The Food and Agriculture Organisation of the United Nations (FAO) just released the proceedings of the Ministerial Meeting on Food Price Volatility, a get-together attended by more than 30 agriculture ministers in Rome late last year.
The meeting, held on World Food Day, was set against a backdrop of the mid-2012 price hike on international food markets, the third in the last five years. As we will discuss in a minute, here at Land Commodities we see this as merely the beginning of a pattern that could support a reliable and relatively simple trading strategy for years to come. With one caveat: that politicians don't prevent investors from being able to do the trade in the first place.
Reading the proceedings of the meeting, every minister seemed to have the same speechwriter ("we all need to work together more to sort this food crisis thing out") and the speechwriter certainly agreed with himself / herself on the subject of investors' involvement in the commodity markets: a) we don't like it; b) it must be restricted.
The French Minister for Agriculture, Food and Forestry, H.E. Stéphane Le Foll, opened with:
I would like to touch on financial regulation. This does not fall directly within our remit as agriculture ministers, but we cannot keep silent about the undeniable influence of financial markets based on agricultural commodities.
Next to the podium, the German Minister for Food, Agriculture and Consumer Protection, H.E. Ilse Aigner, fleshed those views out:
Policy-makers need to safeguard the functioning of these markets and protect them from the risks of excessive speculation. As a consequence, transactions performed by stakeholders on futures markets will be recorded in the future.
In the G20 Action Plan we also demanded an adequate market regulation. For this purpose we need: the introduction of a position limit for financial investors on agricultural futures markets; hedging measures at the trading hubs with regard to high frequency trading; and instruments to avert risks to physical agricultural markets.
And from the Spanish Minister for Agriculture, Food, and Environment, H.E. Miguel Arias Cañete:
The international agricultural commodities market appears to be increasingly similar to the financial markets: if we want to avoid living in a constant state of alert, they must be regulated.
According to Aigner:
… better coordination between member states are the main instruments to counteract extreme price fluctuations.
The possibility that the self regulating price discovery mechanism facilitated by the free market trade of commodities (including by investors) may be the most effective means of broadcasting price signals to consumers and producers is clearly off the table. Apparently, a cabal of European bureaucrats will be able to do a better job of moderating supply and demand. But we'll leave the subject of regulations and commodity trading for another post.
Anyway, onto the ministers' advice on trading the food crisis whilst you still can (and yes, it's very easy to make agricultural commodities trading sound cavalier, which is exactly why the ministers may very well succeed in getting voters behind new regulations). First, let's take a look at what got all the ministers to meet in the first place.
The graph below shows the change in the real price of grains over the last three decades according to the World Bank grain price index (we've used the World Bank version instead of the FAO Index because the FAO don't publish figures that go back that far).
The bull case for agricultural commodities (which unsurprisingly we subscribe to here at Land Commodities), is that both the upward price trend of the last decade and the increased volatility around that trend line are the new normal. This is because the supply and demand fundamentals driving the new normal are here to stay for the foreseeable future.
In the words of the Spanish minister:
Experts broadly agree on the causes of high volatility and high food prices. Among them are the inelastic demand for food and speculation in the futures markets, underinvestment in agriculture in recent years, low food stock levels, the rising demand for food due to population growth and dietary change, and limited natural resources and climate change.
As historical data shows production gains are diminishing, as is per-capita arable land availability and per capita production of grain for food and feed. And this is all set against a backdrop of rising demand from emerging markets and the energy sector.
In short (H.E. Akira Gunjim, Minister for Agriculture, Forestry and Fisheries for Japan):
In the medium and long run, the world's food supply and demand are projected to remain tight.
So the trading strategy is simple: if prices ever drop well below the trend line, buy agricultural commodity ETFs like JJG, RJA or GRU and it won't be long before the next price spike, because as the Spanish minister puts it:
When the international agricultural commodities markets start to become strained, even if the demand-supply gap is small, two interrelated phenomena occur: demand increases way beyond normal expectations and supply is disproportionately reduced.
The good news is that based on a particularly surreal statement made by the French minister, agricultural commodity investors may not need to worry about new regulations quite yet:
The last few weeks have been dominated by one question: is there going to be a meeting of the Rapid Reaction Forum? In the end, its members have decided that if prices are high the situation does not justify a physical meeting, as this could send out a signal that we are on the verge of a crisis.
That's right. The Rapid Reaction Forum set up by the G20 to deal with the effects of price spikes decided not to meet because there was a price spike. A lack of meetings could slow the regulatory process at least a bit.
When or if they finally do impose restrictions on commodity trading, there is still the fallback of direct farmland investment. As we discussed in a related post, rising commodity prices and agricultural productivity are captured in appreciating valuations of the underlying land resource upon which all agricultural commodities are produced. And no matter what regulations are imposed, that will always be the case.