For UK residents such as myself, barely able to tolerate herding their family through airport security for a summer holiday abroad, the torrential rain lashing the car crawling down the motorway to Cornwall was an ominous sign. In some parts of the UK, August 2015 was the wettest for a century.
Farmers bringing in the harvest complained about idle combines and the cost of running grain dryers at full tilt. However, on the continent growing conditions, and holiday making conditions too, were much less hostile.
In Northern Europe excellent weather facilitated some of the earliest harvesting of some of the best quality wheat gathered in years. Favourable conditions also prevailed in North America, the leading agricultural superpower, where the right combination of sun and rain led to yield expectations rising steadily through the summer. The US Department of Agriculture’s yield estimate for corn is approaching record levels for the second year running.
However, good production and ample inventory levels do not offer a constructive environment for agricultural commodity prices. Agriculture is inextricably linked to oil via the nexus of biofuels. In November 2014 Saudi Arabia refused to act alone within Opec to curtail oil production, a move that brought the final pillar of the commodity edifice crashing down, dealing agriculture a further blow.
So is there any point in making a dedicated investment to agriculture?
We think there are pressing reasons to prepare for a recovery: the duration of the downturn, a calculation of the marginal cost of production, seasonality and ongoing demand growth.
Agricultural commodities peaked in August 2012 as corn futures hit $8.32 per bushel, and have been declining ever since. Three years of price declines have brought the fundamentals of supply and demand back to the fore – fantastic news as the calculation of marginal cost is relevant again.
Current prices are at or below the current marginal cost of $3.50-$4.00 for corn production in the USA, and, even better, unlike oil production, there are no complicating factors such as budget deficits of semi autocratic regimes, large sunk costs for unconventional hydrocarbon extraction or international political jockeying to consider.
Most farmers are rational individuals and most exporters are based in democracies with at least some free market credentials. These individuals are likely to make the rational decision to leave marginal acres unplanted if they might make a loss tilling them. This decision is easier if you just lost money tilling that same bit of dirt the prior year.
This year turns out to be seminal – not since 2003 has the average US farmer lost money on all three of his staple crops: corn, wheat and soybeans. We think that through autumn/winter 2015, through the harvest and the peak seasonal supply, we will see trough prices.
That is not to say we will see $8 corn again soon. Inventories are greater than 20 per cent of annual use, so that price level would need two sequential crop failures from here. But rational production adjustments set the market up for positive price movements in the event of any disruptions next year.
Besides, the annual demand for large categories of agricultural produce continues to grow. China has only 7 per cent of the world’s freshwater resources and is struggling to defend its 120m hectares of agricultural land from urban sprawl. It already imports 73m metric tons of soybean annually, which is expected to grow to 98m by 2020. Similarly China will import corn once its strategic reserves are adjusted. (By how much is unknown: reserve levels are a state secret).
Idiosyncratic opportunities also abound. We are at the limit of how much we can trawl from the sea. Aquaculture is struggling to keep up with demand, and returns in this industry remain excellent. In the developed world we are beginning to eschew processed food, but there are far more people in the developing world where the quality and variety offered by processing is a marked improvement in diet.
Categories such as processed dairy and prepared meats are growing at near double digit rates. Meanwhile in the developing world, health considerations are driving change and opportunity, for example in the consumption of isolated proteins for fitness or in natural sweeteners to reduce sugar intake. Each of the examples above is represented by at least one listed company and these stocks offer excellent investment opportunities.
With the commodity price storm fading the tailwinds following the sector will return, and the range of opportunities offered by this dynamic sector will persist.
Hugo Rogers is fund manager on the Liontrust Global Equity Team.