After focusing on the energy sector the last few months we return to another long term bullish story – agriculture.
USDA Forecast – Record Prices in 2011
Last week the USDA held their annual forum to discuss the outlook for the agriculture sector in 2011. Joseph Glauber, the USDA’s Chief Economist, forecast the grain markets will be ‘stressed’ this year and tightness will extend into 2012. Corn and soybean markets face the largest challenges due to demand and supply issues and the low levels of inventories.
Glauber forecast nominal record prices for corn, wheat and soybeans in 2011, and predicted that the tightness and high prices in the markets would "not be entirely mitigated over the course of one or even two growing seasons." Ending stocks for corn is forecast to be the smallest since 1996 and soybeans will amount to a few week's supply suggesting very little cushion for unexpected shortfalls.
The US exports around 60 per cent of the world’s corn supply, so the outlook for corn is important since increasing prices quickly filter into the food supply chain. Corn prices have risen an incredible 90 per cent from a year ago,
In 2011 the acreage devoted to corn is forecast to increase substantially, but even with this additional acreage and good weather inventories of corn are not expected to recover from abnormally low levels. The USDA forecast points to the potential that high food prices could persist far longer than they did in 2008 when they hit record highs, then fell sharply as the global economy fell into recession.
The Financial Times published a series of charts illustrating the upward trend of grain prices:
Food Prices: UN and IMF
Food prices rose in February for the eighth month in a row according to the United Nations. Prices rose in all the commodity groups measured last month except for sugar.
The UN noted that grain costs may continue to rise in the next several months. Rice prices, the main foodstuff for half the world’s population, are expected to stay relatively level with will reduce the chance of having another global food crisis like we saw in 2008.
On a similar note International Monetary Fund researchers believe that high food prices are a long term global problem which will linger for years. Improvements in crop yields or increases in acreage planted will not alleviate the problem as weather, bio-fuels, and increasing demand will put upward pressure on prices. In the IMF’s quarterly Finance & Development magazine they noted that a large part of the recent food price spike was due to temporary factors such as weather, but the longer term reason for rising demand and prices for food reflect structural changes in the global economy that will not be reversed.
Middle East/North Africa demand
Food and oil prices are interrelated, in part because modern farming practices are energy intensive and in part because oil exporters have an incentive to keep oil prices high enough to pay for agricultural imports.
Bloomberg noted that “Rising food costs contributed to riots across North Africa and the Middle East in the last several months that toppled leaders in Egypt and Tunisia. Prices surged as bad weather ruined crops from Canada to Australia and Russia banned grain exports after its worst drought in a half-century.”
Javier Blas of the Financial Times made some excellent comments on the interrelationship of food and oil in the Middle East:
The Middle East and North Africa has little farmland and even less water, so over the past 40 years it became the world’s largest importer of food commodities, notably of cereals. Egypt is the world’s biggest buyer of wheat while Saudi Arabia is the top importer of barley. The region is also a leading importer of sugar. This dependence on food imports is unlikely to change anytime soon.
The region’s hydrocarbon wealth, generated after the first oil crisis in 1973-74 – and its lack of political accountability – led the region to unsustainable solutions to resolve its food problem.
Saudi Arabia launched a programme to grow wheat in the desert, tapping fossil water aquifers. With plenty of money at hand and no questions about depleting water resources, Riyadh had an early victory. The kingdom was not only growing enough wheat to feed itself, but also harvesting a surplus for exports across the region. But the success came with a heavy price: Riyadh paid prices five times above international levels. And, in the end, it ran out of water. Two years ago, during the 2007-08 food crisis, Riyadh announced the phasing out of its wheat programme. Since then, the kingdom has become one of the world’s top wheat importers.
With a young and growing population, the need for food imports will only increase over the next decade in Saudi Arabia and the rest of the region.
Governments appear to agree: countries are building strategic stocks or even launching their own agricultural commodities trading houses. The slightest sign of any social trouble – particularly if accompanied by rising food inflation – is met with panic buying in the international food market, in an effort to flood local markets with supplies and push domestic prices down. All these factors help to keep global agricultural commodities prices higher.
The Financial Times had an excellent graphic illustrating the amount of grain imported by Arab countries – and the massive amount of grains exported from North America:
Due to the concerns about rising food prices and limited supplies a number countries are planning on building grain storage silos. Last month Egypt said it will build a network of storage silos. South Korea, the world's fourth-largest grain importer, is also among those building a strategic grain reserve, while Saudi Arabia (another major importer) hopes to double wheat reserves within three years. China is also expected to build up government reserves of grains and edible oils and to expand stockpiling capacities.
Major importers such as Egypt and Iran held high stocks of grains in the 1970s but reverted to "just in time" buying from exporters. Due to the recent events this model most likely will change, with countries building substantial grain reserves and storage. Stockpiling by the major grain importers to head off political unrest will increase demand in a tight market, and has been identified as a factor likely to cause further volatility in grain markets.
Creighton MainStreet Report
The Creighton mid-America farmland price index expanded for the 13th straight month last month, and their the farm equipment sales index also remained in expansionary mode. Based on their survey farmland prices in mid-America continue to grow at an annualized rate of more than 15 percent and agriculture equipment sellers “are experiencing surging sales across most of the region”.
Benner Drought Cycle
All bets are off on the global grain market if the U.S. experiences one of the periodic droughts that tend to target the Midwest corn belt. Weather in the U.S. corn belt has for the most part been very favorable for crops over the last decade. Yields have been at or near all time highs, assisted by advances in plant genetics as well as by fertilizer application.
Some agricultural climatologists caution that historically the crop conditions during growing season in the Central U.S have periodically deteriorated due to drought or disease, and that such occurrences while infrequent have a major impact. Dr. Elwynn Taylor of Iowa State University notes that over the last century there have been 17 general drought years in the Central United States – roughly one year in six. But he notes that an analysis of crop yield records indicates the distribution of the drought events was not random.
Samuel Benner, a farmer who was wiped out in the panic of 1873, proposed that a drought pattern for Central North America exists and is governed by a 18 to 19 year cycle. Others proposed a cycle closer to 22 years. Surprisingly, Dr. Taylor notes that tree ring analysis over the past 800 years indicates that a drought cycle exists, and that the drought cycle is closer to 19 years than to 22 – confirming Benner’s premise. Exactly why droughts have occurred in such a cyclical manner in the Central U.S. is not clear to scientists.
What is significant about the 19 year Benner cycle is that “drought years [for the Central U.S.] since 1970 are usually considered to be 1974, 1983, 1988, and perhaps 1995” according to Dr. Taylor. So it has been some time since the last cyclical drought – which statistically increases the chances of another drought to more than the one-in-six long term average, possibly by a factor of two.
Should a drought impact crop yields in the U.S. at a time when the global inventories to use ratio is so low prices are likely to rise to levels that will spark substantial social unrest on a global basis.
Investment Implications
The trends are in place for a long term boom in the agriculture sector which should benefit companies that operate in that niche.
