As I have suggested in previous newsletters, commodities and commodity stocks should form a key component of a diversified asset portfolio to protect against future inflation, as well as take advantage of the long-term trend of a growing imbalance between the demand and the supply of commodities causing a paradigm shift in price trends (as detailed by Jeremy Grantham of GMO in a 2011 quarterly note). Following-up on this topic, the theme of this newsletter is the case for agricultural commodities, and I summarise below an interesting monthly note from Niels Jensen, the CEO of Absolute Partners, a London based alternative asset manager:

-With the world population projected to rise to 8.3 billion by 2030, and the average calorie intake expected to rise from the current 2,780 kcal per day to 3,050 kcal per day, the implication is an increase of 30% in the global daily calorie consumption.

-In addition, diets in the developing world are likely to shift from a grain rich diet to a protein rich diet causing a significant increase in the demand for grain as livestock is inefficient in converting grain to energy. It takes 2-3 kgs of grain to produce 1 kg of chicken, 4 kgs of grain to produce 1 kg of pork, and 7-8 kgs of grain to produce 1 kg of beef.

-The rapid urbanisation of China over the last 20 years provides a glimpse into what the future might hold on a global basis – urban parts of China spend 2.7 times more on food items than rural areas, partly due to higher prices but also because of higher living standards.

-Between 1994 and 2009, China doubled its per capita annual meat consumption to 70kg, but ranks much lower than the US, New Zealand and Australia which average 100kg and Europe which averages 80kg.

-The increasing trend towards meat consumption in China is putting further pressure on its grain production, as about 70% of China's corn produce and 14% of its wheat are being used to feed it livestock industry.

-It is expected that by about 2015, China will have more middle class families (with annual disposable income of more than $10,000) than the US, totalling about 120 million households which will have a dramatic impact on not just autos, energy steel, cement and copper but agriculture as well.

-China is also constrained by a growing shortage of arable land and water - with rapid urbanisation causing more cropland being lost to city dwellers and forcing China to buy grains in international markets. In addition, China needs to feed 20% of the world's population with only 6% of its fresh water, leading to excessive ground water depletion in many parts of China.

-The OECD projects that the global middle class will increase by 3 billion by 2030, causing a historically unprecedented increase in living standards and a concomitant increase for livestock and grains amidst a backdrop of a declining amount of arable land due to urbanisation.

-The growth of the grain based bio-fuel industry (particularly in the US and Brazil) has exacerbated the pressure on the grain industry.

-Investment Implications:

-With arable land and water being finite resources, and the demand for these resources increasing significantly into the future, it would be critical to have exposure to agriculture in the form of farmland, grains and agricultural stocks. – where returns are expected to outpace bonds and equities over the next 5-10 years.

-However, few investors have exposure to agriculture, probably due to the difficulties in trading the futures market and the cyclicality of agricultural prices.

-Obtain exposure to specialised managers which engage in relative value strategies to exploit relative prices movements between different crops and managed futures.

-Invest in a portfolio of listed stocks, with a focus on providers of machinery and fertilisers to reduce the risk of betting on the wrong crop.

Some interesting observations and important implications for investment portfolios. Having exposure to arable farmland and a diversified portfolio of agricultural and water stocks ( through funds, ETFs and single stocks) as a component of the overall commodity exposure (which includes energy and metals) would be critical for outperformance over the longer term. Given the cyclicality of agricultural prices, it would be best to build exposure gradually and use dips in prices to add to exposure.

Regarding the recent weakness in many of the economic indicators for the US economy (with 11 out of 13 indicators missing consensus expectations), the grand daddy of all leading economic indicators (the LEI-see chart below) clearly indicates that the US economy is still ways from dipping into a recession. However, it is important to monitor if this weakening trend continues into the summer, as it does not bode well for the stock market as the second chart below illustrates.









Another troubling sign is the fact that the US High Yield bond has flat-lined over the last 4-6 weeks while the stock market and investment grade credit have outperformed (see chart below courtesy of AdvisorAnalyst) . We have seen this pattern before and the old saw that 'credit anticipates and equity confirms' has been extremely useful a number of times over the past few years (as the second chart illustrates clearly). So be cautious but not necessarily bearish at this stage!






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