An Unexpected Hurdle For The Food & Beverage ETF (PBJ)

by on August 16, 2010 | ETFs Mentioned:

There is no shortage of obstacles facing the food and beverage industry in the current environment. Elevated unemployment levels have caused consumers to pare household budgets, and ongoing jitters over more turmoil in the future have led many to steer clear of high margin items in favor of the basics. Moreover, emerging worries over deflation have threatened to put an effective price ceiling on staple items, potentially erasing profits in labor-intensive corners of the industry [see ETFs For Deflation Defense].

As if those worries weren’t enough, the industry also has to worry about a potentially devastating sugar beet shortage stemming from an unexpected judicial ruling.

Last week a U.S. District Judge in San Francisco struck down the government’s approval of genetically modified sugar beets, blocking use of a crop that has been used for the last five years. Genetically modified sugar beets account for about half of U.S. sugar production, but could be off limits if new regulatory approval isn’t granted by next spring.

Modified sugar beets already in the ground will be allowed to remain there, meaning that there is no shortage looming in the short term. And it seems likely that regulatory bodies will ultimately approve the use of the modified beets, which are altered in the same way as most of the corn, soybeans, and cotton grown in the U.S.

It’s important to note that the judge didn’t ban the use of the modified seeds, but rather ruled that the U.S. Department of Agriculture hadn’t fulfilled its obligation to consider the environmental impact of sugar beets that are immune to weedkiller. The concern raised by the Sierra Club, Center for Food Safety, and other organizations is that widespread use of the modified beets could spur the evolution of weedkiller-resistant plants.

ETFs To Watch

So what does all of this mean for investors? If the USDA completes its regulatory review process and re-clears the planting process, maybe nothing. But if that process drags out, or if sufficient concerns over the environmental impact prevent re-approval, a number of companies could feel the pinch.

One ETF that seems to be potentially impacted is the PowerShares Dynamic Food & Beverage Portfolio (PBJ), a fund comprised of stocks of U.S. food and beverage companies. “Food companies that depend on a steady supply of U.S. sugar face uncertainty over where they will source their sugar beets after next year,” writes Scott Kilman. Sugar is a key raw material for many food and beverage firms, and a significant disruption of U.S. supplies could wreak havoc on the industry’s procurement and production processes [also read Does Your Portfolio Have A Craving For PBJ].

Another ETF to watch as this drama unfolds is the exchange-traded note from iPath that offers exposure to sugar prices through a futures-based strategy. The Dow Jones-UBS Sugar ETF (SGG) has been one of the worst performing commodity ETFs so far in 2010, losing nearly half its value before a recent rally that brought the year-to-date return to just -25% [see SGG's return profile]. If a big chunk of the U.S. sugar production disappears next year, the price of the commodity could skyrocket [also see Three Ways To Play Jim Rogers' Advice].

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Disclosure: No positions at time of writing. Picture is courtesy of JWGreen.