Trading Agricultural Commodities, Softs and Grains Exposure

Investors looking for new opportunities may want to consider trading agricultural commodities, a sector of the commodity universe likely to receive growing attention over coming months.

Though the energy complex has dominated until now, a number of factors suggest that the agricultural sector will play a big role in the global economy.

Just consider the recent attempts to make global trade more efficient under the World Trade Organisation (WTO) umbrella.

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Much hope was resting on a successful outcome to the Doha round of trade talks.

Unfortunately, these crucial talks stalled and the opportunity was missed to increase global trade by billions.

Overlaying this trade challenge is the surge in global population, expected to increase by 50% from around 6 billion in 2008 to 9 billion by 2020, according to the US Census Bureau.

So world agriculture will have to increase by half again simply to keep up with this population growth. The scene is set for higher livestock and agricultural commodity prices.

Another factor favourable to trading agricultural commodities.

Add to this the growing water shortages in key growing areas around the world and the long term effects of climate change.

Higher temperatures will lead to more droughts, lowering crop yields and in turn this will cause prices to remain high, already exacerbated by many inventories being at near historic lows.

How does this problem play out in the commodity markets so that trading agricultural commodities could be profitable?

As if these economic and environmental conditions were not enough, the way the commodity markets have been operating only adds to this world food challenge.

How is this?

Recently, a growing number of international investment institutions have started to view commodities more as an asset class for long term holding and diversification rather than as a short term speculative opportunity.

A number of commodity index funds have been launched which track the top commodity indexes such as the Dow Jones AIG CI , Goldman Sachs CI and the Rogers International (RICI).

They maintain their exposure by purchasing futures contracts in the indexes and then just roll them over.

So effectively agricultural futures contracts which form part of these indices are purchased in growing numbers and held, that is the funds are long the index.

A CFTC study looking at the impact of commodity index funds on the markets found that some of these index funds held up to 50% of the futures contracts in wheat, livestock and corn on Chicago, Kansas City and New York exchanges.

So if you are thinking of trading agricultural commodities which ones could you trade on world commodity markets?

The third most widely produced crop in the world is rice, of which there are many varieties including brown, black, red and white.

Over 90% of global rice is grown and consumed in Asia, with China, India and Indonesia in the top three.

Growth of rice has huge implications for other scarce resources such as water. The USA is the 4th biggest exporter of rice after Thailand, Vietnam and India.

Corn or maize is the top cereal crop in the world, with the USA producing about 280 million metric tons (2005) which is about 40% of total world production.

China is second with 19%. About half the corn planted in the US is genetically modified.

The key issue going forward is how far will the increasing competition for corn between food and biomass for bio ethanol fuel is going affect the market price.

After corn, wheat is the most widely produced cereal in the world, and there among the varieties traded are hard red winter, hard red spring and soft red winter.

Wheat is a staple food for bread and other carbohydrate products and China is the top world producer, followed by India, USA and Russia.

A major world crop grown for its source of oil and protein is soybean, where most of the bean is used for oil and the remaining meal is used for livestock feed.

The USA is the top producer (83 million metric tons, 2005) followed by Brazil and Argentina, where strikes by farmers protesting at increases in export taxes affected supply and helped drive soybean prices up towards record highs.

Coffee is one of the soft commodities where Brazil (33.74 m bags of coffee, 2007/8) is the top world producer, followed by Vietnam, Colombia and Indonesia., according to the International Coffee Organisation

Two varieties of coffee are traded, the Arabica (75%) is grown mainly in Latin America and East Africa while the Robusta (25%) is cultivated mainly in Central Africa and South East Asia.

The most important soft commodity in the textile world is cotton, where the largest producer by some way is China, followed by the USA , India, Pakistan and Uzbekistan.

Leading the world in exports is the USA, where the industry is worth over $25 billion, however, the WTO has said there are serious issues relating to subsidies paid to US farmers which distort world cotton prices.

West Africa accounts for around 70 per cent of world cocoa production, with the top producer, Cote D'Ivoire, accounting for 40 per cent of the total. While Latin American output has declined, the difference has been taken up by strong growth from Indonesia.

Sugar is another soft commodity which will see strong long term growth due to increasing demand from emerging Asian economies, particularly China.

The other cause is competition between food and biofuels, where the sugar is converted into ethanol.

The leading producer in the world is Brazil (29%), a country which is also using this commodity to fuel road its transport network, followed by India, China and the USA.

So if you are considering trading agricultural commodities, you may want to look a closer at some of the above, all of which are traded on the major global commodity exchanges.

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