Agcapita July 2009 Update


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Agcapita is Canada's only RRSP and TFSA eligible farmland fund and is part of a family of funds with almost $100 million in assets under management. Agcapita believes farmland is a safe investment, that supply is shrinking and that unprecedented demand for "food, feed and fuel" will continue to move crop prices higher over the long-term. Agcapita created the Farmland Investment Partnership to allow investors to add professionally managed farmland to their portfolios. Agcapita publishes a monthly Agriculture Brief which deals with agriculture specific investment issues along with big picture macro-economic issues.

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Agcapita July 2009 Update

  1. 1. Agriculture Brief July, 2009 1
  2. 2. Monthly Highlights CONTENTS 2 Funds Making Hyperinflation Bets 2 Inflation Protection 3 Borrower of Last Resort 4 US Interest Payments Will Balloon 5 Invest in What China Needs 5 Investing in the New Environment 9 Global Money Supply Analysis 11 No-till Farming 11 Canadian Farmers Diversify 13 Appendix 1
  3. 3. Global Macro Outlook FUNDS MAKING HYPERINFLATION BETS INFLATION PROTECTION There have been several fund launches recently with Agcapita’s view is that there have been a growing hyperinflation as their underlying investment premise. number of signs that the monetary actions taken by Pitched as high-risk, high-return propositions these the worlds central banks are generating inflation: funds are predicated on what the founders perceive − Long Bond Yields: An increase in yields for as the inflationary policies of the worlds governments long-term bonds, likely reflecting, in part, the and central banks. Hyperinflation is clearly not greater premium investors are demanding to a mainstream view, but it is one beginning to be compensate for inflation. The yield on 10-year contemplated by high profile investors. The primary US Treasuries recently rose to a six-month reason is a growing belief that the world’s central high of 3.75 percent. That increase helped lift banks, most particularly the US Federal Reserve, will US 30-year mortgage rates above 5 percent be reluctant to raise interest rates and reduce the for the first time in nearly three months. money supply when the circumstances require. The − Gold Prices: The increasing price of the two dedicated hyperinflation funds are: traditional inflation hedge gold. Recently an − Excelsior Fund from 36 South Investment ounce of gold approached US$1,000, a level Managers Ltd. - targets returns that will be just below its all-time high set in March 2008. five times the average annual rate of inflation − Energy Prices; Prices of energy and energy of the Group of Five economies. Founder stocks, seen as a hedge against inflation, Jerry Haworth predicts that the world is “in have been increasing. the lag period between when the seeds of inflation are sown and when their off- spring, Curtis Arledge, of the fund management firm that is higher prices, are evident for all to BlackRock, has allocated about 5 percent of the see.” Haworth feels that most investors are fixed-income portfolios he manages to inflation underestimating the risk of inflation. hedges. BlackRock is one of the world’s largest − Universa Investments LP – Universa is fund management firms with over US$1.0 trillion advised by “Black Swan” author Nassim in assets under management. As far as inflation Taleb, which has constructed a strategy protection, according to Mr. Arledge “Anytime you’re to profit from the premise that US stimulus buying insurance, you want to buy at a time when the efforts will result in hyperinflation. probability of needing it is low, because it theoretically costs less. You don’t want to buy fire insurance when you see smoke coming out of your house.” 2
  4. 4. Global Macro Outlook (continued) John Osbon, the head of Osbon Capital GOVERNMENT AS BORROWER OF LAST RESORT Management, says that to take advantage of the likely inflationary trends ahead, investors should buy Proponents of the deflation viewpoint rely primarily Treasury Inflation Protected Securities, which trade on the view that “the federal reserve and the banks like standard Treasuries but have inflation protection can create credit, but people may decide not to built in. “Ten-year inflation is priced at 140 basis borrow.” However, even if the private sector refuses points right now, meaning that the term structure to borrow money at 0% interest, central banks and of interest rates say that inflation will be 1.4% per