Rising food prices over the last year have been a key inflationary driver - the other being energy prices.
On the one hand this is bad news, it pushes up the cost of living for us all. But on the other it's been a great source of profit if you've invested in food. If you haven't already invested, is the party over? or might you still make money?
Let's take a look at the main things to consider.
What are food investments?
Food, often called 'soft commodities', comprises 3 main areas: grains (e.g. corn and wheat), other crops (e.g. coffee and fruit) and livestock (i.e. meat).
Each of these foodstuffs is bought and sold on global markets, so it's possible to invest and trade. However, it's not easy buying a few tonnes of wheat then storing it in the hope the price rises, so many investors use futures contracts instead. These allow you to buy or sell an agreed amount of food at an agreed price on a specific future date. You don't ever have to own the food as you can sell the future contact to someone else before the due date.
What affects food prices?
As with any commodity, price is determined by supply and demand, so we need to consider the main factors affecting this:
Bad weather usually hurts crop production, reducing supply. For example, Russia last year endured its worst drought in 50 years which, according to the US Department of Agriculture (USDA), reduced Russia's annual wheat supply by around a third.
The problem with weather is that it's unpredictable, better weather this year could boost supply hence soften prices, or draught could continue and probably further push up prices.
Emerging markets demand (demand)
Food demand from developed countries tends to be fairly stable. But it's growing from emerging markets, as increasing prosperity leads to more demand for food and a shift in taste.
Figures from the International Coffee Organisation (ICO) suggest that consumption by coffee producing (mostly developing) countries has grown around 40% over the last 10 years, whereas developed country consumption has only increased by around 5% over the same period.
If these kinds of trend continue then a sustained long term increase in demand for many food stuffs seems inevitable, especially those that have traditionally been more restricted to developed markets.
Alternative fuels (demand)
Some crops, notably wheat, corn, rapeseed and sugar are used to produce fuel (called 'biofuel'). Demand for biofuels is affected by both legislation (i.e. governments forcing more biofuel use) and the price of oil (the higher the oil price the greater the attraction of using crops for fuel rather than food). As the long term trend is currently towards greater use of alternative energy (and greater energy consumption altogether), we can expect biofuel demand to continue growing future.
Decisions on what to grow (supply)
If practical, farmers will often switch crop production if they think they can earn more by growing a different crop. This means that crops with especially high prices may well see supply catch up over time, potentially pushing the price back down. This is hard to predict, but does tend to cap demand exceeding supply medium term, for most soft commodities.
Most crop producing countries hold stocks of crops in reserve to help tide over periods of surging demand or reduced supply. When reserves are high you'd expect prices to be less sensitive to growing demand or falling supply than if stocks are low - so this factor can also affect prices.
Most food is traded globally in US dollars, so movements between the dollar and pound will affect returns for UK investors. For example, if the pound strengthens against the dollar this will reduce returns for pound sterling investors (and vice-versa).
Does supply keep up with demand?
Getting hold of accurate figures isn't easy, but the USDA publishes data for some crops, for example:
|Source: USDA to April 2011.|
What about past performance?
Looking at the above figures it's not hard to see why some food prices, such as corn, have soared in price by around 80% over the last year. Demand is generally growing faster than supply, exacerbated by poor weather reducing supply over the last year. But prices can crash too, the corn price almost halved between June 2008 and June 2010. Like many commodities, investment speculation is often to blame for such excessive volatility.
|Source: IMF prices as at 31 March each year.|
Will prices rise in future?
Although there is scope to grow more crops around the World, it may be that practical and political constraints (e.g. restricting the chopping down of rainforests to grow food) will curb growth to some extent. The key is whether demand continues to grow faster than supply - and if emerging markets continue their meteoric growth there's reason to believe this might be the case.
But shorter term prices could remain as erratic as the weather - literally. And demand for crops used in biofuel production will continue to influenced by oil prices. Both these factors are very difficult to predict, making short term food investing quite a risky gamble.
I'm a fan of long term (10-20 year) soft commodity investing, but I'd be nervous trying to predict prices over the next year or two - other than to say if the weather improves then prices will probably fall back on the crops most affected by drought last year.
How can I invest in food?
Buying futures directly isn't that practical for most of us, although you can get similar exposure quite easily via spread betting companies.
A simpler (and arguably less risky) way of investing in food is to buy an exchange traded commodity fund, like those offered by ETF Securities. These use futures to track crop prices in return for annual charges of around 0.5% a year.
Or you can invest in the shares of companies that stand to benefit from rising food prices. These might include agricultural equipment, fertiliser and seed suppliers, as well as food producers themselves (e.g. Tate & Lyle and Associated British Foods).
The risk with this approach is that negative stock market sentiment and/or operational problems (think BP) could affect their share price regardless of underlying commodity prices. Plus it's less flexible as you can't bet on specific crops unless you can find a company whose sole business is that crop.
You can spread risk via the shares approach by using funds that invest in a range of 'food' shares. There are only a handful of onshore funds so far: First State Global Agribusiness, Baring Global Agriculture, Sarasin AgriSar and CF Eclectica Agriculture.