Demand for biofuels across the world will lead to a huge jump in investment in the soft commodities sector, according to Baring Asset Management.
In a paper entitled ‘Feast or Famine? Latin America and the soft commodity cycle’, Nudgem Richyal, manager of the Baring Latin America fund, says the commodity sector works in very specific phases.
Richyal says: “It seems clear that the commodity cycle has finally turned. We have seen strong performance from the energy sector, and history shows that soft commodities, such as soybeans, wheat, sugar and oats, tend to be the next area to see inflows of capital in each commodity cycle.
“Secondly, against the backdrop of concern about global warming, demand for soft commodities such as biofuels has grown exponentially.
“This has created a source of demand that simply was not present to the same extent in previous cycles, and is acting as a further positive support for commodity prices.”
Richyal says the most attractive opportunities in the sector can be found in Latin America.
“There are many reasons why, although there is a time lag, soft commodities tend to follow energy in the commodity cycle,” he said.
“The most obvious one is the link between higher energy costs and higher production and transportation costs for soft commodities. As the cost of production creeps higher, producers need to increase prices.
“In addition, though, there is a new dynamic in play in the soft commodities markets: competition between people and combustion engines for the same resource.
“It is a simple process to turn sugar into ethanol, and the price of sugar has started to be determined not just by how much refined sugar people consume, but by the price of ethanol as fuel.
“The same dynamic applies to many other soft commodities. As fuel prices rise, so too the price of those soft commodities that can act as substitutes – biofuels – begins to move higher too. The region of the world with the most efficient agrarian sector is Latin America, with Brazil and Argentina in particular standing out," he continues.
Richyal also says Asia and the rest of the world will look to Latin America for soft commodities rather than seek to supply themselves.
He says this is because farm land in China, India and other parts of Asia is declining, whereas Latin America has “ample land” available.
Tim Guinness, manager of the Investec Global Energy fund, agrees the soft commodity market looks set for extra investment.
“Clearly there is going to be a big expansion of demand and production of soft commodities for biofuels,” he says.
“This is going to bring quite a number of new players into the market. Some of these are going to be building midstream plants and they are going to be interested in potentially hedging their input and output.”
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