Investing in Agriculture - August Agcapita


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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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Investing in Agriculture - August Agcapita

  1. 1. Agriculture Brief August 2009 1
  2. 2. Monthly Highlights I wanted to take this opportunity to discuss the inflation/ deflation debate in a bit of detail. Proponents of the deflation viewpoint rely in part on the assumption that although central banks can create credit people may decide not to borrow. Certainly this is true, private borrowing appears to have been dropping. However this misses the point that even if the private sector is reluctant to borrow money at the current low nominal interest rates governments can do the borrowing directly. Its clear that this is what’s happening - governments are stepping in to replace private sector borrowing and consumption - effectively becoming the “borrower of last resort” - and doing so on a large scale. The questions then become 1) where will the money to fund this borrowing come from and 2) will this borrowing be CONTENTS inflationary? The main sources of government funding are private investors and central banks. It seems likely that in the 2 Biofuel Update US only the Federal reserve will be willing and able to step in 5 Capital Stock in Primary Agriculture and absorb the amounts of debt issuance that the US fiscal 6 Price Drivers of Farmland deficit will require - direct debt monetization and if it were to 7 Survey of Foreign Land Ownership happen, highly inflationary. 8 Sweden Cuts a Key Rate Below Zero 8 Negative US Interest Rates Proposed Inflation was always one of the drivers of our investment 9 Global Government Funding Needs premise when we launched Agcapita. Farmland returns have 10 China’s Fiscal Stimulus a high positive correlation to inflation which simply means 11 Fed to Remain “Accommodating” for that farmland is a good inflation hedge. Keynesian deficit Years? and money printing economic policies are now being pursued 12 Emerging Economies To Lead Future globally. If history is a guide, printing modest amounts of Growth? money creates modest amounts of inflation and printing large 13 Appendix amounts of money create large amounts of inflation. The economist, Ludwig Von Mises once quipped “Government is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink.” Kind Regards Stephen Johnston - Partner 1
  3. 3. Farmland Update BIOFUEL UPDATE CHART 2: PRODUCERS EXPAND OUTPUT A 2008 World Bank report unequivocally blamed the mandated production of biofuels for the surge in Million gallons agricultural commodity prices. Western nations are 18 Ethanol Biodiesel diverting grains, oilseed products, corn and sugar 16 Argentina into biofuel manufacturing in increasing amounts. 14 Ukraine & Russia 12 Brazil 10 China As a result, biofuel production has been growing 8 Canada 6 EU rapidly in most markets and across most biofuel 4 U.S. categories - see Charts 1, and 2. 2 According to the World Bank report, biofuels have 0 2004 05 06 07 08 2004 05 06 07 08 increased food prices by 75 percent. By way of comparison, the US Government claims that biofuels Source: USDA, Economic Research Service using USDA have contributed to less than 3 percent of food price Agricultural Projections to 2017 increases. Chart 3 shows that most major oil consuming countries of the world have implemented biofuel CHART 3: GLOBAL BIOFUEL TARGETS targets. Agcapita’s research estimates that current Region Current Future Brazil E25/B2 B5 by 2010 CHART 1: GLOBAL BIOFUEL PRODUCTION China E10, 35 8% by 2020 Europe 5.75%* by 10%* by 2020 Billion gallons 2010 20 India E 10 in 2003 E20/B20 by 2017 Biodiesel (proposed) 15 Ethanol Canada Provencial E6/B2 by 2012 10 (Canadian Law, C30) 50 USA 15 B gal 2015 36B gal by 2022 (~20% 0 of transport pool) 2000 2001 2002 2003 2004 2005 2006 2007 * Energy content basis Source: International Energy Agency: FO Licht Source: UOP 2
