How investors can harvest gains from agriculture

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Global food prices are on the rise again, raising questions about the impact on inflation and global economic growth - not to mention how some of the world's poorest people will feed themselves.

For investors, though, there is another question: How sustainable is this latest surge in food prices and what are the best ways to gain access to it?

According to the United Nations Food and Agriculture Organization, world food prices rose 2.2 per cent between January and February. Food prices have been rising for eight consecutive months, hitting new highs that surpass the level seen during the 2008 spike.

Some of the gains are due to short-term issues, such as poor harvests in Russia, Argentina and Australia.

However, there are also bigger issues at work here, which is why few observers see these price gains as a short-term phenomenon that can be easily ignored.

More land is being used for corn production in the United States to meet demand for ethanol production, shifting acres away from other crops and creating tighter markets for commodities like wheat and soybeans.

"The competition for arable land between food and fuel has a great deal to do with the higher agricultural prices we're seeing today," said Patricia Mohr. an economist and commodity market specialist at the Bank of Nova Scotia. "And this is a structural shift that won't go away."

Meanwhile, demand for food is increasing. Over the next 40 years, it is estimated that global food production will have to rise by 70 per cent to meet demand. That's partly because of a rising population, which is expected to hit 9 billion, but also because of shifting diets.

As well, as people grow more affluent, they tend to consume more meat, which also has big implications for land use and crop yields.

Already, rising food prices have had a profound impact on publicly traded agriculture stocks, such as fertilizer producers, seed manufacturers, food processors and farm equipment makers.

For many investors, though, a basket of stocks is the better way to go, giving them diversification across a number industries and geographic regions.

Exchange-traded funds, which resemble mutual funds but trade on stock exchanges, are among the most popular and accessible baskets. Many of these ETFs have risen impressively since last summer and are now approaching their 2008 high points - and will continue to rise if the agriculture theme persists.

The Claymore Global Agriculture ETF holds three dozen stocks, including Deere & Co., Archer-Daniels-Midland Co., Potash Corp. of Saskatchewan and Monsanto Co. The ETF has risen 46 per cent since last July, or more than double the return on the MSCI World index.

Investors can also take a more direct approach to the agriculture theme by bypassing companies and investing in the underlying commodities instead.

"You're not dependent upon someone else's earnings or the good decisions of a management team," said Jeff Tjornehoj, head of Lipper Americas Research. "People are interested in this commodity play because it's accessible and easily understood."

The PowerShares DB Agriculture fund holds futures contracts on the most widely traded commodities, including corn, sugar, wheat, cotton and even live cattle. The fund has risen 35 per cent since July.

Similarly, the BMO Agriculture Commodities index ETF also gives exposure to agriculture commodities, but removes currency risk by providing returns in Canadian dollar terms. The fund is new: It began trading in late January.

Alternatively, investors can buy exchange traded notes - which, like ETFs, also trade on stock exchanges but are actually debt securities - to pick and choose among specific commodities. This approach can deliver stomach-churning volatility from month to month.

Still, the right picks can win big: The iPath Dow Jones-UBS cotton ETN has risen 129 per cent over the past 12 months, making it the best performer among the individual commodity ETNs and puts to shame the returns on crude oil and gold over the same period.

For investors who want a wilder ride, ETNs can also provide leveraged exposure to the agriculture theme. The PowerShares DB Agriculture Double Long ETN gives twice the monthly upside - and twice the downside, if commodity prices weaken - of futures contracts on corn, wheat, soybeans and sugar. Since last summer, this leverage has certainly paid off: The ETN has surged 142 per cent.

However, given their potential for big losses, these products are used mostly by investors with short-term horizons.

"They're commonly used by institutional investors who use them as a hedge or some very specialized need," Mr. Tjornehog said. "For the retail investor, they're more like going to Las Vegas."