If prices at the pump are killing consumers, then food prices are about to kick them while they're down.
After the worst drought in 90 years wreaked havoc on domestic agriculture production this summer, the United Nations Food and Agricultural Organization (FAO) released a report concluding that food prices are set to skyrocket, while further disruptions in food supplies in 2013 could lead to a major hunger crisis.
This bleak outlook is being driven by record-low grain inventories, with domestic reserves recently falling to their lowest level since 1974 at just 6.5% of annual consumption. It has also sent grain prices jumping to multi-year highs, pushing the FAO Food Price Index to 216 points in September. This was near last year's record levels that sparked food riots in Northern Africa and the Middle East.
All of this spells big trouble for food prices. Even though this will make trips to the grocery store more expensive, the good news is that it's creating a big investment opportunity for investors.
The best way to capitalize on rising food prices is with the iPath DJ-UBS Grains TR Sub-Idx ETN (NYSE: JJG), an exchange-trade note (ETN) that provides investors with exposure to the price of corn, beans and wheat.
Shares are up an impressive 30% since June. Take a look at the big gains below...
Before this ETN launched in the fall of 2007, investors could only access grain markets through the use of derivatives contracts such as futures and options. But the iPath Grain Index leveled the playing field and provided investors with tools to access markets once restricted to insiders.
It's important to remember that higher food prices don't always translate into more profits for food companies. Not only are those price increases merely a response to higher input costs, but food companies have limited pricing power with consumers. This means a 40% surge in the price of corn can have a crushing effect on the margins of food companies, as we saw this summer.
Channel location is the key to the conversation. Going deeper into the distribution channel gives investors access to companies with more pricing power. This dynamic was on display this summer when McDonald's (NYSE: MCD) and Archer Daniels's Midland (NYSE: ADM)'s margins were hurt by rising input costs. Meanwhile, JJG jump to a new 52-week high to nearly $65. Take a look at how differently these two strategies have traded…
Beyond channel location, it's also important to consider how higher food prices weigh on consumer spending. Lower consumer spending is bad for gross domestic product and earnings, two factors that have a negative effect on equity prices. This would be bad for share prices of food companies that are increasing prices just to compensate for higher input costs.
Beyond long-term fundamentals, the JJG's strong average daily volume of 85,000 contracts provides plenty of liquidity to soak up bigger orders and trades. Its expense ratio of 0.75% is a sharp discount to the category average of 2.5%, while bid-ask spread of only pennies wide reduces price slippage when executing orders.
Risks to Consider: Grain prices have already seen a big jump this year and remain near multi-year highs. Although the United Nations is warning about continued shortages in 2013, the market has priced in some of those expectations.
Action to Take --> This grain ETN is easily the best way to benefit from rising food prices. Investing at the top of the distribution channel gives investors access to additional pricing power unavailable with other food stocks. And with the United Nations projecting food and grain shortages to accelerate into 2013, this ETN is in position to at least retake its all-time high of almost $65, and possibly move higher.