Agriculture Faces The ‘Perfect Storm’

Corn field and storm

Today, most everyone that is directly or indirectly tied to the commodity grain side of U.S. agriculture is smiling all the way to the bank. Most Midwest farmers are seeing their profits dramatically increase to record levels, as a surge in prices has outpaced higher costs, and the equity on their balance sheets is exploding on the upside, due to the dramatic appreciation in farmland values. 

Investors, who have recently discovered the attractiveness of financial investments in farmland and related ag assets, feel validated in moving into an unconventional investment area, agriculture, given the turmoil in financial markets and the unprecedented economic uncertainties facing the global economy. 

Whether you are a farmer or a financial investor, the “trend has been your friend”. Farmers are even trying to get their children to come back to their farm operations, unlike the 1980’s, when farm kids headed to jobs in the big cities due to the poor farm profit picture.

Farmers’ optimism and profit bonanza has been a dramatic revenue and profit booster for downstream suppliers, including basic suppliers and the distribution chain for inputs (fertilizer, crop protection chemicals, and seeds), farm machinery, and farm technology/service providers. 

The major questions facing agriculture, especially the commodity grain side of Midwest agriculture, are twofold:

1. Is Midwest agriculture at a peak, or very near a peak, in terms of crop prices (focusing on corn), profits, and farmland values? 

Our answer, discussed in the first and second article of this series in the September and October 2011 issues of Crop Life magazine clearly suggests that agriculture is facing Ag Bubble 2.0, reflecting “irrational exuberance”, not a “new normal”, which will result in a traumatic downward cycle. 

2. What are the risk/reward parameters of current Ag Bubble 2.0, in terms of crop prices, profitability, and farmland values?

It is our view that Midwest agriculture is at or near a peak and that the downside risks in the short- to – intermediate term (next 2-3 years) are sizable. Furthermore, agriculture faces a “perfect storm”, which could extend the downside risk in farmland, beyond the next few years. 

Reversal In Fortunes

At or near a peak, Midwest agriculture faces a dramatic reversal of fortunes over the next 2-3 years. Given the broad diversity in agriculture from a crop, level of productivity in terms of yields, as well as regional perspective, our discussion and analysis will focus on Midwest agriculture and high productivity corn acreage (180-200 bu/acre), such as in Iowa and Illinois.

As discussed in the second article in this series (State Of Agriculture: Irrational Exuberance Or The New Normal?), Ag Bubble 2.0 has been largely driven by short-term supply dislocations. For example, adverse planting and growing conditions have resulted in back-to-back corn production shortfalls in the U.S. in 2010 and 2011, and near-record low U.S. corn stocks. Record corn prices has rationed demand and creates the incentive for record or near-record U.S. planted acreage, as well as a strong global supply response, in the 2012 planting season. A rebound of the global supply side is the catalyst for a major trend reversal in crop prices and the risk of a dramatic plunge in per acre profits for the 2012 corn crop, from record levels expected this year.

• Crop Prices – Downside Risk to Corn Prices of $4.25-$5.25 Per Bushel from Current $6-7 Levels. Corn prices could strengthen once again over the next 6-8 months and challenge the previous peak of close to $8.00 per bushel in order to provide the incentive to expand corn acreage in the “battle for acres” in 2012, as well as continue to ration current short 2011 production. Should U.S. farmers plant 93+ million acres of corn, ending stock would dramatically rebound. Our estimate of the downside risk to corn prices is $4.25-5.25 per bushel range over the next two years. While weather is a wild card for 2012 corn production, since La Nina conditions have once again resurfaced, should production be negatively impacted, the inevitable decline in corn prices would only be delayed a year until 2013. 

