Drought conditions have ravaged much of the United States this summer, occurring at a critical time during the growing season. As a result, prices for agricultural commodities have climbed sharply. Corn and wheat prices have jumped by more than 40% in the past few weeks; soybeans are up about 20 percent.
The US Department of Agriculture cut its corn crop estimate by 12 percent last week, the biggest downward revision since the early 1970s. And with no rain in sight, that forecast may have to be cut again. The price of corn, the largest crop in the US, is now around $8 a bushel, and some estimate it could easily top $9 or $10 by September.
Given its use to feed livestock, the recent increase in the price of corn will also likely affect meat prices. While food companies may attempt to absorb some of the price increases, it won’t take long for the impact to be felt at the grocery store checkout line. The impact will also be felt at the gas pump, as 40 percent of the corn crop is used to produce ethanol, which is blended with gasoline.
To get exposure to agriculture, you have several options to choose from for your investment dollars. You can invest in the food-related commodities directly. But that entails steep costs such as for storage, transportation and insurance. You can opt for futures contracts, which require a commodities trading account and are highly leveraged so that a small move against you can wipe out your investment. And in recent years, a plethora of commodity oriented Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs) aimed at retail investors have come to market.
At last count, there are 30 ETFs and ETNs available for American investors to choose from to invest in agricultural commodities. These funds run the gamut, attempting to mimic the performance of specific commodities such as corn and wheat, to ones that shadow broad-based indexes.
But before you jump on the ETF bandwagon, know what you are buying.
Owning commodities via an ETF certainly has its attractions. Commodities are not highly correlated to the stock market, so they offer an interesting way to diversify your investment portfolio and reduce potential volatility with a low initial outlay. And these ETFs aren’t leveraged so you never have to worry about getting a margin call.
Keep in mind there are drawbacks to owning the ETF, too. If you hold one for any length of time its structure as a futures-based fund puts you at a disadvantage since the fund needs to roll expiring contracts into a new, higher-priced ones, incurring a cost known as slippage along the way. Management fees (typically around 1% per year) also serve as a performance inhibitor. In addition, while a couple of these funds are actively traded, the average daily volume for most is very thin, which could be a problem when you go to sell.
Perhaps the safest agriculture ETF is the Powershares DB Agriculture Fund (DBA), which based on the Deutsche Bank Liquid Commodity Index, a rules-based index composed of futures contracts on some of the most liquid and widely traded agricultural commodities. The ETF provides exposure to a range of important agricultural commodities. Current approximate weightings: soybeans (16%), cattle (16%), corn (15%), wheat (13%), sugar (11%), cocoa (10%), coffee (9%), hogs (8%) and cotton (2%). And DBA allows you to avoid the many costs associated with investing in physical commodities.
Of course you can also purchase shares of companies that are in some way leveraged to agricultural commodities. In the long run, your returns are likely to be greater through farm equipment companies such as John Deere &Co. (DE) and Titan International (TWI), or fertilizer stocks such as Mosaic (MOS) or Agrium (AGU).