. The poorest of the poor, already marginalised, become even poorer. Small farmers in developing countries who have been forced to grow cash crops suddenly can't sell because of a market-induced glut on the other side of the world - and farmer suicides are becoming an epidemic as a result. And transferring food-growing regions to producing ethanol for bio-fuel (so the West can maintain its addiction to fast cars) means the people reliant on the food from those regions go hungry. It might make a few investors cash-rich, but morally they're bankrupt. How about some articles on ethical/green investments instead?

  • Gazprom - 2011-01-28 11:15

    I'm in total agreement with Richard above. 1.5% increase in food prices?? Obviously the writer of this article has their partner do the shopping. Food price speculators are the tape worms of the global economy. They should be pulled out and stepped on. Keep squeezing the masses paper shufflers - you're just rolling out the rope you will be hung with.

  • PHILLIP - 2011-01-28 12:02

    hi can you advise how i can buy shares direct without going through a third party thanks regards phillip

  • VinChainSaw - 2011-01-28 13:06

    Caroline, whilst I appreciate your concern I'm curious as to how small cash farmers will sit with a glut of crops they're unable to sell in a market dominated by shortages. I share you outrage but I think your conclusions are faulty. Farmers in developing countries will have a field day by being able to sell their crops at a far greater profit, the non-farming consumer (esp poor consumer in developing countries) is the one headed for a nightmare.

  • zanel - 2011-01-28 14:22

    SPECULATING ON FOOD PRICES TO RAISE THE PRICES TO MAKE PROFITS IS GREEDY AND UNETHICAL

  • Annemarie - 2011-01-28 15:08

    Great story Helena! However I would like to know how can I invest in companies that support sustainable and ethical food production. How about an article on the above?

  • Joe - 2011-01-28 18:04

    Thiss article really talks to the core: will we continue to exploit systems for personal gain at the expense of others. In the past this effect was much more hidden, but now it is applicable to food, it is apparent. Secondly: the people most affected by this are also partially complicit in the conditions that allow the exploitation: they keep on breeding (let's just call a spade a spade) thereby increasing demand for food (and resources). We are fornicating ourselves into this position. The rest have unsustainable lifestyles. If you do not by now recycle, reduce and re-use then you are as much part of the problem.

  • @Richard@Caroline - 2011-01-31 08:17

    Wow, what a bunch of losers. That's like saying investing in sasol is encouraging higher oil prices. Please if you're stupid stop commenting, it's really scary that there's more than one of you that thinks like this.

  • Chris - 2011-02-03 11:22

    Critics of speculation must realise that it is not speculation that drives prices higher, but fundamentals. If a speculator is wrong, he or she will lose money. It is not always a one way bet. Many people have been predicting that the rand will weaken, and although speculators bet on this, it hasn't sent the rand weaker.

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