Images of rioters in Egypt and many other places in North Africa are everyday news, and many investors are likely wondering how this affects their portfolios. Well, last week there were outflows from emerging market funds after the massive inflows of 2010 — a record year to the tune of $95 billion. Some profit-taking and reallocation of funds is normal, and I certainly don’t see this as a sign that Egypt is derailing the secular trend of emerging markets growing faster than developed markets, based on organic economic growth and driven by a virtuous savings-and-investment cycle.
But we do have an intensifying inflationary problem in the emerging world, which has caused investors to panic — fearing retaliatory tightening by central banks. This may cause some further selling in my favorite emerging markets until it becomes clear what the size and scope of emerging market central bank reaction will be. In the meantime, commodities and commodity-related investments continue to flourish and may be some of the best stock picks.
Since last summer, when the second round of quantitative easing — or QE2 — was announced in the United States, the equally-weighted CRB Index (CCI) of 17 different commodities has advanced from 447 to 661, a huge move. The spike in prices of agricultural commodities may be a cause behind the riots in Egypt, but they are bringing serious profits to producers of agricultural commodities, fertilizer and equipment companies.
Here are four ways to play this trend of rising food prices:
Agricultural Commodity ETNs
The Elements Rogers International Commodity Agriculture ETN (NYSE: RJA) is one way to play the commodities themselves, as opposed to the producers. An exchange-traded note (ETN) is very different from an exchange-traded fund (ETF) as it represents a junior subordinated liability of the issuer, in this case Merrill Lynch. It even has a maturity date of 2022, which means that at that time Merrill will either close the ETN and return all monies, or roll out another one.
The ETN business came about as an attempt to corner the arbitrage market for the commodity futures that the ETN invests in. With ETFs, there is more than one arbitrageur so there are less arbitrage profits.
Still, this is a unique way to track the agricultural component of the Rogers International Commodity Index as most investors likely don’t want to deal with soybean, corn and wheat futures individually. Any pullbacks here are probably buying opportunities for RJA.
Farmland and Cattle Stocks
It’s difficult to invest in farms directly, but one of the few ways is via Argentina-based Cresud (NASDAQ: CRESY), which owns a lot of cattle and arable farmland, produces milk and agricultural commodities and deals in real estate.
The company has many stakes in other ventures, which themselves have stakes in even more ventures, suggesting that the value of its parts may very well be larger than the whole. Cresud owns 57% of Argentinean land company IRSA (IRS). In turn, IRSA owns 63% of Alta Palermo, which operates in shopping centers, 10.4% of Hersha, a U.S.-based REIT, which invests in hotels in the northeastern United States, as well as 24% of Banco Hipotecario, the 11th largest bank in Argentina in terms of assets. In addition, Cresud owns roughly 23% of BrasilAgro, which owns 430,000 acres of mostly Brazilian farmland devoted to sugar cane, grains, livestock, forestry, etc.
The stock is not terribly liquid. I’ve watched a trader move it by 1 point with a (mishandled) $1 million buy order. But for individual investors this should not be an issue. Interested investors should do more homework on CRESY, but the company has a lot of arable land that is currently not being farmed, a valuable asset in times of accelerating inflation and rallying agricultural commodities.
Fertilizer Stocks
BHP Billiton (NYSE: BHP) tried in vain to take over Potash Corp. (NYSE: POT), the world’s largest producer of potash, a key fertilizer ingredient. POT stock was trading around $110 before the failed takeover attempt, and it rallied to the $150s after BHP announced its plans, and it kept rallying even when the merger fell apart as management stood its ground that the company is a lot more valuable. POT currently trades near $190.
The current valuation is 17 times forward earnings and shares have traded as high as $240 in 2008, at a similar level of the commodity prices. Fertilizer demand grows as food demand grows, and this is the premier fertilizer property on the market.
The other potash producer — Mosaic (NYSE: MOS) — is having series of secondary offerings that would result in Cargill giving up 64% control it currently has. With no such controlling shareholder remaining, there is speculation that the company may become an acquisition target. The secondary offerings may temporarily suppress the price as the float increases, but this surely is worth the upside in a takeover bid.
Ag Equipment Stocks
The premiere agriculture equipment stock is Deere & Co. (NYSE: DE), which always tends to trade at a premium to CNH Global (NYSE: CNH). Both stocks have done very well with this rally in agricultural commodity prices — as farmers make more money they tend to buy bigger tractors more often — but the difference here is similar to POT and MOS.
The summary is that CNH is a majority-owned subsidiary of Italy’s Fiat, so the float is not as large. This is a cause for big institutional investors to gravitate toward DE, but should not be an issue with retail investors. CNH has excellent exposure to Latin America, where the agricultural commodity boom is creating fortunes.
