Monday, April 18, 2011

Agriculture: A Long-Term Investment Theme

Two recent items reminded me again of the serious challenges facing the world’s food output and the positive investment consequences.

The first is personal, though trivial in the context of global affairs.  Last week I noticed that the price of sunflower for my bird feeders had jumped by 25% in a month.  The proprietor explained that sunflower growers in the Midwest had shifted acreage to corn because of the roughly 75% increase in corn prices since last summer.

Such a shift in acreage is not uncommon, given the vagaries of crop markets and growing conditions.  But while year-to-year vagaries will no doubt continue, I think there is a long-term change taking place in the supply and demand conditions for agriculture.   There are two main reasons:  greater demand for meat, and a surge in demand for crops used for biofuels.

Meat-based diets require vast amounts of grain.   In developmental economics, rising affluence leads to rising demand for meat.  China and India fit this developmental model, which will cause a surge in grain demand to produce the meat.  In the U.S., annual consumption of meat is 130 kilograms per capita, while in Europe it is about 100.  In China it is only 55 kilograms, but it was only 39 kilos a decade ago.  In India it is only 7 kilograms.  Both countries will likely consume much more meat in the future, based on the developmental model and the example of Taiwan.  In 1980, Taiwan was about where China is today, with per-capita meat consumption of 43 kilograms.  Since then, it has doubled to more than 90 kilograms.

It takes about six kilograms of grain to produce one kilogram of beef.  It also takes vast amounts of water (an estimated 4,000 gallons per kilogram of beef).  Unfortunately, I haven’t found any outstanding publicly traded investment opportunities in the water area.

In addition to an inexorable increase in food demand, crop demands for use as biofuels have already driven up prices and seem likely to continue to do so.  The second recent news item was a New York Times story about the diversion of cassava root production for fuel in Asia.  Since 2008 the price of cassava has roughly doubled, as 98% of cassava chips exported from Thailand have gone to China to make biofuel.

In the U.S., forty percent of the U.S. corn crop is used for ethanol (a huge public policy mistake of providing a $.45 per gallon subsidy that costs taxpayers $6 billion per year).  Warren Buffett said that “ethanol from corn is about the dumbest idea I’ve ever heard of.”  Corn ethanol generates 1/3 less energy than a gallon of gasoline, and the reduction in oil imports resulting from the use of ethanol is equivalent to estimated savings from properly inflating the country’s auto tires or by increasing the average fuel economy of autos by 1.5 miles per gallon.  Also, why doesn’t the U.S. doesn’t drop the  tariff on cheap, efficient, Brazilian sugar cane-based ethanol to reduce our oil imports?  

The consequences of these forces driving demand for farm crops are enormous for hunger, economics, and geopolitics around the world.  Soaring food prices have caused riots or contributed to political turmoil in a number of poor countries in recent months.  To use the cassava example in Asia, if the price of cassava rises enough, farmers could well divert production to that instead of rice or other vegetables.  While it is an inconvenience for many in the developed West to absorb rising food costs that are part of processed foods, for many of the world’s poor the effects can drive millions more into malnourishment or starvation.

It is a major public policy dilemma:  food versus fuel, and to what extent to subsidize food prices.  It also poses a challenge to ethically-inclined investors.  Is it ethical to profit from—and even contribute to—the hardships of others, through sharp increases in crop prices? 

From purely an investment perspective, despite the sharp increases in agricultural commodity prices over the past two years, agricultural commodities are still historically cheap in inflation-adjusted terms.  This has not been lost on many investors already, as land prices in Iowa, e.g., have soared, as have the stock prices of the relatively few companies in this area, such as Deere and Potash Corp. 

But for long-term inflation protection and protecting the real value of cash reserves when stock prices are high and yields on cash are near zero, instruments tied to agricultural commodities prices (or precious metals) seem like a good way to protect capital.  An additional appeal is that most are priced in U.S. Dollars, and if the dollar declines over time, the prices of agricultural commodities will rise accordingly to compensate producers for the dollar’s decline.

There are ETFs that allow investors to share in increases in the commodity prices.  Two of my favorites are notes whose prices are linked to underlying agricultural commodity prices.   The first is issued by an arm of the Swedish government and whose price is linked to the price of the Rogers Intl. Commodity Index—Agriculture Total Return (RJA: $11.11).  The index is a basket of 20 agricultural commodity futures contracts.  The other ETN is the Barclays iPath Dow Jones-UBS Grains Subindex (JJG:  $54.50), whose price is linked to the prices of corn, soybeans, and wheat.

Both of these notes have risen sharply over the past year, so accumulating them on a correction or slowly over time seems prudent.

Steve Lehman

S & P 500:  1299
Russell 2000:  818

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