Despite limitations, agricultural commodities give promise, says Michael Lang.
Commodities are likely to be one of the best-performing asset classes over the next 10 years. But they are also likely to be one of the most volatile.
The global economy is entering the "10s" with high debt levels at the private and public level. Governments facing a debt problem may decide that a little inflation is helpful in effectively devaluing the debt they have issued. If this happens, specific commodities could perform strongly.
Investment markets appear to have forgotten that man, despite his many accomplishments, owes his existence to a six-inch layer of topsoil and the fact that it rains.
For 35 years, agricultural prices have declined, after adjusting for inflation. Little wonder New Zealand has slumped from the third wealthiest nation in the OECD, as measured by income per capita, to 22nd.
Despite the long decline in agricultural prices, the world's population has continued to grow at 1.5 per cent a year. Growth in emerging economies is leading to the loss of agricultural land due to water shortages and urbanisation.
But more significantly, a move to protein-rich diets requires significantly more agricultural output. A kilogram of meat requires feeding animals somewhere between 3kg and 5kg of grain or rice.
In eight of the nine most recent years, the world has consumed more grain than it has produced. As a result, global inventories of grain have fallen to levels marginally above those during World War II.
Economic behaviour is conditioned by pricing, meaning the economy as a whole will not allocate more resources to a sector unless the price or rewards for doing so are increasing.
Given the multitude of competing options for capital in today's global economy, agricultural prices will need to revisit their all-time highs to ensure production keeps pace with rising global demand.
With the economic outlook still murky, investment in agriculture provides exposure to an industry that follows a very different cycle from the broader global economy.
This makes agricultural commodities more defensive than industrial-driven alternatives, such as copper and oil and the companies that produce them.
Despite being an agriculturally dominated nation, New Zealand's investment markets offer few opportunities for investors seeking to participate in rising agricultural prices.
Investors can gain a diversified exposure to agricultural commodities by buying an exchange-traded fund that, for a nominal fee, passively tracks the performance of wheat, corn, sugar, soy, coffee, cocoa and related agricultural commodities.
Those investors enamoured with China may wish to consider agricultural commodities as an alternative to Chinese shares.
The Chinese sharemarket is now trading at similar prices to internet shares during 1999 and 2000. Such valuations leave investors with little margin for error.
Interestingly, China has 22 per cent of the world's population but only 7 per cent of its arable land and 8 per cent of its water.
If its economy continues to grow then, judging by the dietary shifts witnessed during other countries' industrialisation, the demand for agricultural commodities will explode - rewarding New Zealand's OECD ranking and investors in agriculture.
* Michael Lang is the chief investment officer at New Zealand Funds Management.