governments can do the borrowing and buying year for the next 10 years,” he says. “There is no directly. Its clear that the worlds’ governments are inflation in sight right now, which is why we believe doing exactly this - stepping in to replace private everyone should own some inflation protection.” In sector borrowing and consumption – effectively other words, buy it when its inexpensive. “To my becoming the “borrower of last resort” to generate knowledge, no nation has ever run fiscal deficits inflation. of over 6% without triggering inflation,” he says. “Our budget deficit this year is 12%!” Osbon recommends a 5% to 15% portfolio allocation to inflation hedging bonds and also considering commodities as another way to play inflation, though CHART 1: he says they deserve their own allocation. GOVERNMENT DEBT ISSUED ANNUALLY Agcapita views inflation indexed government bonds $3.0 trillion +500% less favourably than many investment managers. The key weakness of inflation protected government 2.5 +400 bonds is that the government gets to calculate 2.0 U.S. Britain the rate of inflation. The incentive for government +300 1.5 U.S. is always to under-report inflation for a variety of Euro zone +200 reasons. This under-reporting risk is best summed 1.0 up by a quote from fund manager Marc Faber – 0.5 +100 Euro “Never ask the barber if you need a haircut. Never zone 0 Britain 0 ask the realtor if the house you are considering buying is a bargain at the price offered. And never 05 06 07 08 09 10 05 06 07 08 09 10 projected projected ask the government to calculate the rate of inflation when it can save millions of dollars in cost-of-living Source: The New York Times adjustments.” 3
  5. 5. Global Macro Outlook (continued) Where will the money to fund this borrowing come US INTEREST PAYMENTS WILL BALLOON from? These are the main sources: 1. Domestic private investors The US is expected to issue more than $5 trillion 2. Foreign private investors in additional debt over the next 18 months. 3. Foreign central banks Assuming US long bond yields stay under 5% the 4. Domestic central banks US government’s total annual interest payments are projected to exceed $800 billion, up almost 500% Of the four funding sources it seems only likely that from 2009. Harvard economist Kenneth Rogoff in the US the Federal reserve will be willing and able predicts for every percentage point higher over 5% on to step in and absorb the amounts of debt issuance long bonds, the U.S. government will have to pay an that the US fiscal deficit will require – direct debt extra $170 billion in annual interest payments. monetization and highly inflationary. CHART 2: CHART 3 GOVERNMENT REPLACES THE CONSUMER Actual Projected Rise in Government Borrowing Offsets CBO White House Fall in Private borrowing $236.2 billion estimate estimate 20% ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 ‘14 ‘15 ‘16 ‘17 ‘18 ‘19 15% 0 ‘00 ‘01 10% -400 5% 0% -800 -5% 3/52 3/55 3/58 3/61 3/64 3/67 3/70 3/73 3/76 3/79 3/82 3/85 3/88 3/91 3/94 3/97 3/03 3/06 3/09 -1,200 Firms and Households Federal Government -1,600 Source: White House: - $1.75 trillion CBO: - $1.85 trillion In Billions 4
  6. 6. Global Macro Outlook (continued) INVEST IN WHAT CHINA NEEDS INVESTING IN THE NEW ENVIRONMENT As an investor you should focus on being long Bill Gross is one of the world’s largest mutual fund the things for which China has high demand but managers, focusing mostly on bonds. The following insufficient domestic production. is a complete reproduction of a recent investment commentary from Bill Gross that makes very The further the move into the lower left-hand corner interesting reading. of Chart 4, the greater the exposure to Chinese demand factors for the item in question. Currently “Staying Rich in the New Normal By Bill Gross that means potash, soybeans, iron ore and oil. In ‘Behind every great fortune lies a great crime.’ Balzac. these commodities, China’s share of world production Balzac was on to something 200 years ago, but to is low (for potash, China represents less than 5% of be fair to modern day multi-millionaires, the only real global production and China’s production of potash way to accumulate wealth prior to the 18th century is little more than 20% of its domestic demand and was to steal it, or tax it, I suppose, as was the case its ability to satisfy domestic demand with domestic with kings and their royal courts. It was only with the production is low). Source Agora advent of capitalism and annual productivity gains that entrepreneurs, investors, and risk-takers with luck or pinpoint-timing could jump to the head of the pack and accumulate what came to be recognized as a fortune. Still, the negative connotations persist. CHART 4: BUY WHAT CHINA NEEDS I remember a cocktail party in the early 80s where a somewhat inebriated guest engaged me in a debate China Net Buyer China Net Seller about the merits of capitalism. “You’re filthy rich,” he 45 said, which struck me as most unfair from a number China’s Share of World Production (%) 40 Coal Tin Lead of angles. First of all, he hadn’t seen anything yet, I 35 Zinc Steel Products thought, and second, I wasn’t quite sure where the 30 Aluminum “filthy” came from. Resentment that he’d missed 25 Iron Ore out on my presumed good deal, I suppose, and in 20 Stainless Steel Copper the process using a hackneyed phrase that was 15 bitter and biting, yet had some context of historical 10 5 Potash Crude Oil sociological relativity. Still, he might have been on to 0 Soy Beans something there - not about me, hopefully, because 20 30 40 50 60 70 80 90 100 110 120 130 140 150 I’ve always felt that while PIMCO has prospered, it’s Chinese Production as a % of China’s Demand only because its clients have benefitted even more Source: Agora so - but about the developing sense of one-sided, perhaps off-sided wealth generation that was to dominate the next several decades. Granted, we had 5
  7. 7. Global Macro Outlook (continued) Bill Gates and Steve Jobs and other true capitalistic much wealth in proportion to the rest of the world. Its dynamos who benefitted society immeasurably. But fortune-producing capabilities seem to be declining, growing percentages of fortunes were being made by which might suggest that its relative standard of living those who could borrow or aggregate other people’s is doing so as well. If so, the implications are serious, money. Because our economy was still in a relatively not just for Donald Trump but for wage earners early stage of leveraging, those who borrowed money and ordinary citizens, as reflected in their income and used it to invest in higher-risk yet higher-return levels and unemployment rates. Stockholders, financial or real assets didn’t require a lot of skill, 401(k) investors, and yes, bond managers will be they just needed to be able to convince a bank or an affected too. Last week’s furor over the possibility insurance company to lend them some money. After of an eventual downgrade of America’s AAA rating that, the secular wave of leverage would be enough demonstrates that only too clearly. On the night of to multiply their meager equity many times over and May 20, Standard & Poor’s announced a downgrade carry them to a beach where a fortune awaited them watch for the United Kingdom and since the U.S. much like a pirate’s buried treasure. and U.K. are Siamese-connected, financially- levered twins, the implications were obvious: the I remember as a child my parents telling me, perhaps U.S. might be next. In the space of 48 hours, the resentfully, that only a doctor, airline pilot, or a car dollar declined 2%, and U.S. stocks and long-term dealer could afford to join a country club. My how bonds were down by similar amounts. Such a trifecta things have changed. Now, as I write this overlooking rarely occurs but in retrospect it all made sense: a the 16th hole on the Vintage Club near Palm Springs, downgrade would cast a negative light on the world’s the only golfers who shank seven irons into the lake reserve currency, and since stocks and bonds are are real estate developers, investment bankers, or only present values of a forward stream of dollar- heads of investment management companies. The denominated receipts, they went down as well. rich are different, not only in the manner intoned by F. Scott Fitzgerald, but also in who they are and what The potential downgrade, while still far off in the future they do for a living. Whether some or all of them are in PIMCO’s opinion, seemed dubious at first blush. filthy is a judgment for society and history to make. While country ratings factor in numerous subjective Of one thing you can be sure however: over the qualifications such as contract rights, military might, next several decades, the ability to make a fortune and advanced secondary education, the primary by using other people’s money will be a lot harder. focus has always been on the objective measurement Deleveraging, reregulation, increased taxation, and of debt levels, in this case sovereign debt, as a compensation limits will allow only the most skillful - percentage of GDP. Yet, as shown in Table 1, both or the shadiest - into the Balzac or Forbes 400. the U.S. and the U.K. entered the Great Recession with attractive ratios compared to such grievous Readers who are interested in such things as the offenders (and AA rated) as Japan. Forbes annual list of hoity-toities will have noticed that more and more of them are global, not U.S. Yet as the markets recognized rather abruptly last citizens. The U.S., in other words, is not producing as week, both countries seem to be closing the gap 6
