Focus on agricultural solution providers, not commodities says Allianz GI report

The current rally in agricultural commodity markets which has seen grain prices jump by 45.3% between June and August serves as a stark reminder of the long-term global food supply/demand imbalance, a note from Allianz Global Investors says.

But while some see that as a buying signal for commodities, the greatest opportunities could lie amongst agricultural solution providers.

This summer’s North American drought, the worst drought since the 1950s, has decimated fields across the US Farm Belt, forcing the US Department of Agriculture (USDA) to slash corn and soybean yield estimates by 26% and 18% respectively over the last four months. Some independent reports say that is still way too high and yield estimates could be revised lower in coming months.

Supply challenges extend to other grains in other regions. Both Russia and Australia, two significant exporters of wheat, facing unusually dry weather. Some analysts expect Russian and Australian wheat production to experience year-over-year declines of 27% and 20% respectively.

Bryan Agbabian, manager of the Allianz Global Agricultural Trends fund, said that while weather provided the spark behind the recent rally, a decade of steadily tightening supply/demand balance has provided the tinder.

“Despite 10 years of growing global grain production, the growth in supplies has failed to keep up with even stronger global demand growth, particularly out of the emerging markets. We expect the growth of the emerging market middle class will place increasing pressure on farmers to increase the productivity of the world’s limited arable land.”

In July, the UN’s Food and Agriculture Organization (FAO) announced a 6% jump in global food prices, drawing much needed attention to the challenges facing the world’s food supply and the precarious state of the world’s poorest populations.

Grain production is still below the highs seen last year. “If it does not quickly and dramatically improve, we fear the impact of rapidly rising food costs will threaten the livelihood of the world’s poorest,” says Agbabian.

Meeting projected 2050 food demand will require growing food production by 70%, the FAO says. To do this the world needs to make investments of $83bn a year, most of which will have to come from the private sector. Specifically, $20bn should be invested in crop production, $13bn in livestock production, and $50bn in downstream services like processing and distribution.

“As long-term investors in the Agricultural sector, we believe the greatest opportunities lie in the agricultural solutions providers sector, rather than making direct investments in agricultural commodity markets,” bagbabian said.

“We think history is bound to repeat itself, with high grain prices inducing farmers to invest in productivity-enhancing inputs that will allow them to grow more food on their limited acreage. Though these supply responses will likely pressure grain prices, hurting agricultural commodity returns, we expect the providers of the inputs that helped make farmers more efficient will be key beneficiaries, alongside consumers who will experience a much needed respite from food price inflation.”

The Allianz Global Agricultural Trends fund invests in the shares of companies on a global basis, and is designed to focus on two investment themes: companies benefiting from the increasing and changing production of raw materials; and companies operating in the product processing and distribution industries.

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