Agricultural commodities: the perfect storm

Paul Michael Jenkins, senior Investment Advisor with Bateman and Company Ltd continues his series of articles focusing on investment trends for the difficult year ahead.

The second agricultural revolution will soon be upon us. Wise investors and portfolio managers are now turning their attention to the once forgotten agricultural industry.

Premonition

Jim Rogers, notable international investor and co-founder of the Quantum Fund (one of the world’s most successful hedge funds) has forecast agricultural investments as some of the most sound and opportunistic investments in the next 20 years.

Mr. Rogers, who is also known for developing the “Rogers International Commodities Index” has been aggressively positioning himself for what he sees as significant growth in grains, soybeans, sugar and other commodities. Rogers is bullish on soft (agricultural) commodities for the two decades citing the decline in land devoted to production and lowest ratios of food-stocks to consumption in past 50 years.

Rogers correctly foresaw the last commodities rally in 1999 and has been vocal in his investments as he has purchased large acreages of farming land in Canada and Brazil.

Backdrop for agricultural investments

Corn, soybeans wheat and cotton are close to their 20 year lows in terms of global prices. Consequently, farmers (North American) have lost the incentive to produce due to their margins being squeezed by lowered prices. As a result North America has seen a slow decline in farmable land. In fact, harvested land area in the United States has declined by 28 million acres since a peak in 1981.

Many farmers are not able to secure financing for fertilisers and other basic operational expenses as the American banking system is not eager to lend to low revenue generating commodity producers. As well, government subsidies once paid to North American farmers have slowly disappeared and the farmers’ ability to lobby the government for assistance fell far behind other larger special interest groups. These factors have lead to a historically low grain stock to usage ratio. In particular the US Department of Agriculture forecasts that global coarse grain levels are expected to fall to their lowest level since 1976/77.

Rising global demand

The emergence of a new middle class consumer in developing countries drastically influences the demand for agricultural production in the foreseeable future. As China and India further develop, there will be a notable increase in per capita incomes and living standards. Understandably there will be an improvement of dietary habits in these developing nations. This change in food consumption will partially drive the increase in demand for agricultural commodities. Consider that in the next decade a combined total of 1 billion Asians (China & India) are expected to migrate from rural to urban centres. As these newer populations develop, they will most likely gravitate toward higher food quality. Note that high value agricultural products such a lean beef and dairy products require a greater input of agricultural commodities used as feed. Consequently a kilogram of animal protein requires four to six times the same volume of grain to produce.

We now see supply and demand out of balance; the principles of economics will always hold true – there will not be enough supply to meet upcoming demand.

This being said, agricultural futures – specifically corn, cotton, soybeans and grain could be the next bonanza if the supply issue is not addressed in the next several years.

Biodiesels

Also contributing to global demand is an aggressive North American desire for alternative energy. Efforts are in process to decrease dependence on petroleum based energy. Biodiesel is estimated to be the fourth largest energy resource after coal, oil and natural gas. Bioenergy is stored in resources such as plants and grains. Specifically sugar and corn have become energy commodities as they are used to produce ethanol which is used to power ‘energy-efficient’ vehicles. Over 50 per cent of the world’s ethanol is produced from sugar alone. Brazil specifically has been at the forefront of bio-ethanol production. Brazilian sugar cane refineries have been switching from refining sugar to ethanol production. Currently sugar-based ethanol powers about 15 percent of Brazilian cars, however by 2015 analysts estimate that 50% of Brazilian vehicles will be powered by ethanol. In addition 85 per cent of new car sales in Brazil are ethanol based.

These and other types of changes from petroleum to organic fuels are mandated by international standards (Kyoto Protocol) attempting to reduce greenhouse gas emissions. It is expected that the trend will continue as governments change their standards regarding biofuels used not only in automakers but also in transportation industries.

Land and water scarcity

Contributing more pressure on food production is availability of land and water scarcity. Farmable land is becoming increasing constrained in the US, Europe, Brazil and China. Specifically in Europe large portions of the arable land have been set aside for ‘conservation’ as environmentalists press the government with their interests.

In China and Brazil urbanisation is shrinking farmable land as populations grow at striking rates and migration moves masses from rural to urban centres

Water scarcity is becoming a major issue for governments worldwide. Climate studies have revealed a direct link between greenhouse gas emission and the acceleration of global warming. Global warming increases average temperatures, probability of drought and the necessity of water for crops and human consumption. Currently clean and drinkable water are taken for granted. Yet with world population growth and increasing food demands water, and water purification, could greatly affect our quality of food stocks and costs associated with agricultural production.

Agflation

‘Agflation’ is a relatively new financial term that pertains to the global trend of food inflation. Analysts are now studying the global trend of rising food prices. We observe that for the first time in over a decade primary producer of food stocks are passing on higher raw material costs to consumers which contributes to agflation. The significant rise in domestic food prices is a major issue that reserve banks and governments must address as social stresses and civil unrest due to higher food costs are becoming far too common.

 

The perfect storm

Rising demand for agricultural commodities in emerging economies coupled with low worldwide supply is one of the major factors that will influence the price of agricultural commodities. With the growth of Eastern emerging economies comes increased disposable income of a new middle class and an appreciation for a healthier and more robust diet. These social issues, along with global desire for biofuels, make a strong case for agricultural commodities to have a position in portfolios worldwide.

All investment recommendations should be reviewed by your investment professional. The opinions expressed here are those of Mr. Paul Michael Jenkins and do not reflect the overall opinion of Bateman & Co., or this publication