There are many reasons to buy into the commodity boom. The world’s population is increasing and even the UN is starting to question if this growth is sustainable. With a limited amount of arable land, constraints in agricultural inputs, concerning crop yields, and a growing demand for meat there are many factors pushing commodity prices higher.
It is common to hear that the printing of money by the government will push prices even higher, but this analysis has serious problems. Investors who don’t examine history risk making choices on weak evidence and needlessly complicating their decision making process.
Why Ignore the Money Printing?
In a credit based world, banks lend money to people and business. A mortgage for the construction of a new home is a great example. In older economic theories banks are presented as being constrained by the number of reserves they have. In these models the banks cannot lend until they have enough reserves in the bank to cover the new loans. In this thinking money printing by the government increases the number of reserves in the bank and thus causes inflation when the banks make new loans.
Empirical evidence tells a different story. The chart below shows how reserves have exploded and yet U.S. inflation has remained essentially the same. Major central banking officials and the Bank of English believe that banks are not constrained by reserves. America’s adventure with quantitative easing has not produced hyperinflation or the collapse that some predicted.
US Excess Reserves of Depository Institutions data by YCharts
What about Hyperinflation?
It is common to hear predictions of hyperinflation because of runaway government printing. It is easy to get someone to listen to you when they believe that all currencies will be worthless by tomorrow morning.
A look at hyperinflation over the past hundred years shows that it is commonly associated with regime change and substantial amounts of foreign denominated debt. Post World War I Weimar Germany and Zimbabwe had massive amounts of foreign denominated debt along with regime change. Argentina faced large foreign denominated debts during their recent bout of hyperinflation.
Where to Invest
Disregarding government printing, commodities have face strong upward pressures because of a growing world and slowing yield growth. PowerShares Agriculture Fund is based on a number of staple commodities. Currently live cattle, sugar #11, and soybeans have the biggest weightings between 13.4% and 12.9% of the fund. Other staples like cocoa, coffee “C”, and corn are similar with weightings between 11.9% and 10.6%.
Together these commodities make the fund a pretty good representation of what you use on the kitchen table. The downside is that the greater exposure to unstable commodities like coffee can boost the fund’s volatility.
Rogers Intl Commodity Agriculture is a fund set up by the famous hedge fund trader, Jim Rogers. Corn, wheat, cotton, and soybeans are the main commodities in the fund with weightings between 13.6% and 10.0%. Coffee, live cattle, and soybean oil are of secondary importance each with a weighting of 5.7%. Compared to PowerShares’ fund, Jim Roger’s creation offers a more concentrated exposure to primary agricultural commodities grown in America.
Where not to invest
SPDR Gold Trust (ETF) (NYSEARCA:GLD) owns over 1,200 tonnes of gold. Fear and sentiment are some of the forces driving the price of this fund. When people worry about war or a government switching from one currency to another they buy gold as a safe haven. This Gold Trust offers a great way to play geopolitical instability, but long term investors who want to invest in global resource constraints should look elsewhere.
Conclusion
There are multiple theories of inflation. Some say that it is mainly caused are supply constraints while other theories state that the printing of money by central banks causes price increases. You do not need to believe one theory or the other, but instead to examine the evidence. The lack of inflation in the U.S. in recent years is strong evidence that the simple printing of government money is not enough to drive price increases.
The DB Agricultural Fund and Rogers International Commodity fund are two good ways to invest in the world’s increasing population and food constraints. A large portion of the SPDR Gold Trust (ETF) (NYSEARCA:GLD) is driven by sentiment and long term investors who don’t want to play with fickle investor sentiment would find a better use for their money in agricultural commodities.
The article Buy the Commodity Boom, But Ignore Money Printing originally appeared on Fool.com and is written by Joshua Bondy.
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