  4. 4. Farmland Update (continued) biofuel targets in the US, the EU, Canada, Japan, process to create energy – are biofuels as “green” Brazil, India and China alone could require the use as suggested and are they competitive against of over 400 million acres of arable land or over 10% conventional petrochemical energy sources? of the world’s total – a trend that should continue to have a material effect on crop prices. Chart 4 shows clearly, based on current production methods, the competitiveness of most current Some interesting questions arise from this increasing biofuels is limited in the current oil price environment. use of food commodities as an input into an industrial Without government mandates only sugar cane CHART 4: ESTIMATED COST OF FUEL CHART 6: BIOFUEL OUTPUTS/ACRES PRODUCED BY SELECTED BIOFUEL FEEDSTOCKS (PER BARREL) Biodiesel Production from Oils 700 84 Cellulose $305 600 Wheat $125 500 70 Million BTU/acre Gallons per acre Rapeseed $125 400 56 Soybean $122 300 42 Sugar Beets $100 200 Corn $83 100 28 Sugar Cane $45 0 14 0 50 100 150 200 250 300 0 Source: Goldman Sachs Soybean Caster Sunflower Rape- Jatropha Palm bean seed seed CHART 5: COMPARING FUEL CROPS Ethanol Production from Sugars 700 600 52.5 Ethanol per acre Major 500 Million BTU/acre Gallons per acre Crop producer Gallons per acre 400 35.0 Sugar beet France 714 300 Sugarcane Brazil 662 200 17.5 Cassava Nigeria 410 100 Sweet sorghum India 374 0 Corn US 354 0 Barley Wheat Corn Sugar Sugar Wheat France 277 Beet Cane Source: Earth Policy Institute Source: Fulton et al 3
  5. 5. Farmland Update (continued) ethanol could compete in the market. Although Biofuels are also attracting some criticism based on Charts 5 and 6 show that on a gross basis ethanol environmental and land use concerns, which can generates large amounts of fuel per acre, most dramatically vary by the type of biofuel involved as ethanol production methods yield very little net energy can be seen in Chart 7 below. with the exception of sugarcane. CHART 7: FUEL SOURCES Greenhouse Percent of Gas Emissions* existing U.S. Kilograms of Crop land carbon dioxide needed to created per produce mega joule Use of resources during growing, enough fuel to Used to of energy harvesting and refining of fuel meet half of Crop Produce produced Water Fertilizer Pesticide Energy U.S. Demand Pros and Cons Technology ready and relatively Corn Ethanol 81-85 high high high high 157%-262% cheap, reduces food supply Technology ready, limited as to Sugar cane Ethanol 4-12 high high med med 46-57 where will grow Switch med- Won’t compete with food crops, Ethanol -24 low low low 60-108 grass low technology not ready Wood Ethanol, Uses timber waste and other N/A med low low low 150-250 residue biodiesel debris, technology not fully ready low- med- Technology ready, reduces food Soybeans Biodiesel 49 high med 180-240 med low supply Rapeseed, med- Technology ready, reduces food Biodiesel 37 high med med 30 canola low supply Potential for huge production Algae Biodiesel -183 med low low high 1-2 levels, technology not ready Source: Martha Groom, University of WA, Elizabeth Gray, The Nature Conservancy, Patricia Townsend, University of WA 4
  6. 6. Farmland Update (continued) CAPITAL STOCK IN PRIMARY AGRICULTURE Primary agriculture began a period of rationalization Most of the decline in capital stock in primary in the late 1980’s after the rapid investment growth of agriculture has been with respect to farm machinery the 1970’s. The investment decline reflected several and equipment. Since the mid-1990’s, total capital different factors, the most important of which was stock has stabilized at around $50 billion (1997$), a significant drop in commodity prices combined and machinery and equipment at around $12 billion with higher interest rates and the restructuring that (1997$). Capital stock in U.S. primary