• Crop Profitability – Downside Risk of 30-50% from Forecasted Record Level of $660 Per Acre This Year. Farm profits are expected to reach a record level in 2011, which might set a high water mark for a number of years. Corn profits/acre (excluding farmland costs) are forecasted to surge to a mega-profit level of $660 for the 2011 crop, which is a dramatic increase from the estimated previous peak of $420 for the 2007 crop. Despite higher input and machinery costs, the dramatic expansion in margins reflects the simple fact that corn prices have dramatically escalated above cost increases. Unfortunately, an expected reversal in corn prices, at the same time that costs are expected to continue to escalate in 2012, are forecast to result in a dramatic squeeze in profits (excluding farmland costs) to the $300-400/acre level over the next two years. However, given the expected continued volatility in prices, we would expect the most productive and astute marketers to demonstrate farm profits above these levels. 

• Farmland Values – Downside Risk of 20-40% from Current Levels Over the Intermediate Term. Given the dramatic escalation in farmland values since 2005, especially over the last two years, farmland values are vulnerable. Downward pressure on prices and profits expected for 2012 will act as a catalyst for building downward pressure on farmland prices in 2012. The combination of dramatically lower crop prices and profits, and an expected rise in interest rates from current abnormally low levels, create the catalyst for a dramatic reversal in farmland prices over the next 2-3 years, which will be discussed in the following section. Our analysis suggests that farmland values (high productivity corn acreage), conservatively, has 20-40% downside risk from current levels. 

Facing The “Perfect Storm”

Farmland values reflect the health of U.S. agriculture. Farmers in the Midwest, flush with cash from last year’s crop, as well as anticipating record mega-profits this year, continue to bid up farmland prices. Farmers have well recognized that farmland investments over the last 25+ years have proven to be a sure bet, in terms of appreciation. While farmland transactions at $8,000+ per acre have been common, average farmland values in Iowa have increased 8.6%/year from $787/acre in 1986 to an estimated $6,250/acre in 2011, with only 2 years that did not see year-to-year price gains. On a similar basis, even more noteworthy, is an estimated annual average increase of 13.6% over 2005-2011, with estimated 19.6%/year gains just over the last two years (2009-2011). 

Despite the long-term escalation in Midwest farmland values, there is a growing probability that values are reaching a strategic point of inflection and will be subject to growing downward near-term pressure and significant intermediate- and long-term downside risk. Continued farmland purchases by optimistic farmers, with excess cash, could continue to levitate farmland values, in the face of an expected dramatic decline in crop prices and profits over the near-term. However, at some point, even the most optimistic farmers will be forced to capitulate. Looking back in history, many farmers who paid record prices of $4,000+/acre in the late 1970’s look smart today, but were burdened by underwater investments for 25+ years, until 2005-2006. 

Agriculture faces a “Perfect Storm” in terms of a secular reversal in the key drivers of farmland values.

The fundamental drivers of the value of any capital asset, such as farmland, are future earnings expectations and the discount rate, or cost of capital, which are used to discount future earnings. The dramatic surge in farmland values over the past 6 years has been driven by the dramatic rise in crop prices and profits, at the same time that interest rates have fallen to record lows, as evidence by the current 2.0% interest rate level for 10 year U.S. treasury bonds (risk free rate). Based on our view that crop prices and profits are at, or near a peak, in 2011-2012, a key reversal of the three key value drivers, especially a long-term secular uptrend in interest rates from current abnormal low level (due to Federal Reserve policy actions to stimulate the economy), will put significant downward pressure on farmland values over the intermediate-to long-term.

Farmland Value And Interest Rates

Interest rates play a major role in farmland values, since they are a key determinant of the cost of capital, used in the valuation process. The downward trend in long-term interest rates since the mid-1980’s has been a key value driver that has supported the steady rise in farmland values, especially during the last 4-5 years. 

While one can argue that current abnormally low interest rates will remain low over the next 12-18 months, it is only a matter of time until interest rates start to rise to more normal levels (4-5% interest rate for 10 year U.S. treasury bonds). The “bond vigilantes”, or the bond market, will start to increase interest rates, apart from U.S. Federal Reserve policy actions, once economic activity start to strengthen, in concert with an expected rise in inflation from current levels, which even under conservative assumptions, can be expected to start to develop in the next two years. 

