Capturing cover-story status in this week's Business Week, The Economist, and being featured in Investor's Business Daily (IBD) weekly "Industry Snapshot", the rally in agriculture is no longer in stealth mode. This sector has largely flown under the radar screen because it lacks the "sex and violence" characteristics of other commodity bull markets in energy, base and precious metals. The combined market cap of the industries' top three companies-Monsanto, Sygenta, and Bunge-is less than $94 billion, according to IBD. You simply don't have the buzz of a Transocean/Global Santa Fe merger or the contentious back-and-forth speculation over bids for diversified mining giants like Rio Tinto and Xstrata present in this sector. This tends to keep it out off of the front pages and out of the financial media limelight.
To his credit, Jim Rogers touted the virtues of owning the ags along with the other commodities in his book written a few years ago, presciently titled "Hot Commodities." When I first read the book, just after it was released, I must confess to skipping all of the chapters and sections related to agriculture. I was more captivated by gains in gold than gains in grains. But that has all changed. No longer can this group be ignored by anyone who, like me, believes that non-paper assets are poised to accelerate their significant outperformance over paper assets.
I would recommend reading the articles in the publications mentioned earlier, but The Economist's article sub-headline, "Rising incomes in Asia and ethanol subsidies in America have put an end to a long era of falling food prices," best summarizes the what is behind the rally. The surge in price is more demand than supply-driven. Against the backdrop of record crops is increased demand for meat in India and China which requires much more animal feedstock. Add to this the frenzy over corn for ethanol in the US crowding out planting crops for soybeans and wheat and you are paving the way to an explosion in price. If we see gains similar to what we experienced in the 1970s, then we only have witnessed 15% of the upside and this boom is just beginning.
I would suggest three ways for investors to comprehensively participate in the sector.
The first is to own the agricultural commodities themselves. This can be done through managed futures contracts or through newly developed ETFs which trade the futures contracts for you. The PowerShares DB Commodity Fund (DBA [1]) is rebalanced each November and consists of equal positions in corn, wheat, soybeans, and sugar. This places it right in the middle of the ethanol and animal feed boom. Volume is nice at almost 400,000 shares trading daily. Finally, though new, this offers an investor a rare way to capture covariance or inverse correlation with the broader market.
When almost every asset class in the world was peaking in early to mid-October, DBA was selling off. Conversely, when the market was tanking in November, DBA steadily rallied, registering respectable 5% gains for the month. For this reason I consider a large portion of DBA to be a nice defensive position and a good inflation hedge for any portfolio.
The second way to participate is more offensive in nature, but also involves a newly developed ETF. The Van Eck Global Agribusiness ETF (MOO [2]) consists of companies "engaged in the agriculture business."
Of the 197 industry groups which IBD ranks, the Agricultural Operations group has moved up from 125 to No. 24 in six months. According to IBD, "the industry includes seed supply, agricultural biotechnology, ag-chemicals, fertilizers, farm machinery, food production, grain processing as well as wholesale and distribution." There is clearly a lot of momentum with this group. Because the P/Es are so high for so many of the names in this sector, I tend to favor just investing in the ETF which limits your downside risk while giving you solid upside exposure. I would look to aggressively buy select names in the group after a 10-20% sector correction.
A third way to invest in agriculture is to buy shares of CME Group (CME [3]). After a lengthy one-year period of consolidation, the stock broke out to the upside a couple of months ago and recently broke through its pre-November swoon high of around 690.
With a relatively lofty 50 P/E multiple you might consider wading into this name, perhaps establishing one-half of your position now. The Chicago Mercantile Exchange (CME) recently acquired the Chicago Board of Trade (CBOT), making them the king of agricultural futures contracts transactions. The volume of agricultural trades will continue to soar. In addition to agriculture trades, the CME is the leader in the trading of other futures contracts in interest rates, forex, equity indexes, and energy through its on-floor operations in its CME Globex electronic trading platform. These areas are where all of the excess liquidity the world's central banks are creating is flowing. Until the system collapses this is perhaps one of the best ways to take advantage of the world's inflating money supplies. With the huge amount of leverage in the system, I expect that volatility in these markets will increase which will increase the trading activity and profits for CME. If you are looking for a way to take advantage of aglation, reflation, and inflation, CME is an investor's dream.
CME is one of the biggest beneficiaries of the surge in volume in derivative trades. According to Bloomberg, "Derivatives traded on exchanges surged 27 percent to a record $681 trillion in the third quarter, the biggest increase in three years...Trading surged as investors bet on losses linked to record U.S. mortgage foreclosures and policy changes by the Federal Reserve and the European Central Bank to offset the credit slump...The turbulence in financial markets led to the busiest trading on record.'' Expect more of the same in the future.