Minding Ag's Business

If you've read 10-year commodity price outlooks from either USDA or the highly regarded Food and Agricultural Policy Research Institute (FAPRI) at the University of Missouri, you're likely nervous about Doomsday scenarios in agriculture. Under average market conditions, FAPRI forecasts commodity prices over the next 10 years will run $4 for corn, $5.27 for wheat and soybeans about $10/bu. In contrast, season-average cash corn prices spiked to $$6.89 for the 2012 crop. By their account, net farm incomes will average $91.3 billion annually over the next decade, or about 30% less than 2013's level.

Contrarian speakers addressing the Global AgInvesting conference in New York last month were decidedly more upbeat about world demand and questioned ag's ability to supply it. They think global commodity markets will be considerably more robust than many of the official governmental forecasts contend. If true, both global commodity prices and farmland values could be far healthier than others predict.

"Is the Super Cycle over? No, food prices are on the rise and will continue to be volatile," said Philippe de Laperouse, a managing director of HighQuest Partners. "In a historical context, commodity prices are not that expensive."

Michael Whitehead, director of agribusiness industry insights for ANZ, one of Australia's largest banks, questioned the United Nations' Food and Agriculture Organization forecasts that demand will rise only 1.1% to 2050. "With full respect to them, they are underestimating demand for dairy in China and meat for countries like Indonesia," he said. "Demand growth must run faster than 1.8% compounded annually, and that makes a huge difference in trade flows."

Whitehead believes that "China effectively abandoned" its grain self-sufficiency policy last February, when policymakers announced they would instead concentrate on domestic production of meat, vegetables and fruit, opening the way for expanded corn and feed imports. Until now, soybeans and cotton represented the bulk of U.S. trade there.

Indonesia, the world's fourth most populous country, already relies on Australia as its largest source of live cattle imports. But as the population moves from a motorbike to car economy, their protein needs will switch from goat to beef, Whitehead said. "Just to get to 90% self-sufficiency in cattle within 10 years will require massive imports." Peak meat is years away, he added.

Whitehead sees a big gap between the world's growing ag consumption and slower growing yield gains in ag productivity. "If anything, demand is under stated and the allocation and foreign investment needed for agriculture is still at a very small [under funded] stage."

Bruce Sherrick, director of the TIAA-CREF Center for Farmland at the University of Illinois, also painted a more comforting view of where U.S. land values are headed . By his account, a 26-state market basket of farmland has outperformed many other asset classes from 1990-2013, returning an annual average of 10.87% versus 7.48% for the Dow Jones and 6.44% for AAA-bonds. If you include the 1970s and 1980s (see table) farmland returns still averaged 11.73% annual gains. Stocks averaged 6.89% during this 43-year period and actually fluctuated far more than land.

Compared to other assets, "the relative riskiness of farmland looks quite attractive," Sherrick said.

In fact, the worst possible decision a farmland investor could have made was investing in the early 1980s. But if he'd done so, he'd only have bled for three years, Sherrick pointed out. "In stocks there are a lot of times you could have made a lot of bad decisions. Holding period really matters in stocks--and it doesn't rebound as quickly as cropland."

Three factors moderate risks of a near-term farmland bubble, Sherrick said. First, commercial farms in Illinois have registered very strong incomes the past 10 years. That has helped them solidify their financials and pay down debts in the interim. Second, flex leases are becoming the norm for cash rents in Illinois, so growers should see an automatic moderation in rents when commodity prices and/or revenues tumble, depending on the index.

Third--and most important--has been the advent of revenue protection insurance since1996 that now sets a floor on crop revenues, Sherrick emphasized. Crop insurance participation rates leaped from about 55% in 1997 to about 85% today as growers recognized the benefit of insurance that protects both price and yield. So when the worst drought in 25 years reduced some Midwest corn yields by half of more, there was no outcry from crop disaster victims for supplemental aid like there was in the 1980s.

"Crop insurance worked exactly like it was supposed to operate in 2012," he said. "It was a perfect validation."

So what could threaten farm repayment ability and/or land values in the near term? Not much, Sherrick thinks. Farm incomes may dip the next few years, but are likely to remain above the long-term average. He doesn't worry about changes in the Renewable Fuel Standard, saying "it would not be a major game changer in the big scheme of things." Lenders have also operated more conservatively in this cycle than in the 1980s, so he sees nothing precipitating a real estate crisis like credit excesses did then.

"There are a lot of reasons to believe this is a pretty stable period for agriculture," Sherrick said. In fact, even a big correction in land values could be absorbed without much pain. "Quite honestly, you could have a 20% reduction in land values and lenders would not likely have dramatic losses like they did in the 1980s, thanks to greater collateral positions," he said.

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