Soft commodities

I have been very successful over the past two years investing in energy and commodity funds, especially natural resources such as oil, gas and water. Having made such a good profit, I am interested in using the profit to invest in other types of commodities, such as agriculture-related commodities as I see the demand for the likes of grain and sugar rising as the demand from China increases. What information is available to support this view?

The commodity boom has certainly not reached its peak yet, despite some exceptional three-year performances. Industrial metals, for example, have seen the strongest gains - up 149 per cent over three years and the energy sector up 95 per cent over the same period.

While these and other 'hard commodity' sectors still offer good potential, many analysts are moving their attention to 'soft commodities' this year. These include agricultural commodities such as wheat, coffee and sugar.

Historically, it has been very difficult to invest in such commodities unless you do so by tracking a commodity index, like the Goldman Sachs Commodity Index. Alternatively, you can do so by spread-betting, but this involves much higher risks to your capital.

However, fund managers are now starting to be more and more interested in the opportunities that softs bring and, in the UK at least, new funds are being launched that invest directly into these commodities.

Until now, there has been little interest and, in fact, there has been a long downturn in soft commodity prices for the past 15 years. There are, however, strong arguments that we could be at the beginning of a dramatic change fuelled mainly by the China story as it and other developing country's demand increases as their populations become richer. China has now overtaken America as the world's leading consumer of commodities like wheat and meat.

In 2004, China consumed 382 million tons of grain against 278 million tons in America (source: Earth Policy Institute). China also consumed 63 million tons of meat compared to 37 million tons in America in the same year.

It is argued that there is still plenty more room for growth because consumption per person in China is still a lot lower that western countries. After all, there are 1.3 billion Chinese compared to 300 million Americans!

The Chinese currently consume less than 300 kilos of grain a year per head. To sustain an American-style diet which is rich in meat and dairy they will require 900 kilos because cows and chickens eat a lot of grain.

Taking another commodity, coffee - Chinese consumption is 50 times lower than Switzerland, even though its population is 200 times bigger. It is believed that this gap could shrink as affluent Chinese take more western habits on board.

Like any commodity investing, there are risks and we have after all witnessed a 15-year bear market in soft commodities. The change to more western-style diets of developing countries such as China however must not be ignored and I believe there are certainly opportunities to be taken advantage of (source: The Sunday Times of London, January 22)

Mark Hollingsworth is the director of Hollingsworth International Financial Services - licensed by the MFSA to provide investment services under the Investment Services Act 1994 (IS/32457). Address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively, he can be contacted on 2131-6298/ 9984-2614 (office hours) or e-mail mh@hollingsworth-int.com

Past performance is no guide to the future and, except where amounts are guaranteed, the price of your investments (and the currency in which it is denominated) may fall as well as rise. Your personal tax situation will depend on residence. Always consult a professional adviser. This article does not intend to give investment advice and its contents should not be construed as such. Readers are encouraged to seek professional advice on their personal financial situation.