How to profit from rising soft commodities prices

Times are tough in Japan. Not only do its residents have to put up with regular doses of bad economic data and a stock market that unjustly has spent the year so far in freefall, but now the prices of most of their favourite foods are soaring too.

I mentioned the shock rise in mayonnaise prices across Japan in this column last year (the Japanese appear to find that the taste of most things can be improved with a dollop), but this is nothing compared with what's going on with the price of milk.

This has doubled in the past year, emptying the wallets of cheese lovers across the country and most recently causing popular fast-food chain Cheesecake Factory, caught between fast-rising input prices and static sales prices, to shut its doors for good.

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Of course, it isn't just in Japan where milk prices are on the up. And it isn't just milk prices that are rising. Wheat prices leapt about 150% last year (to a level described as the "agricultural equivalent of $100 oil") while rice prices climbed 180% or so.

Overall, according to Mysupermarket.co.uk, the price of an average basket of supermarket food has risen 12% in the past year. The reasons for all this have been much written about. The supply of food hasn't changed much, despite all the recent droughts and floods. Instead it is about the surge in demand.

The Chinese, as commodities guru and ex-Soros side-kick Jim Rogers points out in his new book A Bull in China, "are famous for eating just about anything". They'll slice out a snake's gall bladder and "squeeze the bile into a wine cocktail" and think nothing of making a meal of "camel's paw".

But these days it seems that it isn't just anything they want to eat. A rise in average incomes, the emergence of the middle classes combined with a good dose of well-judged marketing means the traditional diet of rice and vegetables with a few exotic extras thrown in is being abandoned in favour of a more western diet.

In 1966, Rogers told me last week, only 4% of the Chinese diet was made up of meat. Today it is four times that and, reportedly, there are more statues of KFC's Colonel Sanders around than there are of Mao. At the same time the demand for cheese and milk is rising very fast, partly thanks to the extraordinary speed at which Pizza Hut and Starbucks have muscled their way into the region.

In 2006, China accounted for 13% of global milk production but demand is rising at about 25% a year and should keep doing so for some time. Right now the Chinese consume only a 16th as much dairy per head as the Americans. But there is no reason to think they shouldn't eventually consume the same amount, be it in the form of cheesecake and ice cream or the probiotic yogurts fashionable among Beijing's urban young.

All this protein eating obviously pushes up demand for the sources cows, pigs and chickens. Hence the rising prices of the things cows and pigs eat grain. To produce the 50kg of pork the average Chinese person now eats every year you need 150kg of grain.

Of course, the Chinese aren't the only ones putting pressure on global food supplies. They are joined by the rest of emerging Asia and crucially also by the expansion in the American ethanol programme since 2005. Politicians hope biofuels can solve three of the main problems that come with using oil as their main energy source its fast-rising cost, its nasty environmental impact and its security (better to grow your fuel in Iowa than buy it from Saudi Arabia).

Unfortunately, while we don't yet know that biofuels can do any of those things early evidence suggests they cannot, but the jury is still out we do know that the attempts to find out is adding to the huge pressure on food supplies. This is in turn pushing prices even higher.

Note that the price of palm oil, a standard cooking oil which can also be used as a biofuel, has more than doubled in the past 18 months.

There's not much to be done about all this in the short term. Crop yields in China and India could be pushed up with better irrigation, but water is already scarce in both places.

Marginal land could be pushed into production, but there simply isn't enough of it to increase supplies significantly and it wouldn't be much good for the environment anyway.

Alternatives are to grow more genetically modified foods or to simply dump the biofuels dream. Neither of these things is going to happen in a hurry; the fact is that cheesecake in Japan is going to keep getting more and more expensive for some time to come.

There aren't many good places for your money in the markets this year, but food, it seems, is going to stay one of them.

Note, said Rogers, that while it looks like prices have risen a lot recently on the back of the "very strong fundamental changes" in the market, they are still low by historical standards.

Take inflation into account and sugar is 85% off its all-time highs in the 1970s and coffee would have to rise another 70% before it started to hit record levels.

You can buy into the boom by buying shares in the grains exchange-traded fund (ETF) listed in London (AGGP): it tracks the prices of soybeans, wheat and corn.

Otherwise you might look at a fund I've mentioned before, the CF Eclectica Agriculture, which invests in the companies that will make money out of the boom (tractor manufacturers and the like) or even buy Rogers's book in which he lists scores of Chinese companies already making a killing from the changing eating habits of their nation.

Think China Animal Husbandry Industry Co (SHA:600195), which is a major supplier of animal feeds, or perhaps China Yurun Food Group (HKG:1068), which processes pork and "is the one Chinese firm that knows how to make maple cured bacon and pepperoni".

First published in The Sunday Times 20/1/08