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High grain prices boost agriculture outlook

Friday 17th September 2010
Agriculture stocks have rallied in recent weeks, prompted by adverse growing conditions in Eastern Europe, Russia's ban on
grain exports and BHP Billiton's approach for Potash Corp.

According to Barings, the earnings outlook for agriculture stocks is particularly attractive as farmers capitalise on improved farm economics and high grain prices.

Barings is particularly interested in the long-term earnings potential of fertiliser companies and other suppliers and service providers.

Jonathan Blake, manager of the Baring Global Agriculture Fund said: "While it is not clear if BHP Billiton will ultimately gain control of Potash Corp at this stage, its interest highlights both the long-term earnings potential of fertiliser companies as well as the relative attractiveness of current valuations.

"Increased fertiliser demand should translate into a firmer pricing environment, as improved farm economics and the recent rise in grain prices encourage farmers to maximise yields."

Recent news of wheat supply shortages has led to a pick-up in speculative buying. While concerns of supply shortages are likely to keep prices buoyant in the near term, Barings expects prices to start to reverse as speculative funds take profits, producers hedge and these buoyant prices attract additional wheat acreage in the coming winter planting season.

Blake said: "Global grain stocks are actually at relatively comfortable levels having been built up following record harvests over the past two years, and this should allay fears of an outright food scare. However, the risk of further supply shortages will likely keep prices buoyant in the near term and this will benefit grain processing and fertiliser stocks whilst posing something of a challenge to livestock and other protein producers if sustained.

"Our exposure to this area of the market has been reduced. Whilst many producers will naturally mitigate input cost rises by locking in grain prices by buying stocks forward, in the absence of a corresponding rise in meat, fish and diary prices, future profit margins could be at risk. We prefer grain processing and fertiliser sectors as well as the agriculture
machinery sector. Here, lower raw materials costs, higher prices and the unfreezing of credit markets have allowed farmers to begin to upgrade or replace machinery after a two year lull. This theme has been reinforced by recent results by John Deere, CNH Global upgrading their full-year outlook and AGCO beating sell side consensus earnings."

The long-term structural drivers for agriculture related stocks remain very positive and are underpinned by global population growth and economic expansion in the emerging world and increasing bio-fuel usage. Barings believes that investors will particularly benefit from an exposure to the fertilisers, seeds, machinery and storage sectors, which will be the main
beneficiaries of the increasing investment that will need to be made to ensure that this global demand is met.

Blake said: "While the performance of agriculture stocks will likely remain volatile in the near term as concerns over economic activity in China and worries over European bank financing weigh on investor risk appetite, within the agriculture asset class itself, we believe the outlook for grains has improved in the short-term with ongoing strong demand and
reduced supply projections given the recent global weather patterns experienced in the former Soviet Union and Europe. Farmers, therefore, are incentivised to maximise yields at these higher grain prices, which should lead to stronger demand for agricultural goods and services."

The Baring Agricultural Fund invests in a portfolio of companies that should benefit from both the growing and changing global demand for food.

It encompasses a broad investment universe, from fertilisers and logistical infrastructure for delivery through distributors, processors and marketers to food manufacturers and food retailers. The top three sector holdings are currently agrochemicals, food products and major food diversified. On a country basis, the fund is globally invested with a current emphasis on Brazil, China, Singapore and the United States.

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Mike Jones

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