  8. 8. Global Macro Outlook (continued) in record time. To zero in on the U.S. of A., its ephemeral taxes on leverage-based capital gains that annual deficit of nearly $1.5 trillion is 10% of GDP in turn were due to the secular decline of inflation and alone, a number never approached since the 1930s interest rates that at some point had to bottom. We Depression. While policymakers, including the are reaping the consequences of that long period of President and Treasury Secretary Geithner, assure overconsumption and undersavings encouraged by voters and financial markets alike that such a path is the belief that lower and lower taxes would cure all. unsustainable and that a return to fiscal conservatism is just around the recovery’s corner, it is hard to The current annual deficit of $1.5 trillion does not comprehend exactly how that more balanced rabbit even address the “pig in the python,” baby boomer, can be pulled out of Washington’s hat. demographic squeeze on resources that looms straight ahead. Private think tanks such as The Private sector deleveraging, reregulation and reduced Blackstone Group and even studies by government consumption all argue for a real growth rate in the agencies, such as the Congressional Budget Office, U.S. that requires a government checkbook for years promise that Federal spending for Social Security, to come just to keep its head above the 1% required Medicare, and Medicaid will collectively increase to stabilize unemployment. Five more years of those by 6% of GDP over the next 20 years, leading 10% of GDP deficits will quickly raise America’s to even larger deficits unless taxes are increased debt to GDP level to over 100%, a level that the proportionately. Collectively these three programs rating services - and more importantly the markets represent an approximate $40 trillion liability that will - recognize as a point of no return. At 100% debt to have to be paid. If not, you can add that present GDP, the interest on the debt might amount to 5% or value figure to the current $10 trillion deficit and reach 6% of annual output alone, and it quickly compounds a 300% of GDP figure - a number that resembles as the interest upon interest becomes as heavy Latin American economies such as Argentina and as those “sixteen tons” in Tennessee Ernie Ford’s Brazil over the past century. famous song of a West Virginia coal miner. “You load sixteen tons and whattaya get? Another day older So the rather conservative U.S. government debt and deeper in debt.” Pretty soon you need 17, 18, 19 ratio shown in Chart 5 will likely be anything but in tons just to stay even and that describes the potential less than a decade’s time. The immediate question fate of the United States as the deficits string out into is who is going to buy all of this debt? Estimates the Obama and other future Administrations. The fact suggest gross Treasury issuance of up to $3 trillion is that supply-side economics was a partial con job this calendar year and net offerings close to $2 from the get-go. Granted, from the 80% marginal tax trillion - almost four times last year’s supply. Prior to rate that existed in the U.S. and the U.K. into the late 2009, it was enough to count on the recycling of the 60s and 70s, lower taxes do incentivize productive U.S. trade/current account deficit to fund Treasury investment and entrepreneurial risk-taking. But below borrowing requirements. Now, however, with that 40% or so, it just pads the pockets of the rich and amount approximating only $500 billion, it is obvious destabilizes the country’s financial balance sheet. that the Chinese and other surplus nations cannot Bill Clinton’s magical surpluses were really due to fund the deficit even if they were fully on board - 7
