The Agricultural Boom Has Only Just Begun

Over the last year, agricultural commodities have been the biggest gainers on world commodity markets with wheat and soya beans up almost 30 per cent.

At Emirates NBD Private Banking we believe that agricultural prices will continue to increase over the long-term. There are three reasons why investors should hold agricultural commodity products in their long-term investment portfolios.

First, incomes in emerging markets are rising, and people who are earning more want high protein diets. Second, energy, which is a major cost in protein- production, is also set to increase in price, simply because people who live in cities have huge energy requirements. Third, population growth means that an increasingly wealthy and urbanised population needs feeding, and that simple dynamic will keep prices moving higher.

Prior to 2006, commodity prices had been falling in real terms for almost 200 years, as productivity gains and more sophisticated means of hedging weather and delivery risk meant that prices faced by consumers stopped growing as quickly as, perhaps, the price of housing and education.

That has changed. Commodity prices, with the notable exception of natural gas, have been trending higher since the middle of 2007. Commodity prices now reflect two phenomena – supply failing to keep up with demand and a combination of hoarding and price speculation.

Nowadays, agricultural prices don’t just reflect the increase in mouths to feed and the impact that weather has on production. They also reflect the commodity market’s expectation of secular population growth and its impact on the ability of producers to meet future demand.

A long time ago someone said to me that investing in emerging markets is investing in structural change. That is what we are seeing in commodity markets. Immense structural change has occurred since the financial crises of 1997/01.

China joined the World Trade Organisation in 2001 and real GDP growth has been in double digits for much of the succeeding years. Equally, India’s reforms have led to a massive boom. Both are experiencing a huge increase in material wealth.

Brazil, which was floundering in 1999, elected President Lula in 2002 on a reform ticket and hasn’t looked back since. Large population markets in the emerging world like Mexico, Nigeria and Indonesia have also experienced much faster growth. All of these more affluent people need to be fed.

Likewise, urban populations have expanded dramatically. The World Bank estimates that someone living in a city uses four times the power used by their rural cousins. Urban populations will have doubled in size between 1995 and 2025, when almost two-thirds of the world’s population will live in cities.

The power demands that come with urbanisation lead to higher energy and water demands. Higher energy prices mean higher input costs for commodity producers. Water increasingly needs energy from desalination.

The next phase of structural change in emerging markets will be an investment/ legislative boom in distribution networks to make supply chains more competitive and end-user prices more downwardly mobile. But we aren’t quite there yet.

In the 2000s, industrial metals and gold were the main sources of commodity speculation on the basis that countries build and people consume durable goods when their incomes are growing quickly and they have access to better housing.

Aside from housing, China is the world’s largest consumer of meat products. Eating meat is a sign of wealth and that luxury requires a lot of energy inputs. Brazil has the world’s largest fresh water resources and is set to become the most prolific producer of soya-beans next year. Russia also has a huge reserve of fresh water in Lake Baikal and pasture land across Siberia.

Growth in emerging markets is becoming ever more intertwined, with multi-decade secular trends offering enormous opportunities for those with foresight.