Sunday, April 27, 2008

Playing an acknowledged theme - is outperformance possible?

"It's tough to make predictions, especially about the future." - Yogi Berra

Just like a trying to see a lighthouse on a foggy day, trying to clearly envision the future can be tough. However, making out the likely shape and dimensions of those things you are trying to avoid, or aim towards, will likely speed you safely on your journey.

It's like that in investing too. Picking out the broad trends to aim for, or avoid, can help elevate your portfolio returns.

Agricultural commodities are one big, broad, theme going forward. The popular press has recently jumped all over this, pointing to food unrest around the world. While the 'contra the herd" crowd would suggest that any trend reaching the front cover of your favorite pop magazine or newspaper is, most likely, nearly played out, they would probably be not so certain that this trend has.

Examination of the underlying factors suggest that this trend is likely to continue for awhile. Here are the factors, as I see them:
  • Continued global population growth - check, this is still ongoing and unlikely to stop for several decades.
  • Continued use of food stocks for bio-fuels - check, this is still ongoing. In the US, about 30% of the corn crop is going towards bio-fuel, compared to around 10% in the early 1990's. Given the presidential candidates positions to date, and the strength of the lobbying industry in the US, this appears unlikely to diminish any time soon.
  • Diet - a meat-centric diet is a huge consumer of grains for animal feed (it takes anywhere from 5lbs to 18lbs of grain to produce one lbs of meat [depends primarily on meat type]). With a rising middle class in China and India turning away from a formerly mostly vegetarian diet, this will continue to pressure grains. Check, this factor remains in play.
  • Arable land is decreasing - decades of industrialization, and of water course management, have reduced the amount of quality arable land available. Growing desertification is also a factor too. Check, this factor remains in play.
  • Climate change - long known by scientists to be likely to reduce yield in several ways. Humanity continues to pump out voluminous greenhouse gases, suggesting this factor will only intensify in the future. Check, this remains a factor.

Of course, against those trends, you have to consider the possibility of opposing trends occurring. I see those potentially as:

  • Potential reduction in bio-fuel use - a possibility, but with the opposition of vested interests, unlikely within a 10 year window.
  • Change in diet - again a possibility, the increasing cost of a meat-centric diet may reduce the volume of meat consumed in some areas,. Yet with this burgeoning middle class in so much of the world, it feels unlikely to occur without some support from government, and people's own conscience. Overall, it feels unlikely to occur much within a five year window.
  • Finally, the potential for increased production of foods, due to farmer's using more fertilizers and bringing all available land into production. This, I consider very likely. However, this may very well be offset by the declining yields associated with climate change.

On balance, I'd say that the current trend isn't anywhere near played out, and that agriculture remains a major investment theme going forward. If you agree, then you may very well want to stuff your portfolio with agricultural-related investment products, something I believe will fuel investment returns for a very long period of time.

Full disclosure: Long JJG, MOO, & COW (TSX exchange).


The Confused Capitalist