  9. 9. Global Macro Outlook (continued) which they are not. Someone else has got to write with its publicly announced and near daily purchases checks for up to $1.5 trillion additional Treasury notes of Treasuries and Agencies at a $400 billion annual and bonds. Well, you’ve got the banks and even rate. That in combination with a buy ticket for over individual investors to sponge up some of the excess, $1 trillion of Agency mortgages has been the primary but a huge, difficult to estimate marginal supply will reason why capital markets - both corporate bonds have to be bought. The concern is that this can be and stocks - are behaving so well. But the Fed accomplished in only two ways - both of which have must tread carefully here. These purchases result serious consequences for U.S. and global financial in an expansion of the Fed’s balance sheet, which markets. The first and most recent development ultimately could have inflationary implications. In turn, is the steepening of the U.S. Treasury yield curve nervous holders of dollar obligations are beginning and the rise of intermediate and long-term bond to look for diversification in other currencies, selling yields. While the Treasury can easily afford the higher Treasury bonds in the process. interest expense in the short term, the pressure it puts on mortgage and corporate rates represents a The obvious solution to both dollar weakness and serious threat to the fragile “greenshoots” recovery higher yields is to move quickly towards a more now underway. Secondly, the buyer of last resort in balanced budget once a sustained recovery is recent months has become the Federal Reserve, assured, but don’t count on the former or the latter. It is probable that trillion-dollar deficits are here to stay because any recovery is likely to reflect “new normal” GDP growth rates of 1%-2% not 3%+ as CHART 5: SIXTEEN TONS we used to have. Staying rich in this future world will require strategies that reflect this altered vision of global economic growth and delivered financial Federal Gov’t Debt markets. Bond investors should therefore confine Country to GDP Ratio maturities to the front end of yield curves where U.S. 45% continuing low yields and downside price protection U.K. 50% is more probable. Holders of dollars should diversify their own baskets before central banks and sovereign Japan 171% wealth funds ultimately do the same. All investors Germany 39% should expect considerably lower rates of return than Canada 42% what they grew accustomed to only a few years ago. China 20% Staying rich in the “new normal” may not require investors to resemble Balzac as much as Will Rogers, Brazil 36% who opined in the early 30s that he wasn’t as much Source: PIMCO. All data as of Q4: 2008, sourced from concerned about the return on his money as the individual country national accounts return of his money.” 8
  10. 10. Global Macro Outlook (continued) GLOBAL MONEY SUPPLY ANALYSIS Financial commentator Mike Hewitt has conducted Chart 7 shows the growth of aggregate money a very useful analysis of global monetary aggregates supply since 1971, the last year that US dollars were in an attempt to arrive at a measure of global convertible to gold. money supply. There are several different monetary aggregates used to measure a nation’s money It is worth noting that four currencies (EUR, USD, supply. These monetary aggregates can be thought JPY and CNY) comprise nearly 75% of all circulating of as forming a continuum from most liquid LMO to banknotes and coins. (See Appendix for data). the least liquid LM3. Chart 8 shows the historical outstanding stocks of Chart 6 shows the countries used to measure M0, M0 for currencies analyzed by Hewitt. M1, M2 and M3 in Hewitt’s study. CHART 6: 138 COUNTRIES INCLUDED IN CHART 7: ESTIMATED GLOBAL MONETARY ANALYSIS AGGREGATES (JAN 1971 TO MAY 2009) 60 50 (in US $ trillions) 40 30 20 10 European Union West African Union Central African Union 0 Data Aavailable No Data Available 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: M3 - Broad Money M2 - Money + Close Substitutes (Quasi-Money) M1 - Currency in Circulation + Demand Deposits (Money) M0 - Currency in Circulation Source: 9
  11. 11. Global Macro Outlook (continued) Though the exact numbers are subject to interpretation, the trend is clear. Global money supply is increasing at an accelerating rate. In 1990, the total amount of currency in circulation exceeded US$1 trillion. Twelve years later, the total amount exceeded US$2 trillion. This doubled again less than six years later. CHART 8 ESTIMATED GLOBAL CURRENCY IN CIRCULATION (JAN 1971 TO MAY 2009) 4.5 4.0 3.5 (in US $ trillions) 3.0 2.5 2.0 1.5 1.0 .5 0.0 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 US Dollar (USD) Japanese Yen (JPY) Euro (EUR) Chinese Renminbi (CNY) All Others Source: 10
