State Of Agriculture: Irrational Exuberance Or The New Normal?

Corn Field

Today, as exemplified by the Midwest ag marketplace, corn prices are approaching $7.50/bushel, land rents are pushing $350-400+per acre levels and prime farmland has reached $10-13,000/acre. In the first article of this series in CropLife® (Is Agriculture Facing A Bubble?), we raised the issue of whether these ag marketplace indicators reflect “irrational exuberance” or a “new normal”. Is agriculture facing Ag Bubble 2.0, reflecting “irrational exuberance” in the corn fields?

Agriculture has always been driven by optimism. However, those farmers and ag business people operating across a broad spectrum of markets tied closely to the farm gate (including ag dealers, distributors, and basic suppliers of crop inputs), that have been able to consistently and profitably capitalize on changing marketplace conditions, recognize the importance of optimism, tempered by marketplace “realism”.

Critical to this “realism” mindset is the recognition of three key frameworks:

Ag Commodity Markets Reflect More Than Supply/Demand. Ag commodity markets (e.g., corn, soybeans, wheat, and cotton), as well as farmland values are not only driven by market fundamentals, but also by human behavior and the psychology of crowds. There is the growing realization that price movements for ag commodities have been accentuated by the “financialization” of futures markets. Investors’/speculators’ growing appetite for ag commodity investments has magnified price movements, and more closely aligned the movement of ag commodity futures prices with financial equity markets.

Ag Commodities Markets are Influenced by Cycles. Macro (economic) and micro (ag industry) drivers have become much more globally complex. Their growing connectivity has accelerated the speed of change and created greater volatility in ag markets. It is important to understand where agricultural markets sit at any point in time, from both a short- and long-term cycle perspective.

Value of a Risk/Reward Focus. Critical to ag business decision making is to need to constantly assess, on a risk/reward basis, key indicators of the financial health of the commodity side of agriculture, and most importantly, their financial inter-relationships. It is critical, from a financial risk perspective, to understand when prices and values become dramatically distorted, either above or below intrinsic values.

Simplicity Out of Complexity

The key question is whether agriculture, exemplified by U.S. Midwest agriculture, currently faces Ag Bubble 2.0, and if so, do the causal driving factors suggest that “risk” far outweighs “reward”. We believe the answers lie in a mindset that focuses on creating “simplicity out of complexity”, recognizing the complexity and interplay of key macro (economic) variables and key micro (ag industry) dynamics.

Although the dynamics we are discussing will impact, in varying degrees, all major commodity crops (key backbone to U.S. agriculture), we have focused on the most profitable commodity crop, corn, the key driver of crop profitability and farmland values in Midwest agriculture.

The outlook for the U.S. ag economy is inextricably tied to U.S. and global macro forces, focusing on four key economic variables:

1. Economic Growth. Ag demand is expected to show moderate growth reflecting the dual speed growth dynamics of the two major global blocks. The industrialized world (U.S., Europe, and Japan) is expected to suffer from an extended period of subpar growth. Developing economies (e.g., China, India, and Brazil) are facing slowing growth and persistent inflation.

2. Inflation. Despite global commodity inflation, overall inflation levels in the U.S. and the industrialized world are expected to remain moderate (2-3%), while developing economies are tightening policies to battle excessive inflation.

3. Interest Rates. U.S. interest rates, as exemplified by 10-year U.S. treasuries, which have reached record lows of 2.0%, are important to farm profitability, due to their impact on working capital costs and fixed assets/farmland acquisition costs. Interest rates are expected to stay low in the near-term, but will be subject to significant increases to more normal levels in the intermediate term, as easy Fed policy is reversed and U.S. economic growth strengthens over the intermediate term.

Importantly, the dramatic decline in interest rates from the mid-1980s has been an important positive value driver to farmland values, through the lowering of capitalization rates. While it is only a matter of time, the expected rise in interest rates, which will increase capitalization rates, will be a significant driver of farmland value deflation. Therefore, from a farmland value risk perspective, one has to simply ask oneself, is there a greater chance for interest rates to go higher or lower in the not too distant future?

4. The U.S dollar. The long-term decline in the value of the U.S. dollar has been a major positive for crop prices and foreign demand, which in turn, has boosted crop profitability and farmland values. However, a negative for commodity prices has been the recent strengthening of the U.S. dollar due to investors’ focus on its relative safety compared with other currencies, given current global economic turmoil. Despite expected volatility, the U.S. dollar could strengthen over the intermediate-term, in response to rising relative interest rates, as well as potential meaningful U.S. action to shrink the long-term U.S. budget deficit. A fundamental strengthening in the value of the U.S. dollar would be a major negative value driver for agriculture.

