Profiting from Rising Food Prices

11/12/2009 11:22 am EST

Focus: ETFS

Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Carlton Delfeld, editor of Around the World with ChartwellETF.com, says growing world population and tight food supply will drive agricultural commodities higher.

The UN Food and Agriculture Organization (FAO) released a report indicating that a number of factors are expected to contribute to significant volatility and sustained high [food] prices over the short to intermediate term, potentially causing a sharp rise in the number of hungry around the world.

According to the FAO report, a repeat of the 2007 and 2008 price spikes is a distinct possibility, and prices of many food commodities are expected to remain above pre-2006 levels until at least 2016.

Agronomists and development experts who gathered in Rome last [month] generally agreed that the resources and technical knowledge were available to increase food production by 50% in 2030 and by 70% in 2050—the amounts needed to feed a population expected to grow to 9.1 billion in 40 years.

But the question is whether the food can be grown in the developing world where the hungry can actually get it, at prices they can afford. Poverty and difficult growing conditions plague the places that need new production most, namely sub-Saharan Africa and South Asia.

While agricultural commodities, unlike precious and industrial metals, have not been stellar performers this year, supply constraints and inflationary expectations [probably] will change this picture.

Investors looking to make a play on food prices through ETFs have two primary options: the PowerShares DB Agriculture Fund (NYSEArca: DBA) and the iPath Dow Jones-UBS Agriculture Subindex Total Return ETN (NYSEArca: JJA).

The most significant difference between these two ETFs is the commodities and their weightings in their respective basket. DBA applies a base weighting of 25% to four commodities: corn, soybeans, sugar, and wheat. As the prices of these commodities change, weightings will depart from these baselines between rebalancing points. A sudden surge in prices like what has occurred with sugar recently has led to an uncomfortable allocation to this crop above 35%.

The index to which JJA is linked also offers exposure to corn, soybeans, sugar, and wheat, with these four commodities accounting for approximately 70% of the benchmark. The remaining 30% is allocated between coffee, cotton, and soybean oil.

While some commodities have been weak performers this year, such as the 11% pullback in wheat this year, the cycle will change as the specter of stagflation and shortages gains momentum.

Tip: Start a small position and build on dips as a long-term core holding.

The risk factor is medium and I recommend using a 6%-8% trailing stop loss.

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