Financial Market Commentary

Posted by Jessica Collins.

In recent years, a confluence of  macroeconomic and industry-specific factors has led to record-high prices and unprecedented volatility in the global agricultural commodity markets. [1] Specifically, simultaneous increases in demand and production costs along with intensifying supply-side pressures have led many experts to forecast extended periods of higher-than-average prices for many commodities. [2]  

Farm-based commodities have recently experienced unprecedented growth in demand from both traditional and non-traditional sources.  Traditional demand has increased primarily via worldwide population growth. The world’s population currently exceeds 6.5 billion, is projected to reach nearly 9.5 billion by 2050.  [3] 

Increases in demand have also been driven by global industrialization’s positive effect on disposable income in emerging economies like China and India. [4] As a result, citizens of these countries have begun to shift away from the grain-centric diet of developing countries to the protein-rich diet common to countries with higher per capita GDP.  [5]  Because, on average, one pound of protein requires nearly seven pounds of grain to produce, the increase in demand for meat has a large multiplier effect on the demand for grain.  [6]  Moreover, increased globalization, free trade, and currency exchange considerations have increased agriculture-based exports from producing countries like the U.S., Canada, and Australia, as well as Europe and South America, which has increased competition and intensified demand on a global scale.  [7]

In addition to traditional food-related demand, coarse grains such as corn, sorghum, barley, oats, and rye and edible oils and edible oil products have experienced exponential demand growth due to the rapidly expanding biofuels initiative in the United States, Brazil, and the European Union. [8]  The World Bank estimated that nearly all of the increase in global corn production between 2004-2007 was used for biofuels production in the United States.  [9]  Moreover, as evidenced by Congress’s recent mandate to increase domestic ethanol production nearly five-fold by 2022, the biofuels component of agricultural commodity demand is not likely to decline in the near, or even intermediate, future.  [10]

Most agricultural commodities are also experiencing significant supply-side pressure from a variety of sources.  Recently, the global supply of agricultural commodities has been severely affected by unfavorable weather conditions (e.g., droughts, flooding, and freezes) in several regions, including the U.S., Europe, Canada, Argentina, Ukraine, and Russia.  As a result, global stockpiles of agricultural commodities have fallen to their lowest levels in many years.  [11] 

At the same time, increased competition for productive crop land and the reconfiguration of planting decisions to maximize returns from biofuels-related plantings (e.g., corn and soybeans) have drastically affected the supplies of most agriculture commodities. [12]  Significant increases in production costs, led by record oil and fertilizer prices, and increasing scarcity of productive farmland and sufficient and accessible water supplies have further contributed to limits on worldwide production capacity.  [13] [14]  Finally, political unrest in producing countries has slowed or stopped production on otherwise physically productive land, further tightening supplies.  [15]

Unlike many other commodities, agricultural commodities are crucial to the survival of nations.  In a recent study, researchers concluded that nearly 60 percent of all global conflicts over the past two decades have been primarily driven by disputes related to food, land, or water. [16]  Recent spikes in food prices have lead to food smuggling in some countries and riots in others.  [17]  Because of the universal necessity for food and the irreplaceable role that agricultural commodities have in worldwide food production, market analysts, including the United Nations Food and Agricultural Organization (FAO) predict that “when commodity supplies eventually recover and prices moderate from current high levels, the new equilibrium prices will be significantly higher than has traditionally been observed during periods of market balance.”  [18]  As summarized in the table below, even when the volatility is removed from short-term prices, long-run commodity price projections forecast equilibrium prices for most major crops that are 19 to 110 percent higher than their recent five-year average.  [19]   

 Source

The preceding analysis suggests agribusiness and agricultural-related firms may present interesting investment opportunities.  Companies with operations and/or substantial investments in one or more key grain producing nations, such as the U.S., Canada, Europe, Russia, Brazil, and China, may be favorable over countries operating primarily in resource poor nations. 

Companies with significant command over their supply chain are likely to display significant operating advantages, but because of the capital-intensive nature of the industry, especially for companies with significant supply chain investment, firms with low debt, good credit rating, and/or relatively easy access to credit markets are preferred in light of current global economic conditions. Moreover, any company with significant supply chain investment should be providing logistical synergies and optimizing efficient operation of all its assets.  In particular, companies that invest in technology to produce more robust, more efficient farmland and crops may provide unique opportunities for investment in the short- and intermediate-term. 

In summary, although current prices and volatility may not be sustainable in the long term, the long-term factors affecting agricultural commodities will most likely result in an extended period of high, although not necessarily record, prices.  As a result, investments in agriculturally-oriented firms appear to be promising over intermediate- and long-term horizons.