Three reasons agricultural commodities will rise

Climate change and a growing global population are putting pressure on supplies of agricultural commodities. That means great opportunities for agribusiness - despite the odd setback.

Time to talk turkey... literally.

In America, most of us are pretty spoiled when it comes to our bellies. We live in a wealthy country where we don't have to worry about having enough food. In addition to the regular supermarkets and farmer's markets, we also have specialty stores that offer a plethora of organic and natural foods.

Nothing to be concerned about, right? Not exactly.

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While we sit and munch away on our nachos and fruit, there are some global developments taking place that are posing an increasingly serious risk to our food production.

But as we've talked about in previous messages with regard to water and uranium, if there's one thing a supply-demand crunch brings, it's profitable investment opportunities. Let's take a look at the situation...

A Small Number With Big Consequences

On Thursday, political leaders from the world's most powerful 'G8' countries agreed on a deal that pledges 'substantial' cuts in greenhouse gas emissions in an effort to arrest the negative effects of climate change. Specifically, it targeted a 50% cut by 2050.

This is just as well, because over the past century, the world's temperature has risen by 0.74 degrees, according to the United Nations.

While that doesn't sound like a big deal, it's enough to trigger some pretty serious events...

For example, Greenland's massive ice cap, covering 624,000 cubic miles and accounting for one-tenth of the world's fresh water supplies, is melting much faster than expected. Not surprising, considering that winter temperatures on the cap have risen by 9 degrees Fahrenheit over the past 15 years. Over the past 30 years, the cap's 'melt zone' has swelled by 30%. That's significant, because the more it melts, the faster the ice sheet slides towards the ocean. Considering that Greenland has enough ice to raise sea levels by 23 feet, if it melted completely, major cities like New York and London would flood.

According to the United Nations' Global Outlook for Ice and Snow report, if world sea levels were to rise just 3ft, 3in, it could cost $950 billion in damage and expose 145 million people to floods.

Right now, however, higher temperatures are causing some crippling droughts in many parts of the world and have lowered crop yields for farmers. In fact, global wheat production has slumped to a 25-year low, due in part to climate changes.

So how is the world going to get fed?

Never Mind Feeding The 5,000... How About Feeding 1.3 Billion?

With 1.3 billion mouths to feed, it's no surprise that China needs its agricultural output to perform at high capacity. But according to the United States Department of Agriculture's (USDA) recent Commodity Intelligence Report, the 2006-2007 winter was the second-warmest on record. And now, 'the warm temperatures and seasonal dryness has resulted in light to moderate drought in many areas of the country.' Droughts are about as friendly as Darth Vader when it comes to producing massive crop yields.

Switching to Europe, the USDA report also stated, 'Widespread spring dryness developed over much of Europe, stressing crops.' Overall, wheat production in Europe this year is expected to be 2.1 million tons below the 5-year average.

But here's where the story takes a twist...

The Agriculture Equation: 50% Growth In 13 Years

According to the United States Census Bureau, there are just over six billion people on the planet right now. And in continents like Africa, there are already millions of people starving.

But by 2020, there will be three billion more people in the world. That means we're essentially going to have to figure out how to boost global agriculture production by 50% over the next 13 years, just to meet the population growth of the world.

That's a major red flag... but a major red alert for investors, too. You see, what we're talking about here is a 'perfect storm' for higher agriculture prices.

Let's dig a bit deeper into the story and take a look at the profit-triggering trends...

Hedging The Harvest: How Bunge Bungled Its Commodity Strategy

With climate changes contributing to food shortages, it's only logical that agriculture prices are going to rise as a result. That could begin to change the approach that many agriculture companies take to commodity hedging. And it's something that could potentially increase net income at the same time.

For example, let's take a look at Bunge (NYSE:BG), a worldwide leader in 'agribusiness' in over 32 countries. The company produces fertilizer, animal feed, oilseeds and grains, consumer food products, and milled wheat and corn for commercial food processors.

As you can see from the company's 46% year-over-year surge in first-quarter sales, lower supply and higher prices is already beginning to have an impact. Okay, now for the bad news: The company took a massive hit, too. Net income slumped 76% during the quarter.

How is this possible, given the rosy picture I just painted? It's because the loss actually had little to do with the company's agriculture output; it mostly occurred because of pretty ugly unrealized market-to-market losses on hedged commodity inventories in South America.

This basically means that the futures prices of agricultural commodities increased by more than current prices. In other words, farmers sold the actual crops for less than where the futures were trading, because Wall Street has priced in an expected future demand spike for commodities like corn-based ethanol. This turned Bunge's commodity-hedging strategy into a disaster.

But farmers in South America who actually sell crops don't operate on the same level as Wall Street, and probably don't care anyway. We're talking about farmers who just want to sell their crops, not become futures traders or industry analysts.

And because of this disconnect, Bunge got burned - and it provides a valuable lesson in commodity hedging versus simply trading on the real 'cash price' of crops...

Fields Of Gold

When the gold market turned particularly unpredictable a few years ago, many gold companies decided to hedge their production in an attempt to protect themselves against volatile prices.

Over the past few years, though, we've seen a shift in the opposite direction, as more producers have begun moving away from hedging. Their reasoning is that futures prices can often be even more erratic than the actual spot price of gold itself.

The same theory applies in the agriculture sector. And given Bunge's recent hedging horror show and consequent earnings massacre, agri-businesses might start following the example of gold producers, and hedging less in the coming years.

And, if global agricultural prices do continue to climb, a move away from commodity hedging by agri-businesses could actually bolster bottom lines.

And speaking of the bottom line... as the global population grows, it will result in higher agricultural demand and higher prices. This, coupled with a possible move away from commodity hedging, could create strong momentum for many agri-business stocks - and investors could reap the rewards in their portfolios.

By Mark Whistler, Small Caps Specialist, Mt. Vernon Research for the

Smart Profits Report