There are many things that Britain’s small children must be confused about, but the temperament of the nation’s farmers must be quite high on the list.
In all their picture books, happy, red-cheeked men co-exist in harmony with their hens, cows and sheep, drive brand-new, shiny red tractors and smilingly sit down to vast farmhouse teas of fresh milk and eggs every afternoon.
But if the average toddler ever bumps into a real farmer in person they will find things aren’t quite like that any more.
These days, farmers would be better cast as semi-suicidal worriers than as merry rural folk. And for good reason: their business has had a shocking few decades.
The price of sheep and cattle has been more or less the same for going on 20 years. The price of grains has been falling in real terms since the mid-1970s and is now at its lowest for over 100 years, according to Diapason Commodities Management (the corn price is 75% lower than it was in 1975).
Until very recently the oversupply in the industry (the cause of low prices) meant that farmers were reduced to selling their produce direct to the EU, to be added to the wine lake and the butter mountain the bureaucrats were busily accumulating, and to the absurdities of ‘set aside’ (in which farmers are paid for not farming a total of 3.8 million hectares of land).
The upshot of all this has been – for the smaller farmers at least – years of low income. According to Defra, last year 25% of farmers had net incomes of “zero” and 50% of the remainder made under £10,000.
But things are about to change. A great many farmers have gone out of business in the last decade, but those that have hung on, religiously filling out EU forms and applying for endless grants to survive, are about to be rewarded for their astonishing tenacity. Why? Because despite the emotional way so many of us view it, farming is a cyclical industry in the same way as most others, from the manufacture of semiconductors to the production of steel. And the evidence suggests that for agricultural products the cycle has turned.
This week’s papers have been filled with the shocking news that wheat prices have doubled in the last 18 months and that the price of a loaf of Hovis has just gone up by a hefty 8p.
But wheat is not alone in being popular: since around 2002, the prices of corn, soy beans, beef, and practically everything else that farmers produce has been soaring too (this is becoming known as ‘agflation’).
At the same time, the grain and butter mountains are long gone. Global wheat inventories are at their lowest levels for 26 years; the EU sees worldwide cereal stocks falling to their lowest in 28 years; and China’s stocks have also collapsed to historic lows.
Last year, the EU had a buffer stock of 14 million tonnes of grain. This year, we are down to a tiny 2.5 million tonnes. Indeed, so concerned is the EU about matters that the Agricultural Commissioner Marianne Fischer Boel is actually suggesting that set aside be – well, set aside.
So what’s going on? Two things: demand is rising fast, but in a story familiar to those following the commodity supercycle, the necessary supply is not there to meet it.
The sources of demand are well known. First, population growth. By 2010 the population of the world will be three times bigger than it was in 1950. More importantly, a greater proportion of those people – the Chinese especially – will be rich enough to demand to eat well and, in particular, to eat meat: the OECD forecasts that beef consumption in developing countries will increase by a third by 2015.
It takes 7kg of grain to feed a cow to produce 1kg of beef, so more meat consumption means exponentially more grain consumption, and hence higher grain prices. Note that Chinese food prices jumped 7.6% in the first half of this year. Pork prices were up 70% and even the price of a boiled egg rose 28%. Finally, note that India has swung from being a net exporter to a heavy importer of wheat in the last year.
However, it is not population growth that has really kick-started prices, it is the new green revolution – the biofuel boom. We’ve written about this in detail in previous issues of MoneyWeek (see our biofuels section for more), but the basic point is that most developed countries have put policies in place to encourage the use of various kinds of ethanol instead of fossil fuels.
The result has been a sudden shift of millions of hectares of land from food production to fuel production. A decade ago, 5% of US corn went to make ethanol. In 2005, that number was 14%. In 2006 it was 19%. This year it is forecast to be over 27%.
This is a trend that will keep going: this time last year, says The Guardian, there were fewer than 100 ethanol plants in the whole of the US. There are now 50 more being built and a staggering 300 more planned, and US farmers have increased their corn acreage by 19% in response.
Interestingly, this is not the first time that a passion for biofuels has caused havoc in the food markets. It also happened after the first oil shock, says Hugh Hendry of Eclectica Asset Management. Then Brazil suddenly decided to run cars on sugar-based ethanol. This led to “mayhem”, with the sugar price rising eightfold in a year. The ethanol subsidies in the US are now having the same effect there. “As corn prices rise and acreage is diverted away from wheat and soy beans, price inflation could spread across all agricultural commodities.”
Not so well known are the supply issues facing the industry. Most of the good agricultural land around the world is already being intensively cultivated and much of that land may well not be good land for many more years.
It has, says Tom Stevenson in The Daily Telegraph, been “seriously damaged” by the intensive farming methods of the last 50 years. Within 15 years, “perhaps 30% of all agricultural land could be unusable”, thanks to over-use and erosion. A century ago, say analysts from Bedlam Asset Management, the land to the west of Beijing was fertile for 200 miles.
Now, “the trees are gone, the pasture is eroded” and the city’s residents are caught in endless sandstorms as a result. Overall, between 1970 and 2000 the world’s deserts have expanded by 160 million hectares (“an area about equal in size to seven Great Britains”, says Stevenson).
Figures from the Worldwatch Institute in Washington suggest that around five million to eight million hectares of land already go fallow every year due to their deteriorating quality.
