NTR - DBA: Agricultural Play Aims To Give Best Of Both Worlds

2023-11-30 14:56:58 ET

Summary

• Invesco DB Agriculture Fund aims to make investing in commodities easier for investors.
• The fund tries to avoid the negative effects of contango by finding the best contract to own for the next 12 months.
• We examine the setup.

The last few years have seen quite a few supply imbalances within the commodity markets. In 2021, we saw lumber prices go vertical. In 2022, it was oil, European Natural Gas, and wheat which felt the brunt of the Russian invasion. In 2023, it has so far been dominated by Cocoa.

Orange Juice has not exactly been a slouch either.

Investors tend to have difficulty in investing in commodities as the process is very different from investing in stocks. One fund that aims to make this easier (at least on a relative basis) is Invesco DB Agriculture Fund ETF ( DBA ).

The Fund

The Invesco DB Agriculture Fund "seeks to track the performance of the DBIQ Diversified Agriculture Index Excess Return (DBIQ Diversified Agriculture Index ER or Index) plus the interest income from the ETF's holdings". These holdings are primarily made up of US Treasury securities and money market income securities. So how does this work?

The Mechanics

When you go long (one cannot call this a purchase) in a commodity futures contract, you are essentially speculating on the price of the commodity for a specific month. At contract expiration (or usually 3-4 business days prior, depending on the broker), investors have to close these out and "roll" to the next futures contract. In the absence of this role, you would actually have to take delivery of the contract. Pretty much no investor is looking for 5000 bushels of Corn to show up on their doorstep as part of their diversification strategy. So this delivery is to be strictly avoided. One exception here might be the precious metals contracts, where the associated bullion is manageable from a delivery standpoint. But generally, contracts are rolled, and most brokers will force you to close or roll contracts near expiration, as they are not set up to arrange delivery either.

This "roll" can be problematic in most commodities, most of the time. The reason is that most markets spend a lot of time in a state of Contango. Contango is a state where further out prices are more expensive than the front month. So if we see Wheat Futures (ignore the cash price), we can see December 2023 is the lowest price of all. So if you rolled the contract you would sell near $555 and then have to purchase the March 2024 nearly $583.

This Contango is an absolute killer for returns as you buy high and sell low.

United States Oil Fund, LP ETF ( USO ) which started trading more than 17 years back, did so when Crude Oil prices were at $70.00. Today we are a bit over that on Crude Oil prices per barrel, but note the performance of the fund.

That is Contango in action.

DBA In Action

DBA like its sister funds Invesco DB Energy Fund ETF ( DBE ) and Invesco DB Base Metals Fund ETF ( DBB ), tries to sidestep this issue. Instead of mechanically buying the front months and rolling endlessly while decimating investor dollars, it tries to find the best contract to own for the next 12 months. Rolls are done sparingly (DBA and its index are rebalanced and reconstituted annually in November) and in some cases, the roll can actually be beneficial, thanks to the opposite of Contango, known as Backwardation. The fees are a bit high relative to what ETFs charge these days, but it is a special type of fund and one could argue that it is worth the 85 basis points of management fees.

The Fund is designed for investors who want a cost-effective and convenient way to invest in commodity futures. The Index is a rules-based index composed of futures contracts on some of the most liquid and widely traded agricultural commodities. You cannot invest directly in the Index.

Current Setup

DBA owns a bushel of commodity futures including Sugar, Soybeans, Corn, Cattle, Cocoa, and Coffee.

As can also be seen in the chart above, most of these futures are many months out, with the exception of Feeder Cattle Futures. One additional detail here for those unfamiliar with futures is that your money can be held in Treasury bills or a similar cash-like riskless instrument while you are long the Futures. So you can earn cash-like returns on your investment in addition to the potential upside.

You can see below that DBA is capitalizing on this as well.

Performance

While the theory has been good, the returns have been so-so, especially if you go all the way back to the fund's inception.

In fact, the fund has had negative returns over 10 years and since inception. This should not surprise anyone who follows the CRB. Granted the CRB index is all commodities, not just the agricultural ones which DBA invests in, but they tend to move in the same direction over time. That CRB index is down about 15% since DBA's inception.

We also had ZIRP for the 2009-2021 timeframe, and DBA could not get a boost from the risk-free rates. So DBA has done exactly as it should have on a longer-term basis.

Verdict

We may be moving to an age of scarcity within commodities. Capex levels are very low, especially relative to where they need to be.

Agriculture does not exactly fit into the same picture, as it is not a capex sensitive sector. But indirectly, there are repercussions. For example, higher oil and natural gas prices tend to create higher fertilizer prices, which tend to create higher soft commodity prices. DBA is one way to play this. With the high interest earned on the cash portion and a more intelligent way of finding the right futures, the ETF does offer you an easier way to try to play the agricultural market. The evaluation though, should not be relegated to just the futures. There are other ways to play this area and one could argue that the Fertilizer producers like The Mosaic Company ( MOS ) and Nutrien Ltd. ( NTR ) could make a good alternative. REIT investors might even gravitate towards farmland ownership via Farmland Partners Inc. ( FPI ). We think that stocks also offer better prospects and hence are not purchasing this ETF at present.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

For further details see: