Commodities have been in a slump for the past several years. The Dow Jones Commodity Index has fallen over 13% in the past three years, while commodities like oil have fallen considerably more. The decline of the Chinese economy and mixed global economic activity have kept prices down, and the resurgence of the U.S. dollar paired with a rising rate environment is making a commodity recovery difficult.
Unpopular as commodities may be, the most unpopular of all has arguably been the soft ones, such as wheat, corn, soybeans and other agricultural commodities – but that trend could be on the verge of a major shift. Commodities as a whole are starting to gain ground as the dollar struggles to maintain its dominance – the Dow Jones Commodity Index is up over 7% year-to-date. Soft commodities are also starting to attract Wall Street’s attention, and changes in agribusiness could propel them higher.
Investing in Agriculture
The agricultural sector is beginning to show signs of strength with companies like AGCO increasing their fiscal 2016 sales guidance. Agricultural ETFs are also starting to recover with the largest ETF in the space, PowerShares DB Agriculture Fund (DBA), attracting $162 million in investor inflows this year. The last time the ETF garnered investor inflows was back in 2009.
So what’s changing investors’ minds?
It could be simply a contrarian play by investing in an undervalued sector that hasn’t seen much activity in the past several years, or it could be because U.S. inventories of certain crops are falling – even after five years of record production and bumper crops. According to data from the Chicago Mercantile Exchange, agriculture futures and options trading volume is averaging 1.5 million per day – double the amount in 2010.
Surprisingly the strongest support for a bull market in agricultural commodities stems from China. Its economy may be in decline with less demand for commodities like steel, aluminum and copper, but its population is only growing larger. A bigger population equals greater food consumption.
China is estimated to consume 54.6 million tons of pork this year, while their production capacity is only 53.5 million. That means there’s a growing market for imported pork – an order that the U.S. is ready to fill. And to be able to feed the livestock, there needs to be adequate feed from crops like soybeans.
The Business of Food Production
Agribusiness is caught in a historic wave of mega-mergers with pending deals like Dow Chemical and DuPont, and Bayer’s $66 billion acquisition of Monsanto on the table. Executives say these mergers would allow them to spend more on research and come up with the answers to a growing global food crisis.
But not everyone agrees that consolidation is good for the agriculture industry. If all pending mega-mergers close, then three companies would control 80% of U.S. corn seed sales and 70% of the global pesticide market. That could create higher prices for farmers and have an unintended negative political effect.
The idea of genetically modified food has been a hot-button issue and one that would only get stronger if these mega-mergers go through. But consolidation would mean more money freed up for scientific research and a reduction in inefficient overlaps from companies that supply farmers with seeds, fertilizers and pesticides.
From an investment standpoint, the agriculture sector could be the next bull market – and changes in agribusiness could help pave the way for a long bull market in soft commodities. Technologies like CRISPR, a gene-editing technology, and synthetic biology are still in their infancy and their widespread use is only just starting to get underway.
The political ramifications of GMO agribusiness is something that needs to be considered very carefully. How these technologies are released onto the market will have significant health and environmental risks, and the global food production industry is headed for a massive upheaval. Investors will want to monitor how politics plays a role in these changes and what the fallout will be if any or all of the mega-mergers are approved.