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The global boom in the price of farm produce - from wheat to corn - has raised the profile of agricultural commodities as an alternative asset.
There is a growing awareness that soft commodities can play a key role in an investor's portfolio by offering a potential cushion against inflation.
Commodities can be an effective hedge against inflation. From metals to grains, they can provide stability during periods of stock market volatility. When equity prices fall, commodity prices tend to rise. While stock and bond markets tend to start discounting a potential recession ahead of a slowdown, commodities tend to continue prospering as long as demand exceeds supply.
China and India's rapid economic growth has fuelled the global boom in commodities. Rising demand for crops to produce biofuels has driven up demand for corn and wheat. The switch from fossil fuels to green energy is expected to accelerate demand for biofuels as concern about climate change grows around the globe.
The boom in agricultural commodity prices has also been driven by growth in the world's population, a shortage of arable land, political uncertainty and a shift towards more western diets in emerging markets.
We believe that the commodities bull-run could last up to 20 years, punctuated by periodic bouts of selling.
Commodities yielded robust returns in 2007 with spot prices for oil, gold, wheat and corn hitting record highs. The broadly-diversified Merrill Lynch Commodity index eXtra TR returned 33 per cent last year with all sectors, except base metals, contributing to the rise.
Demand for key commodities is expected to remain firm even in the face of an economic slowdown in the United States.
The energy sector is competing with food producers for crops to convert into biofuels. The rapid expansion of the ethanol and bio-diesel industries in the past decade has driven up agricultural commodity prices. Ethanol production in the United States, for example, has been soaking up more than 30 per cent of the US corn harvest. Ethanol production is also rising rapidly in China and Europe.
Crisis
A shortage of arable land, regional desertification, water shortages and freak weather is likely to cap agricultural output growth for years to come. Wheat prices have spiked due to poor weather in Europe, Australia, Canada and China. In the United States, wheat stocks plunged to their lowest level in 60 years.
Soybean prices rallied in 2007 due to soaring demand for protein-based diets in emerging markets, growth in bio-diesel production and a significant switch to corn production in the United States.
Rising feed prices for cattle pushed up slaughter rates in the United States. The number of calves on US farms in 2007 dropped to its lowest level since 1951.
The commodity boom has not gone unnoticed. Interest in agriculture as an asset class has been reflected in the number of commodity-linked exchange traded funds and structured notes which are available to investors.
As investors consider their allocation of assets in a portfolio, it is worth bearing in mind that soft commodities can offer an effective hedge against the threat posed to their wealth by inflation.
- The writer is chief investment officer, Merrill Lynch Global Wealth Management (EMEA).
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