Food and water investments weather drought
BY MarketWatch — 12:01 AM ET 07/20/2012
CHICAGO (MarketWatch) -- Record heat, dry skies, and acres of drought-stricken corn is stressing farmers and cereal makers, but commodities and natural resource investors are cool and composed.
Weather has caused a "supply shock" that observers say only reinforces a longer-term investing theme in the scarcity of food and water.
A hungry and thirsty world is growing, and "you can't triple a population in a lifetime without consequences," said Jeremy Grantham, a closely followed value investor and co-founder of asset management firm GMO LLC., in a speech at the Morningstar Investor Conference in June.
The situation is equal parts opportunity and clock-ticking pressure to devise new ways to use and produce finite resources and their alternatives, and to grow food on dwindling arable land. Agriculture demand will continue to spur innovative irrigation techniques and to address the need for fresh drinking water in developing countries. And therein lies another potential investment -- water solutions.
For now, the focus is on supply. June was the fourth-hottest month in the U.S. since 1880, according to the National Oceanic and Atmospheric Association (NOAA) and July has been toasty too. The heat and drought prompted officials to cut harvest expectations. USDA's July 11 report featured a 12% drop in the outlook for domestic corn output, crossing out predictions for a record harvest. The U.S. soybean crop, which pollinates later than corn, is on track to be the smallest in four years. Global wheat production estimates are down 1% from a June prediction.
Stalks and stocks
Grain futures prices and shares of broad-based commodities funds are at multi-month highs in response. A proxy for the agriculture sector, exchange-traded PowerShares DB Agriculture Fund ETF is up 14% in just the past month, prompting some chart-watchers to warn that this double-digit spurt looks stretched.
Agriculture-related stocks have been a mixed bag. Price incentives and expectations for crop yield catch-up boosted spring planting, and fertilizer shares may find support as field conditions are sorted out in coming weeks. Shares of fertilizer-makers Potash Corp. of Saskatchewan Inc. (POT) and Mosaic Co. (MOS) , for example, have been rising along with grain futures prices. Monsanto Co. (MON) , meanwhile, could benefit from sales of its drought-tolerant seeds.
But the drought's impact on the farm economy could hit equipment makers such as Deere & Co. (DE) . Food processors such as Archer Daniels Midland Co. (ADM) face higher raw input prices that could trim profit margins.
Weather fluctuates and markets jump. Certainly, the global reach of crop production can't be dismissed. Drought in one region simply means higher prices and increased planting incentive for growers elsewhere. But the U.S. is the biggest producer of corn and soybeans and the largest shipper of grain. About 60% of the contiguous United States was officially in drought, or roughly 3.1 million square miles, according to NOAA's July 10 release. The heat wave was breaking slightly for much of the country and spotty thunderstorms did move in across parts of the Midwest late this week.
"The weather hit at a time of falling grain reserves, resulting in a tight stocks-to-use ratio -- an impact that can stick around across seasons," said Abraham Bailin, who follows commodity exchange-traded funds at investment researcher Morningstar Inc.
So, how do investors turn a grain shortfall into a potential portfolio windfall?
Bailin pays attention to PowerShares DB Commodity Index Tracking Fund ETF for its diversification across commodities. He cites the fund's ability to take the guesswork out of managing the price fluctuations across the futures-markets calendar, including contango, an inverse relationship where current spot prices are higher than forward prices.
Bailin recommended United States Commodity Index Fund (USCI) for its relative stability and diversification. He also points to a suite of indexes from SummerHaven Index Management, including SummerHaven Dynamic Commodity Index Total Return .
Investors with higher risk-tolerance can dig into focused ETFs, including Teucrium Corn Fund (CORN) and Teucrium Soybean Fund (SOYB). Read more: Corn fund is ETF of the week.
Not a drop to drink
For some investors, feeding the world is really about water.
"You can't even start a discussion about water conservation without talking about agriculture first," said Kent Croft of Croft Leominster, Inc., portfolio manager of the Croft Value Fund. "There's a lot of room to become more efficient in water if the right push is there."
Available fresh water is less than half of 1% of the Earth's total water. And some 70% of fresh water goes to agricultural production, according to United Nations water division statistics. You can think about it in these terms: It takes seven pounds of feed to produce one pound of beef and 155 gallons of water to produce one pound of wheat.
Croft's water-related investments include Valmont Industries Inc. (VMI). Irrigation equipment was 39% of the company's 2011 operating income. (Other income comes from another population-growth theme: upgrades and maintenance to U.S. and international electricity grids.)
Water infrastructure is another area of interest, both for new construction in developing regions and repairs for crumbling pipes in the developed world. Croft points to Xylem Inc. (XYL) , which tests water, repairs systems and sells valves, pumps and dispensers -- all key to getting water to farmland, factories, and homes.
Other stocks to consider, although not part of Croft's holdings: pump-maker Flowserve Corp. (FLS) and irrigation and machinery company Lindsay Corp. (LNN).
ETF investors can wade into a pool of water offerings: Guggenheim S&P Global Water Index ; First Trust ISE Water Index ; PowerShares Water Resource Portfolio and PowerShares Global Water Portfolio (PIO).
Lands of opportunity
Farming is becoming more factory-like with huge corporations managing land, but the reality is that agriculture needs fresh labor, according to commodities investor Jim Rogers. He's reinforced that view in recent television and magazine interviews.
Rogers is bullish on one of the purest of agricultural plays -- land. But if that's a bit ambitious, there are other investment routes, including shares of land management companies. Adecoagro S.A. (AGRO) , for instance, is a Luxembourg-based company that owns significant farmland holdings in South America.
Noted GMO's Grantham: "The developed world will have to behave sensibly, but of course they will behave casually, with lots of waste, and that will push the price (of resources) up faster than it need rise because we (developed world) can afford it, at the expense of the developing world."
His bottom line: "Think favorably about resource funds."
Rachel Koning Beals is a Chicago-based freelance writer and editor.