agriculture was occurring in agriculture production. Farms has undergone a similar investment cycle to that of were consolidating, allowing more efficient use of Canada. machinery and equipment, as evidenced by large productivity gains. CHART 8: INVESTMENT IN PRIMARY CHART 9: CAPITAL STOCK IN PRIMARY AGRICULTURE, 1961-2005 AGRICULTURE, 1961-2005 Billions 1997 $ Billions 1997 $ 9 80 Gross Investment Total 8 Depreciation Machinery & Equipment 7 Net Investment 6 60 5 4 3 40 2 1 0 20 -1 -2 -3 0 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 Source: Statistics Canada Source: AAFC calculations. 5
  7. 7. Farmland Update (continued) PRICE DRIVERS OF FARMLAND According to FCC and Government of Canada Chart 12 shows this effect on Saskatchewan research farmland prices generally follow price farmland values versus prairie wheat prices. movements in wheat with a lag as can be seen in Chart 11. CHART 11 CHART 12 Farmland Value Farm Product Farmland Value Wheat Price Change (%) Farmland Value Price Change Change (%) Change (%) Farm Product Price (%) Farmland Value 8 80 6 8 Western Prairie Wheat Price 6 6 60 4 4 4 40 2 2 2 20 0 0 -2 0 0 -4 -2 -2 -20 -8 -4 -8 -4 -40 1990 1992 1994 1996 1998 2000 2002 2004 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Source: Farm Credit Canada, Statistics Canada and AAFC calculations. 6
  8. 8. Farmland Update (continued) SURVEY OF FOREIGN LAND OWNERSHIP CHART 13: SHOULD PRAIRIE PROVINCIAL GOVERNMENTS REVISE EXISTING FARMLAND Currently, Manitoba, Saskatchewan, and Alberta OWNERSHIP TO ALLOW FOREIGN OWNERSHIP all have restrictions on foreign land ownership that OF AGRICULTURAL LAND? prevents non-Canadian residents from owning substantial amounts of farmland (Saskatchewan – 10 acres, Manitoba – 40 acres, Alberta – 20 acres). Recently, there have been calls for the removal of Don’t foreign land ownership restrictions. Supporters of Know restriction removal believe foreign land ownership 14% Yes would generate new money and capital in the 31% agriculture sector, provide an additional market for farmers who would like to exit the industry, and result in added value to farm incomes, local businesses and communities. Those who oppose the removal of No 55% restrictions believe the legislation prevents absentee landlords from buying large amounts of agriculture land, preserves farm land at affordable prices for purchase by present and future generations of Source: CFIB, Agri-Business Bottom Line No. 20, May Canadians, and supports the development of viable 2006- Prairie Data and strong rural communities. Prairie wide, just slightly more than half of respondents (55 per cent) AB SK MB do not believe provincial governments should revise existing farmland ownership legislation to allow Yes 14% 54% 26% foreign ownership of agricultural land. No 72% 35% 56% Don’t Know 14% 11% 18% 7
  9. 9. Global Macro Outlook SWEDEN CUTS A KEY RATE BELOW ZERO In its July 2 2009 statement cutting various key interest US Fed does not explicitly follow the rule, many rates the Swedish central bank, known as the Riksbank, analyses show that the rule does a fairly accurate also announced that the deposit rate was being cut job of describing how US monetary policy actually to negative 0.25%. The “deposit rate” is the interest was conducted earlier under Alan Greenspan. Similar the Swedish central bank pays on bank reserves. We observations have been made about central banks now have a major central bank targeting negative in other developed economies, both in countries like interest rates in nominal terms in a key area of the Canada and New Zealand that have officially adopted money supply. The effect of this unprecedented move inflation targeting rules, and in others like Germany is to pressure banks with reserves on deposit with the where the central bank’s policy did not officially target Riksbank to lend those reserves or be penalised. If the the inflation rate. “ Source: Wikipedia US Federal Reserve were to follow this policy, arguably it would force US banks to engage in large purchases of assets with their excess reserves rather than face the losses created by negative nominal deposit rates – driving inflation. CHART 14: THE “ZERO” BOUND Percent Percent NEGATIVE US INTEREST RATES PROPOSED 10 10 8 8 In a recent article by Paul Krugman he actually argues again for negative nominal interest rates! Krugman 6 6 states that the “Taylor Rule” says that the Fed should 4 4 “lean against” both the business cycle and deviations 2 2 of the inflation rate from a target of roughly 2%, raising interest rates when actual GDP exceeds 0 0 potential GDP or inflation exceeds the target, cutting -2 -2 rates when the reverse is true. The specific definition Federal Funds Rate: -4 Actual -4 of the Taylor Rule is as follows: “In economics, a -6 Taylor Rule* -6 Taylor rule is a monetary-policy rule that stipulates how much the central bank would or should change -8 -8 the nominal interest rate in response to divergences 87 89 91 93 95 97 99 01 03 05 07 09 11 of actual inflation rates from target inflation rates *GS forecasts beyond 2008Q4 and of actual Gross Domestic Product (GDP) from potential GDP. It was first proposed by the by U.S. Source: William Poole, St. Louis Fed. CBO. Our economist John B. Taylor in 1993. Although the calculations. 8
  10. 10. Global Macro Outlook (continued) As Chart 14 shows the Taylor rule indicates that the CHART 15: POTENTIAL SHORTAGE OF CAPITAL Fed should cut rates significantly from the current TO FUND TREASURIES extreme lows — in fact, to a rate of nominal negative 6%. Sources and Uses of US Capital ($ in Billions) The problem as perceived by Krugman is that Downside Base Case Best Case (35% Probability) (60% Probability) (5% Probability) Central Banks cannot cut interest rates below zero $4,500 (recent Swedish Central Bank actions make that $1.5 Trillion $750 Billion claim incorrect obviously – see “Sweden Cuts a $4,000 Shortfall $542 Billion Surplus Shortfall Key Interest Rate Below Zero”). In Krugman’s view, $3,500 which appears to be shared by the current US $3,000 administration, the Taylor Rule problem means the US should undertake further large fiscal stimulus and $2,500 unconventional monetary policy to “re-inflate” the $2,000 economy – in Krugman’s words “quite literally, the $1,500 usual rules no longer apply.”” $1,000 $500 GLOBAL GOVERNMENT FUNDING NEEDS $- Sources Uses Sources Uses Sources Uses Can the US Federal government go to the debt markets for US$2 trillion dollars in 2009 and another Surplus US$1.5 trillion in 2010? Base case government Shortfall assumptions are for a downside fiscal deficit of Household Savings US$1.5 trillion – a figure that has been rapidly Corporate Savings growing over the last few months. Leverage Available to Banks Net Capital Inflow Available Cash At the same time governments in the rest of the world Fed QE Programs (Agency + Treasury) are also ramping up their debt funding requirements. State/Muni Shortfall Chart 15 shows the US will need to issue $3 trillion Total Federal Government Issuance in debt when you include the federal deficit and then New Corporate Debt Issuance off-budget items like TARP, state and municipal debt, New Corporate Equity Issuance etc. Estimates are that globally government debt financing requirements add to US$5.3 trillion without Source: United States Treasury; Congressional Budget taking into account private sector borrowing needs. Office; Hayman estimates. 9
