An ETF for Growing Appetites

Global food consumption is growing. By 2050 the world's population is projected to reach 9 billion, up from 7 billion today. Yet, because diets are improving and an increasing portion of the harvest will be converted into biofuel, agricultural output will likely need to double by 2050 in order to meet demand. Farmers will need to improve crop yields in order to meet this demand because most of the world's arable land is already in use. While advances in technology will likely make this challenge more manageable, companies on the cutting edge of the agriculture industry already provide solutions to help farmers improve their yields. The demographic shifts over the next few decades provide a sustainable tailwind that should drive demand for their products.

Despite its silly ticker, Market Vectors Agribusiness ETF MOO offers a serious way for investors to address these concerns. It provides global exposure to the agriculture industry by investing in companies that sell agricultural equipment, chemicals, and seeds, such as Monsanto MON, Potash Corporation of Saskatchewan POT, and Deere DE. Agriculture commodity prices have a significant impact on the performance of most agriculture businesses because their customers' income and demand for inputs, such as tractors and fertilizer, is tied to grain prices. Yet, commodity prices do not tell the whole story. For instance, a drought can increase the price of corn but decrease the size of the harvest, which may reduce farmers' incomes and their demand for equipment and chemicals. Consequently, the fund's performance may diverge from grain prices. Although weather can have an unpredictable impact on the supply and prices of agriculture commodities in the short-run, the long-run economics of the agriculture industry are compelling. This fund is a suitable satellite holding for investors who want to profit from growth in global food consumption and are willing to ride out wild fluctuations in commodity prices that can erase value with little warning. Investors who are looking for direct exposure to agriculture commodity prices should consider PowerShares DB Agriculture DBA, which holds commodity futures contracts.

Because demand for agricultural products depends on both grain prices and the size of the harvest, MOO's performance can be volatile and susceptible to adverse weather conditions. Operating leverage magnifies the impact of fluctuating grain prices on the performance of the fund's holdings. As a result, over the past five years, the fund experienced a standard deviation of 30.5%, while the S&P 500's was 19.1%.

Although the weather can create significant supply-side shocks that can affect MOO's performance in the short-run, demand will drive the fund's performance in the long-run. Global population growth and improving diets in emerging markets are sustainable trends that will increase the demand for food over the next few decades. However, rising demand is not synonymous with rising grain prices because advances in technology can improve crop yields. Fortunately, many of the fund's holdings provide solutions to help farmers improve their yields. This distinguishes MOO from pure commodities offerings and makes it a better access vehicle for investors who want to capture the benefits of demand growth.

Fundamental View
The USDA revised its crop-yield estimates down in the wake of one of the most severe droughts in recent U.S. history. Its most recent estimate for corn yield, 123 bushels per acre, is significantly lower than its initial spring estimate of 166 bushels per acre. The resulting grain shortage has pushed prices higher across the board but had an especially significant impact on corn and soybean prices. It appears that crop prices have increased enough to offset the negative impact of lower yields on farmers' incomes. Elevated prices also give farmers an incentive to plant a large crop in the spring of 2013. This bodes well for seed and machinery makers, such as Monsanto and Deere, who will likely see healthy orders next year.

The impact of the drought on the demand for fertilizer is more ambiguous. With low crop yields, relatively few nutrients have been drawn out of the soil this year. As a result, farmers may reduce their application of potash and phosphate fertilizers next year. However, this may be offset by the recent decline in dealer inventories of potash and phosphate and a larger 2013 crop. Demand from India and China is unpredictable but can also have a significant impact on these fertilizer prices.

The outlook for nitrogen fertilizer is more favorable. Corn requires application of nitrogen each year. With corn near record prices, we are expecting farmers to plant a large corn crop next year, which should translate into strong demand for nitrogen. Low natural gas prices, one of nitrogen's most significant cost drivers, should boast the profitability of nitrogen fertilizer producers, such as CF Industries CF.   

Because erratic weather and fluctuations in grain prices dominate the headlines and, at times, MOO's performance, it can be easy to overlook long-run demand growth. However, the long-run growth in global food consumption provides the most compelling reason to invest in the fund.