Until now there has been no easy way to invest in “softs” — agricultural commodities such as sugar, tea, coffee, cocoa and wheat. Nor has there been much demand because softs have been in a long-term bear market since 1980.
But some investment professionals think the tide is turning and are tipping agricultural commodities for success.
This has prompted the launch of a scheme from Bespoke Financial Consulting, which invests in soft commodities alongside metals and energy. The FSA-regulated fund, with a minimum investment of £5,000, tracks the Dow Jones AIG Commodity index which has about 30% exposure to softs.
On February 1 BDO Stoy Hayward Investment Management is launching a similar fund that invests in softs alongside metals and energy.
Barclays Capital plans to go one step further and launch a pure agricultural commodities fund next month, with some capital protection. Returns will be based on the performance of the Goldman Sachs agriculture index.
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“Most asset prices have done well over the past three years with the exception of soft commodities,” said Alex Robinson at Barclays Capital. “But increasing demand from China, the use of crops for alternative fuels and a reduction in agricultural subsidies in Europe could reverse the decline.”
Over the past three years softs, measured by the Goldman Sachs Commodity Index, have dropped by 13%, lagging far behind the spectacular performance of other commodities.
Industrial metals is the top-performing sector over the same period, with a gain of 149%. Energy takes second place, rising 95%. Precious metals have gone up by 57%.
But some commentators believe softs are on the up. Jim Beeland Rogers, who co-founded the Quantum fund with the famous investor George Soros in the 1970s, is a fan. He likes commodities because he thinks they are undervalued. He said: “Agriculture is where I would invest right now, because it has lagged energy and metals.”
Another soft-commodities bull is Hugh Hendry, the star fund manager who left Odey Asset Management last year to join Eclectica Asset Management. He thinks uncertain economic conditions will result in a shift into soft commodities, pushing up prices.
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Compared with equities and industrial metals such as copper, soft commodities are not so economically sensitive, making them a useful way to diversify a portfolio.
Bulls also argue that demand from China and other developing economies will pick up dramatically as their populations grow richer.
China has already overtaken America as the world’s leading consumer of a range of soft commodities, including wheat, rice and meat. In 2004 China consumed 382m tons of grain, according to the Earth Policy Institute, against 278m tons in the US. China’s 2004 intake of 63m tons of meat is far above the 37m tons consumed in America.
But there is still plenty of room for growth because consumption per person is still well below western levels. There are 1.3 billion Chinese compared to just under 300m Americans.
Today the Chinese consume less than 300 kilos of grain a year per head. To sustain an American-style diet rich in meat, milk and eggs requires more than 900 kilos because cows and chickens eat a lot of grain and soya beans.
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Chinese coffee consumption is still 50 times lower than that of Switzerland, even though its population is 200 times bigger. That gap could shrink as affluent Chinese pick up western tastes and habits.
China does produce agricultural commodities itself, but analysts predict that production will be reduced by the movement of people out of rural areas into cities. The urban population of China is expected to more than double to over 800m by 2020, according to the United Nations.
And the high oil price is encouraging increased production and the use of alternative fuels derived from crops.
In Brazil half of all cars can now take ethanol — which is largely produced from sugar or corn. America produces about 20m gallons of bio-diesel a year, mostly from soya beans, but has the capacity to produce more than 50m gallons.
While the bull case may appear strong, investors should exercise caution because agricultural commodities can be far more volatile than metals or oil. If poor weather or pestilence hits harvests and reduces stocks, prices can rise rapidly, only to drop back sharply if harvests are better the following year.
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Hilary Coghill, investment director at City Asset Management, a private client manager, believes the safest way to buy into commodities is through a fund that is linked to an index.
“At the moment there are no fund managers with a record of running a soft-commodities fund,” said Coghill, “so it is less risky to buy an index.”
You can also invest in soft commodities by spread betting, but this is risky because you can lose far more than your original stake.