Following the massive injections into capital markets in recent years, inflation has become a major concern of many investors, and the quest to uncover assets that offer portfolio protection against a potential uptick in the CPI has taken on many forms. While inflation-protected bonds are the instrument of choice for some, others have turned their attention to commodities, hoping that the addition of hard assets to a portfolio will reduce overall volatility and provide a hedge against inflation.
Most investors seeking exposure to commodities as protection against inflation focus on gold and oil, two resources that have historically increased in value as inflation rises. But in recent years agricultural commodities have become increasingly popular choices, as increases in population and the scarcity of land create a compelling case for investment. Moreover, because these resources account for a significant portion of most household budgets, investments in agriculture hedge exposure to an unexpected jump in prices. When inflation kicks in, food prices are often among the first to rise, making an investment in “ag” attractive to those worried that a wave of significant inflation is inevitable.
Last year, the U.N. Food and Agriculture Organization (FAO) released a report indicating that a number of factors are expected to contribute to significant volatility and sustained high prices over the short to intermediate term, potentially causing a sharp rise in the number of hungry around the world. According to the FAO report, a repeat of the 2007 and 2008 price spikes is a distinct possibility, and prices of many food commodities (including wheat, rice, and sugar) are expected to remain above pre-2006 levels until at least 2016.
Price Drivers
The prices of agricultural commodities are often viable, and can be impacted by a number of factors:
* Global Population Growth: As the world’s population continues to grow and farm land becomes more valuable, demand for agricultural commodities is expected to continue to rise slowly. Major demographic shifts could have a large impact on prices of certain commodities.
* Technological Developments: The rise of the ethanol industry highlights the impact that technological advances can have on commodity prices. As biofuel production ramped up, demand for corn skyrocketed, sending the prices of many agriculture prices higher. To the extent that new technologies compete for resources with traditional buyers (such as consumers), agricultural commodity prices could be impacted.
* Weather Anomalies: Severe weather conditions, including hurricanes/tsunamis and droughts, can have a major impact on short-term agricultural commodity prices. Since production of certain commodities tends to be relatively concentrated (i.e., wheat and corn in the midwest, cattle in Texas and Oklahoma), the impact of severe weather patterns can be particularly disruptive.
Agriculture ETF Options
For investors looking to gain exposure to food prices, there are a number of ETFs offering various degrees of exposure. In addition to broad-based agricultural ETFs and ETNs, there are a number of products offering more targeted exposure, as well as multiple funds that offer indirect exposure to rising prices through an equity-based strategy.
It should be noted that exchange-traded products offering exposure to agricultural commodities don’t actually buy and store the underlying commodities, as such a strategy would be impractical and prohibitively expensive. Rather, most of the ETFs in the Agricultural Commodities ETFdb Category employ a futures-based strategy to achieve their investment objectives.
While returns to a futures-based strategy generally exhibit a strong correlation to movements in spot prices, the relationship is often far from perfect. In order to avoid taking physical possession of the underlying commodities, these funds (or the related indexes) generally “roll” their holdings each month, selling any contracts that are approaching expiration and using the proceeds to buy longer-dated contracts. When the prices of these contracts vary (i.e., markets are either in contango or backwardation), the slope of the futures curve can have a meaningful impact on returns (see What’s Wrong With UNG? for a look at how contango has impacted natural gas ETFs).
It should also be noted that a number of these products are exchange-traded notes, meaning that they are essentially senior unsecured debt instruments that are linked to the return on a hypothetical portfolio comprised of futures contracts. While the ETN structure can reduce tracking error, it also introduces investors to credit risk.
Broad Based Agriculture ETFs
Agriculture ETF Exposure
Commodity DBA* JJA** UAG*** FUD*** AGF*
Cattle 16.1% 0.0% 0.0% 5.7% 0.0%
Cocoa 11.3% 0.0% 2.6% 2.4% 0.0%
Coffee 10.9% 10.1% 4.2% 3.9% 0.0%
Corn 11.6% 16.3% 20.6% 19.1% 23.1%
Cotton 2.8% 9.9% 5.7% 0.0% 0.0%
Lean Hogs 8.8% 0.0% 0.0% 7.1% 0.0%
Soybeans 12.0% 23.0% 26.2% 24.3% 24.0%
Soybean Oil 0.0% 9.3% 5.8% 5.4% 0.0%
Sugar 14.5% 19.3% 20.9% 19.3% 28.9%
Wheat 12.0% 12.2% 14.0% 12.9% 23.9%
Source: Issuer web sites.
*As of 1/13/10
**As of 12/31/09
***As of 6/30/09
For those who prefer a broad based approach to agriculture investing, there are a number of ETFs that offer exposure to a variety of resources, including sugar, wheat, soybeans and corn. Among the diversified agricultural products are:
* PowerShares DB Agriculture Fund (DBA)
* iPath Dow Jones-UBS Agriculture Subindex Total Return ETN (JJA)
* E-TRACS UBS Bloomberg CMCI Agriculture ETN (UAG)
* E-TRACS UBS Bloomberg CMCI Food ETN (FUD)
* PowerShares DB Agriculture Long (AGF)
As shown in the adjacent table, the composition of these diversified agriculture funds varies significantly, with the biggest difference being the inclusion or exclusion of hogs and cattle (DBA and FUD give these commodities material weightings while JJA, UAG, and AGF exclude them altogether).
Livestock And Grains ETFs
Livestock ETFs
Commodity COW UBC
Lean Hogs 36.5% 44.4%
Cattle 63.5% 55.6%
For investors looking to gain more targeted exposure to agricultural commodities, there are also several funds focusing exclusively on livestock and grains. Livestock ETFs are composed of futures contracts on hogs and cattle, and include the iPath Dow-Jones UBS Livestock Subindex Total Return ETN (COW) and E-TRACS UBS Bloomberg CMCI Livestock ETN (UBC).
Grains ETFs
Commodity JJG GRU
Corn 31.7% 26.5%
Wheat 23.6% 45.6%
Soybeans/Soybean Oil 44.8% 27.9%
There are also two ETFs that target exclusively grain commodities, including corn, wheat, and soybeans. These products includes the iPath Dow Jones-UBS Grains Subindex Total Return ETN (JJG) and ELEMENTS MLCX Grains Index ETN (GRU).
While livestock and grains offer potential for more targeted exposure to particular commodities, they may also be more volatile in certain environments as a result of the more concentrated holdings.
Agribusiness ETFs
While the aforementioned products offer direct exposure to agricultural commodities, some investors prefer to invest in agricultural commodities indirectly, through holdings in agribusiness stocks. Currently, there are two ETFs offering exposure to the global agribusiness sector: the Market Vectors Agribusiness ETF (MOO) and PowerShares Global Agricultural Fund (PAGG).
These funds are very similar in many regards — both invest in companies engaged in agriculture and farming-related activities around the world — but there are several subtle differences between the two. Read more about the differences between these products in PAGG vs. MOO.
Because there is generally a positive correlation between the profitability of agribusiness companies and the market prices for their products these funds offer indirect exposure to rising prices, although they obviously introduce equity market risk as well. PAGG and MOO have become favorites of investors looking to avoid the adverse effects that contango in futures markets can have on agricultural products. |
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