  12. 12. Farmland Update NO-TILL FARMING No-till farming (sometimes called zero tillage or At the World Congress on Conservation Agriculture conservation tillage) has been part of the evolution of held in Kenya in 2005, it was reported that farmers grain growing - a way to produce more grain with less are showing increased interest in no-tillage and the effort, fuel, erosion and water loss. The countries technology is being applied to more than 95 million with the largest acreage under no-till are the US, Brazil, hectares worldwide. These six countries all have Argentina, Canada, Australia and Paraguay. Canadian adoption areas above one million hectares (see farmers, and in particular Saskatchewan farmers, are Chart 9). world leaders in no-till farming practices. In 1991, 6.7% of Canadian farmland was in no-till cultivation CANADIAN FARMERS DIVERSIFY but by 2006 the average was 46.4% according to the Department of Agriculture. In Saskatchewan In 2006, red meats, grains and oilseeds, and dairy the averages are even better. In 1991, 10.4% of accounted for almost 70% of total farm market Saskatchewan farmland was in no-till cultivation but by receipts, down from 74% in 1990 (See Chart 2006 the average had climbed to 60.2%. 10). Since 1990, the contribution of grains and CHART 9: EXTENT OF NO-TILLAGE ADOPTION CHART 10: FARM MARKET RECIPTS BY WORLDWIDE COMMODITY, 1990 AND 2006 26 Total $20.1B Total $32.4B Area under no-tillage 24 $1.1 5.2% Fruits & Vegetables 7.0% $2.3 22 (million hectares) 2004-05 Poultry & Eggs $1.7 8.4% 7.3% $2.4 20 28 $2.5 12.5% Other Farm Commodities 16.5% $5.3 16 14 12 $3.2 15.7% Dairy 14.9% $4.8 10 8 6 27.8% Grains & Oilseeds 4 $5.6 23.3% $7.6 2 0 USA Brazil Argentina Canada Australia Indo-Gangetic-Plains Paraguay Bolivia South Africa Spain Venezuela Uruguay France Chile Colombia China Others (estimate) 30.4% Red Meats 31.0% $10.1 $6.1 1990 2006 Source: Statistics Canada 11
  13. 13. Farmland Update (continued) oilseeds, dairy, and poultry and eggs to total farm CHART 11: REGIONAL FARM MARKET RECEIPTS market receipts are gradually declining, while that BY COMMODITY SHARE, 2006 of red meats, fruits and vegetables, and other farm commodities are increasing. Percent 100 In the Prairies, red meats have surpassed grains 90 80 and oilseeds as the most important commodity in 70 dollar terms. In the Atlantic Provinces, other farm 60 commodities such as special crops contributed about 50 50% to farm market receipts in 2006. In Central 40 30 Canada, red meats and dairy are the most important 20 commodities in dollar terms. 10 0 B.C. Prairies Ont. Que Atlantic Red Meats Grains & Oilseeds Other Farm Commodities Daiy Poultry & Eggs Fruits & Vegetables Source: Statistics Canada 12
  14. 14. Appendix TABLE 1 Percent Amount of all Country/ Currency (Billion Circulating Union Code US$) Currency European EUR 1035.2 24.30% Union United USD 850.7 19.97% States Japan JPY 762.4 17.90% China CNY 492.3 11.56% India INR 140.3 3.29% Russia RUR 110.8 2.60% United GBP 87.5 2.05% Kingdom Canada CAD 43.8 1.03% Switzerland CHF 40.3 0.95% Poland PLN 37.7 0.89% Brazil BRL 37.3 0.88% Mexico MXN 34.3 0.81% Australia AUD 32.4 0.76% Others (89) - 554.9 13.03% 13
  15. 15. DISCLAIMER: The information, opinions, estimates, projections and other materials contained here in are provided as the date hereof and are subject to change without notice. Some of the information, opinions, estimates, projections and other materials contained herein have been obtained from numerous sources and Agcapita Partners LP (“AGCAPITA”) and its affiliates make every effort to ensure that the contents hereof have been compiled or derived from sources believed to be reliable and to contain information and opinions which are accurate and complete. However, neither AGCAPITA nor its affiliates have independently verified or make any representation or warranty, express or implied, in respect thereof, take no responsibility for any errors and omissions which maybe contained herein or accept any liability whatsoever for any loss arising from any use of or reliance on the information, opinions, estimates, projections and other materials contained herein whether relied upon by the recipient or user or any other third party (including, without limitation, any customer of the recipient or user). Information may be available to AGCAPITA and/or its affiliates that is not reflected herein. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice or as a recommendation to enter into any transaction. Additional information is available by contacting AGCAPITA or its relevant affiliate directly. #400, 2424 4th Street SW Tel: +1.403.218.6506 Calgary, Alberta T2S 2T4 Fax: +1.403.266.1541 Canada