When SG has a good idea…

We live in strange times, with virtually every non-zero sum asset having embarked on a dizzy rally, all at once.

Since June, the S&P 500 is up 15 per cent, the yield on the 10 year US Treasury has dropped by 50 basis points, or 12 per cent, and the spot price of Nymex WTI has risen from $65 a barrel to $75 a barrel.

Aside from the fact this belies received wisdom about asset correlations, where can under-invested investors find value in this liquidity drunk market?

This “Rally in Everything”, as Societe Generale’s Dylan Grice observes, has left behind agricultural commodities, as this chart shows:

SocGen chart of grains underperformance

Agricultural commodities may well exhibit different characteristics to oil futures, as well as securities with cash flows and yields, but this underperformance appears strange considering the fact that agriculture possesses the most convincing long term investment story of any asset. Though not new, it is worryingly true: the world’s demand for calories is increasing at a rate that is already unsustainable.As Grice notes in his latest Popular Delusions missive to SocGen clients, the economics for China’s grain requirements look particularly dire (emphasis FT Alphaville’s):
With only 7% of the world’s fresh water and 8% of its arable land with which to feed 22% of the world’s population, China already has to feed 12.5 people per hectare of its arable land compared to 1.7 in the US and 4.1 in the EU1. But China is losing arable land at an accelerating rate, partly due to the industrialization path the country has now embarked upon.
From 1950 to 1975, China lost an average of 600 sq miles of land to desert each year. By 2000, that decline had increased to nearly 1,400 sq miles. Farm land is being sacrificed for new construction land, particularly in the West, and the land remaining is being overused. Worse, the sacrificed land has generally been high quality and only 28% of remaining farm land is now considered high-yielding.

In short, China will never be able to attain grain autarky, and instead will have to buy elsewhere.

China’s per capita grain demand is likely to explode in the coming years. Where will this grain come from? World supplies, as measured by months’ worth of global inventory, remain about as tight as at any time since WW2, despite the past two years’ bumper harvests.

So, while agricultural commodities may still be a punt, at a time when government bond yields are at abnormally low levels on a historical basis Grice recons they provide a far more attractive investment proposition than the return-free risk currently seen in the government bond market.

The inflation shelter provided by grains and the like is an added bonus.

But for many investors agricultural commodities give them the jitters. The market is seen – not entirely without reason – as speculative, opaque and unstable.

Solution:  Grice recommends to gain exposure via the cosier world of equities. Using a rough and ready valuation methodology he suggests to dip into the world of agri stocks by buying those with the highest return on equity weighted against  their price-to-book ratio – essentially those companies that currently look cheap.

This strategy, he notes, would have returned more than the entire stock market since 1987.

Now, you have been informed.

Financial Times

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