We will discuss in detail, the alternative methods of valuing farmland and the basis for our forecasts for significant downside risks in Midwest farmland values in the next article in this series, expected to be published in the December 2011 issue of Crop Life magazine.

What Could Change?

Forecasts, especially short-term ones, in agriculture always carry risks, since many key variables are outside agriculture’s control, such as adverse weather which can impact production. There are a number of “wild cards” that could impact our forecasts, apart from serious economic concerns over the risk of a double-dip recession in the U.S. and Europe in 2012, as well as a dramatic economic slowdown in developing countries.

The key “wild card” that could delay the timing of when Ag Bubble 2.0 deflates, is a repeat of a La Nina weather pattern in 2012 that depresses production levels, It is important to note that back-to-back La Nina conditions does not guarantee lower yields and production in the second year. However, should La Nina conditions in 2012 create a replay of 2011, which would reinforce current high prices/profits/farmland values for another year, we would expect the vengeance of the supply side of Economics 101 will be delayed one year. 

Importantly, forecasting is hazardous, especially when you take a position that is diametrically opposed to the consensus. However, there are unique times, such as today, that an emphasis on anticipating strategic “points of inflection” and fundamental changes in the direction of key market drivers, provides opportunities to limit risk and take advantage of the downside, when market conditions ultimately bottom. 

