George Lee, the manager of Eclectica Agriculture, talks to Neal Underwood about the outlook for agriculture.
Q. Is agriculture a long-term story?
A. Yes. The reasons for that lay in a long cycle. If you look at historical prices, up to 2006 we’d been in a downturn since the 1970s, down 70 or 80%. For farmers, that was a strong incentive to stop investing. If you look at it from a government and technology side, a lot stopped investing in research and development (R&D) in farming. Demand has been driven by population growth, emerging market diets changing and biofuels.
Over the last 15 or 20 years supply has increased by 1% a year and demand at 2 to 3%, gradually eating away into the buffer. We are back at the level we were in the early seventies; the point at which the global supply chain starts creaking. If you extend the graph it looks like the world will run out of food.
We are seeing new technology and R&D, with new varieties of seed. You need a period that allows that investment and process to take place. So the period over the next five to 10 years with higher prices is good for investment.
Q. What themes are you playing within the fund?
A. I take my agriculture universe and look at it from a top-down view, and I do a lot of analysis of individual commodities. That’s two-thirds of the research effort. There is also government policy change. Major themes are higher grain prices, particularly corn and also vegetable oils, and increased spending in emerging markets, predominantly Asia, led by China. I have one-third of the fund in fertiliser stocks, and 15% in machinery. I have plays on grain and particularly corn. Corn is one of the most intensive crops on a per hectare basis, and with the corn price where it is there is a big increase in corn acres this year. My exposure to machines includes companies like John Deere, where we are starting to see upside.
Q. Do the same sorts of themes persist or do they change over time?
A. It depends on the type of technology. Developed markets have used fertiliser to the optimum level, although we are seeing things like slow release technology where you put fertiliser on in the winter when the ground is cold. In emerging markets it’s more about trying to get the guy to put on the right amount of fertiliser. With companies like Monsanto, we’re seeing a big change; a steady growth type story. (Q&A continues below)
Q. Which stocks would you highlight as particularly interesting?
A. One of my bigger plays is on some of the smaller palm oil companies. Palm oil is grown in Indonesia and Malaysia. Its redeeming feature is yields are five times per hectare more than any other vegetable oil. Demand for vegetable oils grows at 4 to 5%; this goes back to emerging market diets changing – the KFC story. Demand has been driven strongly by shifts in emerging market diets. They’ve been able to grow supply by 8% over the last 10 years.
When you plant palm oil plants they don’t do anything for four years, then the yield gradually increases for the next few years. But it will be a lot harder for them to grow supply. In Indonesia they’re being pushed further east towards Papua, where there’s less rainfall and less infrastructure. As demand continues to grow there’s a good chance prices will rise higher. I’m invested in BW Plantation. The idea is for a lot of the bigger companies to get continued growth they will have to take over some of these smaller companies.
Q. What impact does climate have on global agriculture and on your fund?
A. There is a bit of a structural issue in certain countries. A lot of land has been lost to changes in rainfall patterns. They dug too deep and took too much water out. There are some areas where fertility is affected. There are opportunities that this leads to. One of them is drought tolerant seed technology, particularly corn and soya bean seed, where essentially you find plants with a more developed root system. This won’t happen till maybe 2013 but it is coming; it’s one of the biggest reactions to changing climate. The weather also means the supply side is more volatile than the demand side.
Q. Is there a supply/demand imbalance in global agriculture production?
A. In early 2008 it was groaning at the seams, but we got out of it in 2009 with high yields and harvests. Despite that, we have barely made a dent in terms of replenishing inventories. In 2010, with the drought in Russia, yields dropped back to long-term trends. We are going into this year with no buffer inventory. We need to increase supply by 5% just to stand still.
Q. The United Nations Food and Agriculture Organization (FAO) reported that food prices hit an all-time high in November. Why was this?
A. One thing that is different this time compared with the recent high is that in relative terms food is still cheap. Although the index is making new highs a lot of basic staple grains are lower, but some second-tier crops such as cotton, sugar and rapeseed are making new highs. This year is going to be a lot more difficult for farmers. There are no no-brainers this year [in terms of which crop to plant]. It depends on the microclimate and so on. It is difficult to see a real snap-back like we did in 2008. How do we profit? Farmers are going to be incentivised to spend as much as they can to maximise yield.
Q. Should all investors have some exposure to agriculture as part of their overall portfolio?
A. I do think they should have exposure to agriculture, albeit relatively small. In the period from 1980 to 2010, most parts of the world were in a big capital expenditure boom. Agriculture was one sector that really missed out on the bull market. If you’re looking for risk allocation, it is an area that is still depressed. Since the fund’s launch it has had low correlation [with other assets], despite being an equity fund. So it gives you diversification. In 2009 a lot of people thought agriculture was just another commodity inflation play, but it moves to a different beat to the rest of the economy.
Q. Is it still seen as an alternative asset class?
A. It is becoming more accepted. We were the first UK equity agriculture fund. Probably four or five guys have launched in the intervening period. A lot of investors know more about agriculture. It is not yet a big part of allocations. It is not a core part but it is getting there.