Despite Empty Silos and Hunger, Short Commodity ETFs

Nearly 17% of the world’s population is undernourished. Most grain silos in the developing world are empty. Due either to the vagaries of the weather or to man-made errors, crop yields in large parts of Latin America, Africa and Asia have been static for nearly 2 years. Why then does the case to short agricultural commodities have merit, particularly in view of the sharp declines already witnessed in related Exchange-traded funds (DBA, MOO, RJA) in recent weeks?

In normal circumstances, the case to buy agriculture-related ETFs today would stand enhanced by the fact that the stimulus packages announced by major producers like India, China and Brazil do not specifically address long overdue upgrades (yields, water systems, distribution channels and land reforms) in the agrarian segments of the economies. But prices for agricultural commodities are only going to higher when demand increases; lower grain production alone cannot provide the requisite boost in the current environment. The evidence suggests that demand in the most populated regions of the world is declining significantly. The positive impact, minimal or substantive, of stimulus packages will not become a reality at least until late 2009 or early 2010.

Grain prices may have declined in dollar terms, but they remain high, relative to previous years, in local markets around the third world. At the same time, according to a UN study released earlier this week, real poverty levels are rising, and the global recession is likely to push significant sections of the lower middle classes into the ranks of the dangerously impoverished in forthcoming months. The UN study estimates that 963 million people are going hungry today. Almost 65% of the hungry live in just seven countries: India, China, the Democratic Republic of Congo, Pakistan, Bangladesh, Indonesia and Ethiopia. Many African countries (e.g. Zimbabwe) have not made the list due simply to lower population levels.

The mid-2009 highs (DBA) were largely predicated on the notion that the qualitative and quantitative expansion of the middle classes in the emerging markets had created an inherent, exponential demand for food. But those middle classes are now more worried about defaults on their housing and consumer loans than their appetites. For example, visitors to restaurants in the once-booming southern region of China are estimated to have dropped 50% during the past two months, and numerous high-end cafes and bars catering to employees of India’s business outsourcing companies in the high-tech capitals of Bangalore and Hyderabad have gone into reduced-hours mode.

Rallies in commodity ETFs are being driven by the overall optimism governing the $1 trillion Obama Plan, and similar stimulus packages in other countries. But the near-term direction of these ETFs is going to be determined primarily by the ongoing contraction in middle-income consumption. Earlier this year, World Bank economists had predicted that the size of the world’s middle class would rise to become a staggering 52% of the global population (from about 25% today) within 10-12 years, and that China and India alone will account for 50% of that rise. But, today, middle-class disposable incomes in both developing and industrial countries are firmly in decline, with no reversal in sight.

How many working families are entering the poverty zone every day is still a matter of debate, given the erratic nature of statistics from the emerging markets and the failure by most governments to unequivocally identify a living-essentials basket. But it is prudent to stay bearish on commodities (sell on ETF rallies) anyway until the true economic impact of the recent (and disturbing) town-to-country migration trend in the developing economies is known, in precise terms, by mid-2009.

Finally, bearishness in commodity ETFs is further justified by the widespread pricing confusion being caused by exchange rate fluctuations, by monetary policies, by the potential for subsidies and protectionism and by disappearing trade credit facilities—all of which will create price volatility but no sustainable uptrend.

Disclosure: no positions

Comments

[ETF 'STER:]

The world needs food, and even with recession looming there will be demand for basic food stuffs (rice, corn wheat, and soybeans). China needs to grow it's economy by 7%-8% each year just to stay even. India also needs to grow their economy by 5%-6% to break even.

Arable land is in decline the world over, and this is even more so in China. Agricultural land has been converted to factories and power plants, (hydro and coal) and with the growth requirements in just China alone, (not including India) there will be demand increases for all basic agricultural commodities. If there is a weather event in any agriculture producing, exporting country, this will create even more demand for that agricultural product

While I believe that we will have a short term deflationary cycle, the long term trend for all commodities will continue to rise.

All recessions end eventually, and world governments are pumping extraordinary amounts of capital into their economies. This stimulation to world economies has no precedent, and can lead to only one thing, Inflation, and once you let the inflation genie out of the bottle, it is very difficult to contain.

While you may be correct in the next six months, the inevitable result of the world economic policies will be inflation.

GLTA

2008 Dec 11 12:24 PM

[sbenard:]

The past few days have proven the false prophetic nature of this article. Corn skyrocketed today, along with several of the the other grain commodities.

The statement that food commodity prices remain relative high is simply not true. Last week, I pulled long-term charts for corn, soybeans, wheat, and rice. Until this rally of the past few days, all of these grains were at price levels that were the lowest since the year 2000. Grains are grossly oversold and due for a correction HIGHER, not lower. The price action of the past week is proof of that.

2008 Dec 12 04:45 PM

[drbob66:]

Price action of DBA (like practically any sector now) is ambiguous...possible head and shoulders reversal pattern forming...alternativel... it could break down further and retest 21.5. I bought at 23, and will look to add some at 19.5-20.

2008 Dec 13 03:36 PM