MarketNotes

Investments to Dine For - Soft Commodities

"Soft" commodities (aka, softs) are those commodities that can be grown, such as wheat, corn, coffee, sugar and cattle. While the press has had a lot of noise about rising commodity prices, recently, for the most part, all the talk has been about energy (think, oil and natural gas) and "hard" commodities such as aluminum, gold, zinc and silver. With the prices of those goods at or near record heights, it may be time to take a look at the other commodity story: the softs.

The prices of hard commodities have been driven by a variety of factors, but perhaps most significantly by growing demand from large, developing economies such as China and India. With rapidly modernizing economies, growing populations and increasing consumer power, these countries are beginning to devour resources at a pace that rivals North America.

The same forces that pushed the prices of energy and hard commodities to their highs are also driving demand for soft commodities. While it's true that softs never go out of style (folks always have to eat), their current low prices combined with rising global demand are making a very convincing case for investing in soft commodities today.

Population growth and increasing wealth

The world's population is expected to top 8 billion people by 2025, increasing by almost 2 billion between now and then. That is a lot of additional mouths to feed, but that's not the whole story.

In China alone, the urban population is expected to grow by 270 million people over the period. Urban populations benefit the most directly from increasing prosperity, and the impact on dietary habits can be dramatic with increased consumption of meat.

It takes grain and corn to produce meat and increased meat consumption has a direct impact on the prices of these commodities. This is a scenario that is playing itself out in numerous developing economies, with potentially global ramifications for the price of a wide range of soft commodities.

Loss of agricultural lands to urban development

Agricultural capacity is not keeping pace with rising populations and changing consumption patterns. While the world's population is expected to grow by almost 2 billion people over the next 20 years (think about it; 2 billion more mouths to feed), arable land is expected to grow by only 0.2 to 0.3% per year over the period, according to the Food and Agriculture Organization of the United Nations.

Indeed, in numerous countries, urban sprawl is eating into traditional agricultural land. In the 1990s, China lost one million hectares of farmland each year to urbanization and industrialization. The US loses 400,000 hectares each year.

Barring some unforeseen technological innovation, productivity per acre of arable land is not expected to rise dramatically. Thus, conditions are set for significant growth in prices for soft commodities.

Impoverished soil

Production capacity is further diminished by the poor land management practices in many developing regions. Overgrazing and deforestation are leading to massive soil degradation and reduced agricultural productivity.

According to the International Food Policy Research Institute, about 8.7 billion hectares of land worldwide is used for human purposes, and about 3.2 billion hectares are potentially arable. Less than half of that land is actually used to raise crops. Recent global studies indicate that soil quality on three quarters of the planet's agricultural land as been relatively stable since the middle of the twentieth century. However, as for the reamining quarter, degradation is common and the pace of decline has increased over the past 50 years. Despite agricultural advances in much of the world, productivity has actually decreased on approximately 16% of agricultural land in developing countries, especially in Africa and Central America. Almost 75 percent of Central America's agricultural land has been seriously degraded as has 20 percent of Africa's and 11 percent of Asia's.

Increasing non-food use

Will you fill your gas tank with corn some day? Maybe sooner than you think. With governments under pressure to reduce green house emissions and become less dependent on fossil fuels, there is rising demand for alternative energy sources. One solution is ethanol a more environmentally-friendly alternative to gas that happens to be made most commonly from ordinary corn. The US government has stated that use of ethanol as an energy source must double to 7.5 billion gallons annually by 2012.

Softs provide powerful diversification

Softs are non-correlated with traditional asset classes. While the prices of hard commodities, which are used for industrial purposes, tend to move with equity markets, soft commodities show little correlation with the performance of major equity and bond markets. That means Softs can provide a powerful source of diversification, smoothing out the ups and downs of your investment portfolio.

4-week Returns from Jan. 1, 1993 to Sep. 15, 2006
S&P/TSX 60 0.06
S&P 500 0.00
Scotia Domestic Bond Universe - Overall -0.17

How can you participate?

Conditions are right for increased demand for agricultural products on a global basis. But how do investors participate in this market? Traditionally, softs are traded on commodity exchanges, but for the most part, these markets are the domain of the pros the institutional investors. Even most professional financial advisors do not make a practice of venturing into this world. So how then are you going to benefit from the anticipated rising demand for agricultural products?

A simple solution

ONE Financial has recently launched a Principal Protected Note based on two major soft commodity indices: the Goldman Sachs Agriculture Excess Return Index and the Goldman Sachs Livestock Excess Return Index.

In addition to providing you with exposure to this important asset class, the ONE Financial CASH+ Breakfast Notes provide 100% principal protection, tax-advantaged quarterly Return of Capital distributions (based on money market-like rates), and enhanced income and growth potential (up to 2X exposure).

Without a doubt, the ONE Financial Breakfast Notes are the easiest way for you to participate in the soft commodity marketplace. The question now is, are you ready to take advantage of the solid opportunity offered by softs?

Guaranteed by BNP Paribas

The ONE Financial CASH+ Breakfast Notes are guaranteed by BNP Paribas, the 6th largest bank in the world. Established in 1848, BNP Paribas operates in over 85 countries and has approximately 100,000 employees worldwide. BNP Paribas has assets totaling approximately $1.7 trillion, and is approximately the size of Canada's five largest banks combined.

This document contains information that ONE Financial Corporation believes to be correct at the time of production. An investment in the Notes may not be suitable for all investors. Important information regarding these Principal Protected Notes is contained in the Information Statement; investors should obtain and carefully read a copy (available on request) prior to investing, paying particular attention to the associated risks. *Cash Rate is equal to the Canadian Overnight Repo Rate (CORRA) less 0.50%, and is initially targeted to be 3.75% based on rates as at October 17, 2006. Based on these rates, annual distributions could range from 7.5% (2X exposure) to 0% (zero exposure). Please see the Information Statement for further details regarding basket historical returns; past performance is not indicative of future returns. Commissions, trailing commissions, management fees and expenses all may be associated with these investments. In the event of any discrepancy between the information described herein and the Information Statement, the terms of the Information Statement govern. 100% of principal is guaranteed by maturity only for products purchased at their issue price and held to maturity, and there is no assurance that any additional returns will be generated. BNP Paribas is a trademark owned by BNP Paribas S.A. ONE Financial, the ONE Financial logo, "CASH+ Breakfast Notes", "Wealth through innovation" and "We believe in better ideas" are trademarks of ONE Financial Corporation.