The point is that there is no slack left in this system. Unless the Chinese stop eating (unlikely), the Americans start eating less (very unlikely), or the American government suddenly realises that biofuels are a useless waste of time (also very unlikely), grain and food prices have got to keep rising. This is not a blip, but the result of a long term and worldwide shift in the supply/demand balance.
Might all this finally make farmers smile again? It should, says MoneyWeek’s John Stepek in Money Morning. Not only are grain producers set to have a good year at current prices, but scarcity tends to shift pricing power back to the producers in any given industry – and farming should be no different.
When there is oversupply, the retailers are the powerful ones. The supermarket knows that if supplier A won’t deliver at the price it wants, it can go down the road to supplier B (hence the fall in the price of milk to 17p a litre in 1999).
But if there’s a genuine shortage, the supermarket has to think more carefully about how it deals with supplier A, because if it walks away, it may find that supplier B has become more expensive in the meantime.
That’s a power shift we might be seeing kicking off in the UK already. Note the carefully worded statement from Tesco this week: “when there are genuine cost-price pressures in the supply chain we are always open to discussion with suppliers”. Now there’s a turn up for the books.
There is clearly opportunity here. The question is how the average investor should go about taking advantage of it. The obvious answer is to buy a farm, pretty much anywhere as long as it is focused more on grain than meat production (rising grain prices mean rising costs of production for meat producers in many countries).
If you decide to do so, you won’t be alone in your hunt – the world’s big investors and hedge funds are already hoovering up land, from Serbia and the Ukraine to Uraquay. Macquarie Bank has plans to spend A$1bn on ranches in Australia for new funds and MoneyWeek’s own Bill Bonner has recently splashed out on a couple of hundred thousand acres in Argentina.
Here, everyone wants a bit of rural England. In the last 12 months, the price of an acre of farmland has risen 15% to £3,500, 50% more than in 2004.
It’s the same in the US. There, houses may be impossible to sell, but if you’ve got a corn field you are in the money. In 2006, prices rose 16% in Indiana and 35% in Idaho.
Australia is just as popular – land prices rose 10% in Queensland last year – as is Argentina, where the cost of a corn farm has jumped 27% in 12 months. Below, we look at stocks that will help you take advantage of ongoing agflation.
Agricultural stocks to buy now
Hugh Hendry of Eclectica sums up the situation in the food sector very succinctly. “Years of declining real crop prices have led to a lack of investment in the sector. As a result inventories have declined to almost critical levels, leaving the world vulnerable to a demand shock. The catalyst is the rising prosperity of China coupled with the political imperative to encourage the US ethanol industry. Crop prices are now starting to rise. Now is the time to invest in agriculture.”
But how? The obvious answer, says Hendry, is to look for a producer – a company that owns and farms land. There are a few of these about. We’d point to Cresud (US:CRESY), which owns huge amounts of land in Argentina and has a good record of managing it – and its cash flows as well – and to the Australian Agricultural Company (ASX:AAC), which runs a similar business in Australia, where it owns a staggering 1% of the country.
However, Hendry wonders if these companies make the best long-term investments. Sure, in the short term the producers will make good money, but as the strain on their equipment – which has not been invested in for some time – increases, they are also going to find their costs rising.
Better then to look to invest in the companies that are going to sell the producers their equipment and their fertiliser. Possibilities include Europe’s leading plough manufacturer Kverneland (Norway:KVE), one we have mentioned here before; Case New Holland (US:CNH), a New York-listed tractor company; or perhaps US-listed Titan International (US:TWI), which makes a variety of agricultural vehicles.
On the fertiliser front, Hendry is interested in Yara (Norway:YAR), which is one of the world’s largest producers of nitrogen fertiliser and has an “ excellent distribution network”. The shares are also “exceptionally cheap”, with the company valued at only one times its sales.
Another firm well worth looking at is Hong Kong-listed Sinofert (HK:297). Why? Because “applying any old fertiliser” to your crops is not enough. Like humans, “crops need a balanced diet of nutrients.” This is where Sinofert comes in. China has piles of nitrogen fertilisers (made from its own gas and coal), but it has very little potash, which it needs and must therefore import.
The business of doing this is tightly controlled by the government, but Sinofert holds about half the annual potash quota, as well as being able to use its distribution network to sell other products along the way. The shares don’t look that cheap, but the company has a record of 25% annual compound revenue growth and Hendry thinks “the share price has plenty of room to grow.”
Hendry also runs a fund – the CF Eclectica Agricultural Fund – for those who want to invest in rising food prices over the long term without buying individual stocks.
Those wanting to join in the prosperity of the world’s farmers via a fund should also look to those funds run by Diapason (the Diapason Commodities Agricultural Index Fund, or the Diapason Global Biofuel Index Fund), or – for something cheap and simple – to the Exchange Traded Funds market. ETF Grains (AIGG) tracks a basket of soybeans, corn and wheat – see ETF Securities for more information.
Those interested in organic food, an increasingly relevant subsector of the UK market, might look to Cranswick (CWK), tipped by Emma Howard Boyd, head of socially responsible investment at Jupiter Asset Management.
Annual sales of organic food are rising fast – they are now around £2bn a year – and “with about 80% of UK households purchasing organic foods at some time last year, the market is gaining traction across a variety of income groups.”
Cranswick is involved in the “high-welfare pork business” and sells sausages and cooked meats under the ‘Duchy Originals’ brand and has “a high-quality management team with a track record in generating positive cash flows and delivering on their business strategy.” The shares trade on a forward p/e of 14 times.