Farmland, forestry and fisheries: Diversify with soft commodities
In the face of the worst drought in living memory, we take a look at how agriculture contributes to our economy, and what soft commodities might add to an investor's portfolio.
As Aussie farmers battle extreme drought conditions, and escalating an US-China trade war wreaks havoc with soybean futures, we examine how agriculture and other soft commodities can help make up a diversified investment portfolio.
What are soft commodities?
Commodities fall into two buckets; hard commodities - mined natural resources such as oil, gold, and copper, and soft commodities - agricultural goods such as grain, crops, beef, timber and salmon.
The price of soft commodities is largely determined by external forces. Weather, especially in a country like Australia, can play an enormous role, with scorching hot summers or freezing cold winters impacting production. Unless you believe in the wisdom of fortune tellers, it's almost impossible to accurate and consistently predict prices; soft commodities are a highly volatile sector.
Long-term, the price of soft commodities such as timber and dairy is being driven by global macro-economic trends. Urbanisation and the growth of the middle class in Asia for example has seen a growing demand for red meat and dairy. Population growth across the world has driven timber demand for housing.
Soft commodities and the Australian market
Soft commodities such as coffee, sugar and wheat can only be produced in regions with suitable temperature, soil quality and climates. Each continent produces very different soft commodities for internal consumption and external export.
In Australia, while we are blessed with an enormous land mass, the vast majority of the interior is arid or semi-arid, making the soil quality poor. This, coupled with low rainfall and high temperatures, is impractical for the production of many soft commodities. For instance, you won't find many places in Australia that produce commercial levels of tea.
The World Bank estimates that Australia has six per cent of arable land, land capable of being ploughed, which puts us lower than Albania with 22.4 per cent, and on par with Bermuda. The world average is about 11 per cent.
However, there are some soft commodities that Australia is famous for producing, and exporting, including wheat, wool, lamb, cotton, sugarcane, canola and milk.
Source: Food, Fibre and Forestry Facts – a summary of Australia's Agricultural sector, 2017 [National Farmers' Federation]
According to the National Farmers' Federation, Australia's agricultural sector:
- Contributes three per cent to the national total gross domestic product
- Exports about 77 per cent of what gets produced
- Earned the country $44.8 billion in 2016-17 in exports
Globally, Australia is a relatively small player in soft commodities. Take wheat for example – according to the US Department of Agriculture, in 2018/17 the world produced 758.02 million metric tons of wheat and exported 182.64 million metric tons.
The biggest producer of wheat was European Union with 151.68 million metrics tons, while the biggest exporter of wheat was Russia with 42 million metric tons. Comparatively, Australia produced 21.30 million metrics tones and exported 15 million metric tons.
Sector outlook
For the second year in a row, Australia's winter crop production has been impacted by dry conditions, particularly in northern NSW and southern Queensland, according to Rabobank's agribusiness monthly report.
"Cropping regions surrounding Dalby Emerald, Moree, and Dubbo have all had under 50mm of rain since 1 April," the report says. "Rainfall has been marginally better throughout the southern NSW, Victoria, and South Australia; however, it has been inconsistent."
However, Australia is not alone in its weather woes, with a heatwave devastating crop production across Europe. Rabobank says that global dryness had been "very supportive of wheat prices" in August, with global prices "finding their way to three-year highs in July."
While there are risks concerning demand in China and US protectionist policies, Rabobank says Trump's tidings have been "relegated to second-place interest in the current weather market."
"However, the flow on impacts of already-announced measures, including tariffs and US farm support, together with uncertainty over possible additional announcements, are weighting the near market and into 2019, especially for global oilseed markets."
Investors should take a long-time horizon to ride out the ups and downs this sector so often experiences.
How to invest in soft commodities
While difficult to access for retail investors, soft commodities can provide a useful diversifier in a portfolio. Investors can invest in the sector via direct equities, futures, ETF, or opt for a managed fund.
Investors may also have small exposure to soft commodities via their super funds or multi-asset managed funds' alternatives allocation – although Australian super funds have historically struggled to maintain large scale agricultural investments.
Agriculture managed funds fall into two categories; there are some that invest in the commodities themselves via the futures market, or you can plump for a fund that invests in commodity stocks. Investors need to do their homework when investing in agriculture, as one fund can differ greatly from the next.
While agriculture ETFs were all the rage about five years ago, they're no longer in vogue. The BetaShares Agriculture ETF CcyHdg(Synth), which tracks the S&P GSCI Agriculture Enhanced Select Index Excess Return (Hedged into A$), remains, with exposure to global soft commodities including corn, wheat soybeans and sugar. BetaShares Global Agriculture ETF – Currency Hedged tracks the Nasdaq Global ex-Australia Agriculture Companies Hedged AUD Index.
On direct equities, Morningstar analysts cover a range of soft commodity stocks including grain giant GrainCorp (ASX: GNC), and crop protection and speed specialist Nufarm Limited (ASX: NUF), and supplier and producer of poultry Inghams Group Limited (ASX:ING).
Others include listed horticulture company Costa Group, rural services company Ruralco, animal feedstock group Ridley Corp, and Australian dairy company Bega Cheese.
More from Morningstar
• Make better investment decisions with Morningstar Premium | Free 4-week trial
Emma Rapaport is a reporter for Morningstar Australia
© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.
