The best resource stocks for your dollar as food prices soar

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John Reese is founder and CEO of Validea.com and Validea Capital Management, and portfolio manager for the Omega American & International Consensus funds. Globe Investor has a distribution agreement with Validea, a premium Canadian stock screen service. Try it.

One of the most important economic stories of this summer has been the widespread drought that has ravaged the agricultural heartland of the United States.

Over a third of the Midwest was suffering from extreme or exceptionally dry conditions at the end of July. It's been nearly six decades since the U.S. has seen conditions like this. The result: Corn and soybean prices have hit record highs. The drought is just the latest in a string of factors that have driven global food prices higher. The United Nations' Food Price Index is more than 35 per cent above its 2009 level; it has shot up more than 135 per cent in the past decade.

While high food prices are an annoyance in Canada, they are political dynamite in poorer parts of the world. Skyrocketing food prices were a big factor in the Arab Spring uprisings in the Middle East and Northern Africa.

Jeremy Grantham of the investment firm GMO in Boston is one of the more insightful strategists you'll find, and he thinks this is only the beginning of the world's adjustment to higher costs for food. Mr. Grantham dedicated his latest quarterly investment letter to the issue of food shortages, offering a very troubling outlook.

"We are five years into a severe global food crisis that is very unlikely to go away," he said. "It will threaten poor countries with increased malnutrition and starvation and even collapse. Resource squabbles and waves of food-induced migration will threaten global stability and global growth."

Mr. Grantham doesn't see the crisis abating until the global population has "considerably declined" from the nine billion peak it is expected to reach in 2050. Even if the world can produce enough food to feed everyone (which he sees as a huge challenge given the combination of population growth, dwindling supplies of potash and other fertilizers, and climate change), higher input costs will mean higher food prices, which many won't be able to afford.

Mr. Grantham does see some hope on the horizon, notably the improving abilities of scientists to make crops more efficient using genetic engineering. He says countermeasures could be taken to help stem the crisis, but thinks the problem is not immediate enough for wealthier nations like the U.S. to take action.

The food issue is first and foremost a human one: I hope that political leaders, the agriculture sector and science will work to alleviate the impending crisis. But the combination of a burgeoning population and dwindling resources also has investment implications. Mr. Grantham says resource stocks should outperform "over the next several decades," with companies in the farming and forestry sectors "at the top of the list." He recommends that long-term investors have at least 30 per cent of their portfolios dedicated to resource-related stocks.

I wrote about Mr. Grantham and resource stocks about a year ago, when he had mentioned similar themes. Since then, many resource stocks have been hit hard on fears of a global economic slowdown. But Mr. Grantham stresses in his recent letter that these are long-term plays, and I think the area is worth another look. I used my Guru Strategies (which are based on the approaches of such investment greats as Warren Buffett and Benjamin Graham) to find some of the most sound resource stocks. Here's what turned up.

Potash Corp. of Saskatchewan Inc.

This Canadian powerhouse is the world's largest fertilizer company, responsible for about 20 per cent of global potash capacity. It has been growing earnings per share at a 24.6 per cent rate over past few years, part of why it gets a nod from the model I base on the writings of mutual fund legend Peter Lynch. Mr. Lynch famously used the P/E-to-growth (PEG) ratio to find bargain-priced growth stocks. When we divide Potash Corporation's 14.9 price/earnings ratio by the firm's long-term growth rate, we get a PEG ratio of just 0.60. Anything under 1.0 is considered a bargain.

The Lynch approach also likes the company's reasonably low debt/equity ratio, of 47 per cent.

Inmet Mining Corp.

I wrote about Toronto-based Inmet, which produces copper and zinc, a few months back. Since then, mining stocks have struggled, but my Benjamin Graham-based model still likes Inmet.

A big reason is its solid balance sheet. Inmet has $1.3-billion in net current assets and just $17-million in long-term debt. The stock has also been trading for just 9.7 times earnings and under book value.

Agrium Inc.

Calgary-based Agrium provides an array of agricultural nutrients, products and services, including potash, phosphate, and nitrogen. The company has a 44 per cent long-term growth rate and trades for 11.4 earnings, making for a stellar PEG ratio of 0.26. Even better, its inventory-to-sales ratio has been declining, a sign its products are in demand.

Full disclosure: I own U.S.-traded shares of Agrium.