Is agriculture the next big investment thing?

As the world's population expands, China switches from rice to meat, and biofuel growth looks set to rocket, City experts think agriculture is the best place to make money in the next decade

BY Patrick Collinson , The Guardian, Saturday 24 July 2010

Hedge funds, with billions of pounds in assets, are recklessly gambling on food prices, with speculators driving massive price volatility that threatens the most vulnerable people on the planet.

That's the view of the World Development Movement (WDM), which issued a damning report this week arguing for a regulatory clampdown on hedge funds and banks in the commodities market.

It launched a campaign which saw the Financial Services Authority's switchboard jammed with calls from protestors demanding curbs on speculation. But over at Britain's oldest food market, Borough Market in London, fund managers at one of the biggest investment groups in the world, BlackRock, were telling a rather different story.

It was rolling out its World Agriculture fund for small investors who, it says, can profit from the long-term increase in food prices as rising affluence in China, India and Brazil dramatically changes dietary habits.

BlackRock is not alone in seeing agriculture as a potential new goldmine. Last year, Baring launched a global agriculture fund which is already more than £100m in size and has given its earliest investors a 30% gain. Both groups see their funds as appropriate investments for British pensions and Isas over the long term.

Should you be tempted to? Or, by doing so, are you simply exacerbating speculation in food that has seen products such as cocoa spiral by 150% in the last 18 months? And are the claims of the fund managers robust? Is food really that likely to be a good investment over the next 10–20 years?

WDM campaigner Kate Blagojevic aims her fury not so much at longer-term investors, but at short-term speculators who, WDM claims, have made commodity markets more volatile than ever. "Population growth, increased demand and climate change are all contributing to a long-term gradual rise in the price of food.

"But we feel speculators are taking these trends and exacerbating them, creating such price instability that it's having a devastating impact on farmers. Let's say you are a cocoa farmer. Prices are at a 30-year high. How much do you grow next year, when the price might fall as suddenly?"

But haven't commodity prices always swung violently? The WDM report, The Great Hunger Lottery, argues that during the 1990s and early 2000s, aggressive lobbying by bankers led to weaker regulations covering speculation in agricultural contracts. "Over the past decade, the world's most powerful financial institutions have developed ever more elaborate ways to package, re-package and trade a range of financial contracts known as derivatives ... destabilising and driving up food prices."

Indeed, even small investors can now play the commodity markets through "Exchange Traded Funds" (ETFs), synthetic indices which match price movements in things such as wheat, corn and soybeans, and where you can start speculating with as little as a few pounds.

But BlackRock and Baring both deny they are at the speculative end of the market. Firstly, their agricultural funds don't buy underlying commodities, but trade in the shares of companies involved in agriculture.

And BlackRock fund manager Richard Davis is not even basing his case for investment on an explosion in food prices. He reckons that, over the long term, food prices will trend higher, "but they're not about to go through the roof". Instead, there will be a "supply side response," with the fund, he hopes, benefiting from higher profitability among farmers and the companies that supply them as they expand production and reduce unit costs.

Jonathan Blake is the manager of Baring Global Agriculture, and says the fund is about "three Fs": food, feed and fuel. This planet currently supports 6.5bn people, but by 2050 that is projected to grow to around 9.2bn. That's an awful lot more mouths to feed, and it means the long-term price pressure on agricultural products is going only one way – up.

In 1950, there were 0.5 hectares of arable land per person in the world, but it has already fallen to just over 0.2 hectares. BlackRock estimates that global food production needs to rise by more than 70% by 2050 above 2005-2007 levels to cope with rising food demand. Feed is all about the fact that, as consumers in emerging markets start to earn more, one of the first behavioural changes is a shift from a vegetarian diet to a more meat-based diet. That means the demand for animal feed will rocket over the coming years. After all, it takes over 8kg of grain to produce just 1kg of beef.

BlackRock's Davis adds: "We think it's going to be a slow process. We don't think everyone in China is suddenly going to start eating steak – what you tend to see is that it starts with fish and poultry – but it is a process which China has started on."

Indeed, there is some evidence that dietary changes in Brazil, China and India are happening more rapidly than in Japan and Korea during their development phases. If the Chinese match the diets of modern Koreans, it will mean a 3.7% fall in global demand for rice, but a 27% increase in global consumption of meat and fish.

The impact of biofuels is another core reason to buy agricultural equities, say both fund management firms. As recently as 2000, the global land use for ethanol production was around 10m hectares, but it is projected to rise to 120m hectares by 2015. On the one hand, it will reduce the acreage available for other crops, and on the other, it will directly affect the demand for sugar, corn, and oilseed rape for bio-diesel.

BlackRock likes sugar ethanol producers such as Cosan and Sao Martinho in Brazil, where 90% of the new vehicles sold are "flex-fuel vehicles" that can be run entirely on ethanol.

The country is also home to one of Baring's biggest agricultural holdings, underlining its importance as a commodity provider to China. Baring's Jonathan Blake likes Brasil Foods, a low-cost chicken and processed meat producer. It's one of those companies that few people in the West have heard of, but says a lot about how fast emerging markets are developing.

It is the world's 10th largest food company employing 120,000 people in 42 factories. "We have a planet to conquer," chief executive Nildemar Secches told reporters in May as it merged with another big food producer. Since then, its share price has trended upwards to $15 from around $12.

One surprise is that global food prices, despite what WDM argues, have been flat or falling since 2006-07. The harvest last year in North America was good, and global weather conditions have been relatively benign.

One of the uncomfortable facts about investing in agricultural funds is that good weather is a "risk factor" that could depress returns, as harvests are abundant. These funds will also sorely test ethical investors, as "agricultural science" companies such as GM-developer Monsanto can feature heavily.

How to invest

The minimum investment in Baring Global Agriculture is £2,000, while in BlackRock's BGF World Agriculture fund it is $5,000 (£3,300).