The table on this page shows our view of the direction and intensity of key macro (economic) indicators and their expected impact on key ag-industry indicators of the future financial health of agriculture (emphasis on Midwest agriculture), most notably, crop prices, profitability (using corn as an example), and farmland values. We will update this table periodically in future articles in this series, should marketplace dynamics diverge from our expectations.

Understanding The Risks

Market and financial bubbles reflect unsustainable price increases that dramatically overshoot fundamental or intrinsic values, which are driven by over-optimism and a simple view that “the trend is your friend.” However, critical to understanding risk/reward dynamics is anticipating a fundamental change in the direction of key market drivers and assessing the magnitude of the downside risks and upside potential to crop prices, profitability, and farmland values.

Despite the complexity of today’s macro/micro environment, we believe a key insight can be gained through a simple focus on back to basics, “Economics 101”, and recognition of what past cycles can teach us. Namely, the key driver of Ag Bubble 2.0 over 2010-2011, which could extend into early 2012, is very different from the key driver of Ag Bubble 1.0, which occurred over 2007-2008.

The Demand Side

Ag Bubble 1.0 (2007-2008) was driven primarily by strong multi-year global demand, which was boosted by biofuel demand, especially in the U.S. Prices for many ag commodities reached record levels, as exemplified by corn prices reaching a peak of close to $8.00 per bushel in mid-2008. As a result, corn profits per acre increased to record levels in 2008, as crop prices surged beyond cost increases.

Even before demand fell due to the “Financial Armageddon” of 2008-2009 that besieged the U.S and the global economy in 2008’s second half, actual corn demand was being negatively impacted by the impact of high corn prices on major end users. Almost overnight, profitability collapsed to near breakeven levels in 2009, as crop prices declined dramatically more than costs. Despite the fall in ag commodity prices from mid-2008 to mid-2010, farmland values, declined only modestly due to the value support from the dramatic fall in interest rates.

The Supply Side

In contrast, Ag Bubble 2.0 which has once again resulted in near record crop prices, expected record profitability in 2011, and a continued surge in farmland values, has primarily been driven by weather induced production shortfalls. In addition, improved corn affordability by major end users (feed and ethanol), suggests that corn prices could rise further to ration demand for this year’s short crop and add to the incentive to dramatically expand U.S. and global corn acreage in 2012. As a result, corn prices could possibly challenge the previous peak of near $8.00 per bushel over the next 6-8 months.

Should U.S. farmers plant 93-95 million acres of corn in 2012, in addition to expanded acreage globally, and weather conditions permit normal yields, the vengeance of the supply side of “Economics 101” suggests that Ag Bubble 2.0 could dramatically deflate, catalyzing rapid downside vulnerability in prices and profits. The magnitude of potential crop price declines, especially for corn, will depend on the global “battle for acres” in 2012, given supply/demand dynamics and high prices for many competing crops. Corn prices could decline to the $4.25-5.25 per bushel range as the 2012 crop unfolds.

While corn prices will have moved to a new plateau, corn profitability could dramatically decline to near-break-even levels in 2012-2013, the result of a potential dramatic margin squeeze, as prices decline more rapidly than costs.

Farmland Value Vulnerability

The confluence of both short- and long-term cycles suggests there are significant downside risks to farmland values. With significant downside risks to corn (and other crop) prices and profitability, risk/reward suggests that farmland values could peak in late 2011-early 2012 and dramatically decline over the intermediate- and longer-term. The key driver will be declining prices for corn and other crop, catalyzing a dramatic profit squeeze in 2012 (for those farmers that have not captured current high futures’ prices), which will likely continue into the post-2012 period.

In addition, two additional downward value drivers to farmland values are the longer-term outlook for interest rates and the value of the U.S. dollar. Although it is only a matter of time (even if the U.S. Fed engineers additional monetary measures in the near-term that would extend current low interest rates), interest rates are expected to move up from current abnormally low levels. Rising interest rates will dramatically increase capitalization rates, leading to declining farmland values, unless there is a sharp rise in farm rents, which is unlikely. Additionally, the impact of a potential strengthening of the U.S. dollar in response to a fundamental improvement in U.S. relative economic growth, will negatively impact crop prices, foreign demand affordability, crop profitability, and indirectly, farmland values.

Key Wild Cards

In agriculture, it is important to always recognize “wild cards”, since many key drivers are outside agriculture’s control. We believe the two key wild cards that could impact our outlook are “weather” (return of La Nina), and “China” (sharper economic slowdown), apart from the growing risk that the U.S and Europe could slip into renewed recessionary conditions in 2012, which, by itself, would deflate Ag Bubble 2.0.