  11. 11. Global Macro Outlook (continued) CHINA’S FISCAL STIMULUS CHART 16: 2009 PROJECTED GLOBAL SOVEREIGN DEBT ISSUANCE (IN BILLIONS) Chart 17 shows that China’s commercial bank credit has recently increased by US$1 trillion. US, $3,018 Japan, $536 Furthermore, credit is also expanding in other Asian ROW, $421 nations. As opposed to the western economies China, $132 where monetary actions have only resulted in excess Germany, $190 banks reserves accumulating, massive amounts France, $166 of additional money is actually making its way into UK, $319 circulation in developing nations. On aggregate Italy, $95 this expansion argues against deflation in the global Spain, $120 Brazil, $53 economy. Canada, $69 India, $117 Mexico, $22 Russia, $107 CHART 17: EXPLOSION IN CHINA’S G7 $4,394 BANK CREDIT EMU $ 708 EU-27 $1,063 40% 80% OECD $4,822 World $5,365 New loans as a percentage of 30 60 5-Yr. Avg. of Mature Economies $ 1,429 GDP (right scale) Year-to-year 20 change in loans 40 (left scale) The World Bank says that total world GDP in 2008 was $60 trillion so approximately 9% of global GDP 10 20 in 2009 will be required to fund new government debt. It seems unlikely that there is enough capital available to satisfy this demand at current interest 0 0 rates. Arguably we will see government debt crowd 2003 04 05 06 07 08 09 out private debt issuance – not an attractive outcome Source: Bank of China in a capital short global economy. 10
  12. 12. Global Macro Outlook (continued) FED TO REMAIN “ACCOMMODATING” FOR YEARS? Federal Reserve Bank of San Francisco President possibly falling further below the Fed’s preferred level, Janet Yellen said the prospect that policy makers will she told reporters yesterday after a speech in San leave the benchmark U.S. interest rate near zero for Francisco. Given the recession’s severity, “we should the next several years is “not outside the realm of want to do more. If we were not at zero, we would possibility.” “We have a very serious recession, we be lowering the funds rate.” Yellen’s comments go have a 9.4 percent unemployment rate,” and inflation beyond those made by other policy makers after a June 23-24 meeting, when they said the federal funds rate will likely stay at “exceptionally low levels” for “an extended period.” They have held the rate, also known as the overnight lending rate between CHART 18: ANNUAL PERCENTAGE banks, at between zero and 0.25 percent since CHANGE IN THE MONETARY BASE, December. JAN 1, 1961-APRIL 1, 2009 The Fed “did succeed in averting a full-blown 120% meltdown,” Yellen said in the speech to the 100 Commonwealth Club of California. Nevertheless, the threat of another financial shock, such as one from 80 falling commercial real-estate prices, is “high on my worry list.”” Source Bloomberg. Given the growth in 60 monetary aggregates (shown in Chart 18) coupled with the magnitude of the current fiscal stimulus and 40 the limited effect both have had on the real economy Y2K – does the Fed really have an exit strategy? 20 9/11 0 -20 1961 1966 1971 1975 1981 1985 1991 1975 2001 2008 Source: Laffer Associates 11
  13. 13. Global Macro Outlook (continued) EMERGING ECONOMIES TO LEAD FUTURE GROWTH? Kurt Kasun of GlobalMarco recently asked an Chart 20 shows that motor vehicle sales in developed interesting question - “Are the developing markets economies have fallen below those in emerging starting to grow beyond the developed world?” economies. Charts 19 and 20 support the possibility that this may be beginning. In Chart 19 we see that, for the first time, developing countries oil consumption CHART 20: MONTHLY MOTOR VEHICLES SOLD has surpassed that of the worlds’ top 30 (OECD) (MILLION UNITS) developed countries. 4.0 3.5 CHART 19: SHARE OF GLOBAL ENERGY 3.0 CONSUMPTION (%) 2.5 0.70 2.0 0.65 0.60 1.5 0.55 OECD Countries 0.5123 0.50 0.4877 Non-OECD Countries 1.0 “Emerging 16” 0.45 US, EU-15, Japan 0.40 0.5 0.35 Dec 31 Dec 31 Dec 31 Dec 31 0.0 1969 1979 1989 1999 01 02 03 04 05 06 07 08 09 Source: Bloomberg Finance L.P., Chris Puplava “Commodities: Bursting Bubble or Crouching Source: Dr. Marc Faber Monthly Market Commentary (July Tiger?” 2009) “The Trouble with Our Times is that the Future will cpuplava/2009/0708.html Not Be what it used to Be” 12
  14. 14. 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