If we were sitting at a bar enjoying a beer – a good beer – and I had to tell you only one reason why you should have money invested in the agricultural boom in some way, I think I would say this: grain inventories are near all-time lows.
And if you shook your head and still didn’t get it, I would slump in my stool a bit and order another round of drinks. I would remind you of basic economics. Higher demand. Lagging supply. Inventories down. Prices going higher. And that’s why more production of agricultural goods will follow.
I would remind you that the prices of corn, wheat and soybeans are all at elevated levels in recent years. In the last 12 months alone, corn is up 60%, wheat is up 53% and soybeans are up 40%. Why? I would start with one word.
Recall that famous scene in The Graduate:
Mr. McGuire: I want to say one word to you. Just one word.
Benjamin: Yes, sir.
Mr. McGuire: Are you listening?
Benjamin: Yes, I am.
Mr. McGuire: Plastics.
Except my one word would be “ethanol”. Ethanol, as you might have suspected, is the big culprit behind a lot of this madness. How do I mean? Let us see…
Only 14% of America’s corn crop went toward ethanol in 2005. In 2006, that swung out to 19%. In 2007, the USDA figures ethanol production should consume 27% of the US corn crop. This year, US farmers increased their corn acreage by 19% – the biggest increase since 1944.
The whole ethanol craze – driven by government subsidies and higher oil prices – means there is a lot of demand for corn. It means farmers should continue to expand the acreage they have devoted to corn. The Economist Intelligence Unit projects that the demand for corn should exceed supply through at least 2009. (Also, more acreage devoted to corn means less devoted to soybeans and wheat, pushing up the prices of those commodities).
Interestingly, the US is only one of 41 countries encouraging the production of biofuels as a way to lower dependence on oil. It’s just that in other countries, they burn other things – in Southeast Asia, they use palm oil, for instance. In Brazil, it’s sugar cane.
There is another big reason why agricultural prices are rising and why farming is a good business again. A rising and more prosperous global population – think India and China – means increasing pressures on grain production. As populations become wealthier, one of the first things to change is the diet. People tend to eat more meat. More meat means more grains. There are loads of statistical evidence to support this idea, none of which I feel like finding at the moment.
So it seems a good bet that the boom in agriculture should continue for several years yet. Either governments back off on their support of biofuels or the price of oil has to come down. Or 2 billion people in China and India have to stop eating. In my view, none of these things seem at all likely in the near term.
So it also seems wise that investors should take this into account and look to profit from the agriculture boom’s widening effects.
For example, consider how farmers will cope with the higher prices for their goods. They will look to add new land into production. In some places, this will be hard to do. New arable land is not often lying around near key transportation hubs. So there are challenges there.
In some countries, like Brazil or Ukraine – or Argentina – there is plenty of high-quality fallow land. In the hands of a capable operator, such land can become highly productive farmland. Farmers will also look to increase the yield they get from their existing land. This translates into more agricultural equipment, more fertilisers and more crop protection services.
So we can play the agricultural angle many ways and come up smelling like a rose each time. That agricultural bull market is just beginning. Prepare now for the harvest.
for The Daily Reckoning Australia