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Agricultural commodities may witness upward trend

Christopher Wyke, a commodities expert at the investment bank Schroders, says it believes the supply/demand imbalances will force prices of grains 'to rise sharply.' The Financial Times said recently that the emergence of biofuels has transformed how banks and investors look at agriculture.

There were also comments to the effect that the boom in agricultural commodities was in the early stages of an upward cycle whereas hard commodities were already in the middle of a secular boom market.

What do I think? It is true that several softs have had a good run already. In the last several months, the white sugar futures contract has quadrupled. Corn prices are holding steady inspite of record acreage thanks to the ethanol boom. Milk prices are at all time highs. Palm oil futures hit an eight year high this week. Wheat prices are likely to go up after the US Department of Agriculture forecast that stocks will fall this summer to the lowest ratio to demand on record. There is definitely a bullish case but before we examine this, let us examine what could happen to derail the bullish case: Political backlash against rising food prices. Don't forget food prices are very politically sensitive; Crashing energy prices (due to global recession) which makes alternative food based fuels uneconomic; Vocal protests from environmentalists who are already raising a noise against conventional farm and forest land being converted to the production of corn and palm oil for use in alternative fuel programmes; Supply side explosion caused by two main events better genetically modified seeds/fertilisers and by global warming yes, warmer weather will increase productivity in several highly productive farming areas in the Northern Hemisphere.

Now let us examine the bullish case: The developing economies of China and India are growing at a very fast pace. We all know that China's tiny outpost Hong Kong is infinitely more prosperous than the mainland. It is said that an average Chinese on the mainland just consumes one sixth the meat annually compared to his Hong Kong cousins and one eighth the milk.

As prosperity increases on the mainland and the mainland Chinese start consuming more meat etc, imagine what will happen to demand. The same is true in India with generally rising levels of prosperity; The boom in alternative fuels is driving demand for corn and palm oil to new heights; Switching acreage to corn and palm oil will leave less acreage available to other traditional crops thereby driving supplies down; The world supply of arable land is actually decreasing (as it becomes more and more prosperous, China is actually going to become a very large importer of food because it does not have much more arable land and water is so scarce); Reserves of many agricultural commodities are at near record lows relative to consumption despite 16 straight years of favourable growing conditions in the US Midwest (one of the leading production regions in the world).

On balance, I vote for the bullish case but investors will do well to remember that some of the commodities have already had some pretty decent run ups. Are there any commodities which have not participated in this run up and are they worth examining. For this, I turn to my old friend George Kleinman. He says 'Cotton has been in a vicious downtrend this year. On May 11, the near month collapsed to new contract lows, with the new crop December contract falling close to new lows despite a bullish crop report. The US Dept of Agriculture estimated on May 11 that, because of sharply decreased planted acreage, ending stocks for the 2007-08 season would plummet to 6.40 million bales, down sharply from this year's 9.50 million bales. It also raised world usage to 127 million bales from the current 122 million, in large part because of Chinese demand. Acres planted will be nearly the lowest in three decades because competing crops such as corn are much more profitable to plant.

When supplies are projected to fall sharply in an environment of increasing demand, it sounds like a recipe for a market opportunity. So why haven't prices responded? Will they, and if so, when? Neither George nor I recommend timing the market. We will wait for the time when the price trend changes before moving in. Like Jesse Livermore, we would like to be on the right side of the market.