Leave a Reply

State of the Industry Stories

Fertilizer Tender close-up
MicronutrientsHow Micronutrients Fit Into 2017 Fertility Plans
January 10, 2017
Where do micronutrients stand going forward in fertility plans? For one thing, Tim Mundorf, Field Representative with Midwest Laboratories, says Read More
Fertilizer application
State of the IndustryCautious Optimism On Fertilizer In 2017
January 10, 2017
What kind of fertilizer rates are growers and retailers looking at in 2017 and beyond? According to stakeholders CropLife magazine Read More
Asmus Farm Supply crop protection products in storage
State of the IndustryCrop Protection Products Market: Complexity Begets Opportunity
January 10, 2017
While other key market segments in agriculture continue to see tumultuous shifts in sales volumes going forward (large equipment sales are Read More
Pioneer corn seed in storage
Special ReportsState Of The Seed Industry: Better Later Than Never
January 3, 2017
Traditionally, the majority of the nation’s grower-customers made their seed planting decisions in the late fall. Normally, when folks attended Read More
Trending Articles
Crop InputsFlying Under the Radar No More, FMC Goes Big
April 13, 2017
Describing FMC as “under the radar,” admittedly, is probably a stretch. But in a snap of the fingers, FMC upped Read More
Young Corn Plants
Crop NutritionStill Hunting Yields
April 1, 2017
There’s no denying it — the agricultural marketplace today is undergoing a fundamental shift in fortunes. Not too many years Read More
Nutrients for Life Foundation Teacher
FertilizerNutrients For Life Foundation Celebrates 10 Years Teaching Fertilizer Education
March 23, 2017
Those in agriculture know fertilizer is a vital ingredient to grow strong, productive crops. In fact, fertilizer is responsible for Read More
AdjuvantsA New Weed-Control Era Begins: But First, One Last Obstacle
March 4, 2017
There is trepidation, there is reluctance, and there is excitement. Ag retailers feel it all about the new dicamba and Read More
LIFT Academy video screenshot
Crop InputsLIFT Agriculture Academy: A Q&A With West Central Distribution’s Dean Hendrickson
March 1, 2017
West Central Distribution recently launched its LIFT Agriculture Academy, a new, premiere training and professional development resource for West Central’s ag Read More
Farmer and aptop
Matt Hopkins10 Warning Signs Your Website Is Grossly Outdated
February 8, 2017
Your Website is often a visitor’s first impression of your ag retail business. A positive first impression can set the Read More
Latest News
ManagementWashington Update, Dow-DuPont Earnings, and the Passing…
April 27, 2017
Editors Paul Schrimpf and Eric Sfiligoj talk about the latest Beltway news, crop protection company 1st quarter numbers, and the Read More
BRANDT
CropLife 100Former PotashCorp COO Joins BRANDT Board
April 27, 2017
BRANDT has announced the appointment of another industry veteran to its board of directors. David Delaney, most recently EVP and Read More
Syngenta headquarters in Basel, Switzerland
Crop InputsFortune: Inside China’s $43 Billion Bid for Food …
April 26, 2017
(Via Fortune.com) The worst famine in human history occurred in China from 1959 to 1961. An estimated 34 million people Read More
Syngenta Sign
Crop InputsSyngenta Announces Changes in Board of Directors
April 26, 2017
ChemChina and Syngenta announced changes relating to the new Board of Directors of Syngenta following the closing of the ChemChina Read More
Crop InputsBioSafe Systems Introduces PerCarb Broad-Spectrum Bacte…
April 26, 2017
BioSafe Systems announces PerCarb (Sodium Carbonate Peroxyhydrate), a new alternative to potassium bicarbonate and lime sulfur products for use in Read More
Deere Twitter
EquipmentTop 10 Twitter Pics for #Plant17
April 26, 2017
Despite some wet weather in parts of the Midwest, growers and ag retailers are working feverishly to plant this year’s Read More
Donald Trump
Crop InputsTrump Targets Agriculture with Latest Executive Order
April 26, 2017
(Via UPI.com) President Donald Trump on Tuesday took executive action in an effort to help grow the domestic agriculture industry Read More
AGCO Ratliff featured
EquipmentAGCO Mourns Passing of Company Founder, Industry Vision…
April 25, 2017
AGCO Corp., a worldwide manufacturer and distributor of agricultural equipment and solutions, mourns the passing of founder and former President, Read More
Engenia soybeans
Crop InputsINNVICTIS CROP CARE Introduces VANDAL MOC Soybean Herbi…
April 25, 2017
INNVICTIS CROP CARE, LLC has announced the U.S. EPA registration for VANDAL MOC, a combination of sulfentrazone plus metolachlor. VANDAL Read More
Kochia
HerbicidesINNVICTIS CROP CARE Launches STAVE Post-Emerge Broadlea…
April 25, 2017
INNVICTIS CROP CARE, LLC has introduced STAVE as the newest addition to­ its expanding portfolio. STAVE will be a great Read More
Sonny Perdue
LegislationSonny Perdue Confirmed by Senate as Next Agriculture Se…
April 25, 2017
After months without a secretary of agriculture, the Senate voted Monday evening to confirm former Georgia Gov. Sonny Perdue to Read More
BPIA logo
Seed/BiotechBPIA Files Comments with USDA
April 24, 2017
The Biological Products Industry Alliance (BPIA) has filed comments with the USDA’s Animal and Plant Health Inspection Service (APHIS) Plant Read More
Eric SfiligojHope for Application Equipment Sales
April 24, 2017
The old saying goes that a “rising tide lifts all boats.” If this is indeed the case, then things may Read More
Stewardship video screenshot
ManagementNew Video Raises Awareness of 2,4-D Stewardship
April 24, 2017
A new public service video developed and produced by the 2,4-D Research Task Force, in conjunction with the American Soybean Read More
ManagementAn Inside Look at Award Winning Ag Retailer Gar Tooteli…
April 20, 2017
CropLife Editor Eric Sfiligoj discusses An Inside Look at Award Winning Ag Retailer Gar Tootelian Read More
Students Soybean Field
Industry NewsMACA Announces 2017 Young Leader Scholarship Recipients
April 19, 2017
The Mid America CropLife Association (MACA) Board of Directors selected 11 college students to receive the MACA Young Leader Scholarship Read More
Growmark FS Outlet
SoftwareKnoa Software Solution Helps GROWMARK Boost System Perf…
April 19, 2017
Knoa Software, a leading provider of user experience management (UEM) software, has announced that GROWMARK, Inc., a regional agricultural cooperative Read More
Crop InputsFBN Publishes ‘Voice of the Farmer’ Agricul…
April 17, 2017
Farmer’s Business Network (FBN) released today its “The Voice of the Farmer”, which the company is describing as “a special Read More