Population growth trends and changing consumption habits, particularly in the fast growing emerging markets, as well as the biofuel-driven demand may have a long term impact on soft commodity prices, as Oliver Stonner-Venkatarama reports
The recent steep increase in soft-commodity prices is a reminder that the world is rapidly changing and food supplies need to change along with it. China and India being the two most populous countries in the world, will have a progressively greater impact on global demand, not only for hard commodities, which are usually in the spotlight, but also for soft commodities including food, as well.
Consumption habits in Asia are changing, as the average per capita income rises. This trend accelerating, both in China and India, has led to a significant reduction in poverty over the last few years. However, as tastes change, agricultural production and the food industry as a whole, need to adjust.
On top of these structural issues, poor weather conditions have affected output in global food-producing countries, and the increased use of bio-fuels in mature economies has exacerbated the supply and demand conditions for soft commodities in global markets.
Improved weather conditions could bring some short-term relief, but a real cyclical downturn in soft-commodity prices seems unlikely on the back of these macroeconomic and social changes.
Tensions between continuously strong demand for soft commodities and supply bottlenecks, signal investment requirements and opportunities, not only for governments, but also private companies.
The problems that need to tackled are so complex and capital-intensive that they need both public support as well as a private effort for innovation and business success. Activities of the Indian company Reliance provide a good example.
The supermarket chain is only the final point of a new supply chain which starts in the countryside. Farmers taking part in this new project, masterminded by Reliance, get access to the supply network with faster and more transparent price information. These primary markets are linked with retail shops in the cities by a close logistic network. The aim of this holistic approach is to increase efficiency in agricultural production.
However, small farmers still require government support for investments in equipment and irrigation systems. For big farmers, the government should raise the incentives to invest continuously in technical equipment.
There are different ways to take advantage of skyrocketing soft commodities prices. Similar to hard commodities, investing in soft commodities via futures or related investment products, is one way to take advantage of price increases.
However, this approach neglects the need for stronger investments in the agricultural sector. For instance, a company that offers solutions for better irrigation may pose an attractive investment opportunity for public and private investors. Other attractive areas for investment might be logistics or farming technologies that fit the needs of emerging markets.
The broader investment approach regarding soft commodities is also attractive from a different perspective. Instead of benefiting from the social and political implications that arise from price increases, investors can take advantage by resolving the problems.
This positive investment approach may lead to more stable returns due to the fact that the investment is less dependent on primary, volatile price swings.
There is also a strong need for the better utilisation of local farming knowledge which could benefit from modern training methods. Successfully applied, this could lead to a decline in dependence on global agricultural crop supplies.
Difficult climate conditions for agriculture in the Gulf region in combination with the countries' strive for modernisation and environmentally responsible living may prove to be a beneficial by discovering new farming and logistic solutions.
The construction of the Masdar in the UAE may provide the opportunity not only to study in practice new energy, waste and mobility solutions, but also to approach new nutrition challenges.
Appropriate local solutions can be adapted to tackle similar problems in other countries. Supporting research and development activities in these areas may lead to longer-term returns for public and private investors.
Besides energy and logistics, there is a third area of specific knowledge in the Gulf region that is becoming increasingly important to emerging economies; namely the management of scarce water resources.
The problem of water managementwill become more widespread in the coming years and requires solutions that will fulfil the requirements of rapidly-growing population and increased urbanisation, particularly in Asia. Tensions are already apparent, not only between countries, but also between local states within a country, for instance in India.
Improving and expanding irrigation systems for agricultural purposes may lead to new supply bottlenecks in the growing cities, and this needs tackling.
The recent rise in soft commodity prices poses several challenges, particularly for the fast-growing emerging markets, which will not be solved easily. However, price rises create the opportunity for Gulf countries to spend some part of their energy wealth on analysing and tackling these energy, food and water problems.
Funding research and development activities, as well as micro-lending, could be a part of the solution and in return may broaden tomorrow's business base for Gulf corporates.
Soft-commodity prices have probably reached a level that warrant structural changes in demand and supply markets. Further price increases may not only present investment opportunities but also the need for public and private initiatives to tackle price inflation.
Governments and corporates in the GCC have the chance to make a difference by being a part of the solution of future problems. This presents them with an opportunity to shape the future of soft-commodity markets.
Dr. Oliver Stonner-Venkatarama is emerging markets investment specialist for Cominvest Asset Management
Islamic Business and Finance 2008