We will deal with both issues in detail in the next article in this series. However, how quickly Ag Bubble 2.0 deflates in 2012-2013 will depend on the global acreage response to higher prices and an assumed lack of major weather distorted production shortfalls in 2012.

La Nina conditions have returned and are expected to gradually strengthen and continue into the winter of 2011-2012. While strong La Nina conditions (2010-2011) have been typically followed by relatively weaker La Nina conditions, not all La Nina years negatively impact production in the Midwest. An example is the extended La Nina conditions from spring 1973 to spring 1976, during which corn yields were negatively impacted only in 1974.
It is only a matter of time until the supply side of “Economics 101” dominates and Ag Bubble 2.0 deflates.

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
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
AgriSync
Matt Hopkins17 Agriculture Apps That Will Help You Farm Smarter In 2017
December 9, 2016
Ag professionals are working smarter, not harder, than ever before. Smart farming technologies have enabled them to reduce costs, maximize Read More
R4023 Sprayer, John Deere
CropLife 100Ag Retail Equipment Report: The Green Party Continues
December 7, 2016
In the annual race for sales in the ag retail equipment marketplace, the color schemes for participants are a little Read More
Mike Stern
Precision AgClimate Corp. CEO Talks Retailer Support For Digital Ag
December 1, 2016
CropLife Magazine’s sister publication, AgriBusiness Global, recently sat down with Mike Stern, CEO of The Climate Corp., following the Monsanto subsidiary’s Read More
Precision AgTrimble Debuts End-to-End FMIS Platform
November 28, 2016
October’s inaugural PrecisionAg Vision Conference left this author with many thoughts and things to ponder in the coming months. Probably Read More
CHS Primeland
CropLife 100The 2016 CropLife 100 Report: Reviewing The Many Bulls And Bears Impacting This Year’s Marketplace
November 28, 2016
For virtually all of 2016, the nation was wholly focused on the big Presidential election. Some folks aligned themselves with Read More
Latest News
Greenleaf Technologies TADF03-D Dual Fan Nozzle
NozzlesSix Greenleaf Nozzles Approved For XtendiMax With Vapor…
February 22, 2017
Greenleaf Technologies has announced that six of its TurboDrop D Series nozzles have been approved for use with Monsanto’s XtendiMax Read More
Winter Wheat
Industry NewsTiger-Sul Hires Manitoba And Eastern Canada Account Man…
February 22, 2017
Tiger-Sul, a global leader in sulphur fertilizers and crop performance products, has announced that sales veteran Trevor Loewen has joined Read More
NFMS 17 Hagie Sprayer
Eric SfiligojThe Read From Louisville: Uncertain
February 22, 2017
By the time this column appears across the country, the annual Commodity Classic will be in full swing. This means Read More
SprayersApache 1000 Series Sprayer Earns 2017 EquipmentWatch Hi…
February 21, 2017
ET Works has been named a winner in the 2017 EquipmentWatch Highest Retained Value Awards program, the industry’s only award Read More
Measuring Bulk Tanks
StewardshipMeister Media Among 2017 Award Winners Presented By The…
February 21, 2017
The Pesticide Stewardship Alliance (TPSA) held its annual conference in San Diego, CA, earlier this month where three awards were Read More
John Reifsteck
CropLife 100GROWMARK’s Reifsteck Earns NCFC Director Of The Y…
February 21, 2017
GROWMARK Chairman of the Board and President John Reifsteck has earned the prestigious Director of the Year Award from the Read More
Roy Blunt
LegislationARA Recognizes Blunt, Heitkamp For Legislative Efforts …
February 17, 2017
Agricultural industry continues to face federal regulatory challenges. Thankfully, agriculture’s allies in the U.S. Senate stepped forward. The Agricultural Retailers Read More
LegislationThe Fertilizer Institute Commends Senate On Confirmatio…
February 17, 2017
The Fertilizer Institute (TFI) President Chris Jahn issued the following statement on the Senate confirmation of Oklahoma Attorney General Scott Read More
Trump, Senate, Cabinet
LegislationBREAKING: Trump EPA Nominee Scott Pruitt Confirmed by S…
February 17, 2017
Scott Pruitt, who as Oklahoma’s attorney general spent years suing the Environmental Protection Agency over its efforts to regulate various Read More
ManagementFebruary Road Trip Edition
February 17, 2017
Editors Paul Schrimpf and Eric Sfiligoj discuss their recent visits to Indiana and Kentucky. Read More
Heritage Cooperative Finished Building Aerial
ManagementHeritage Cooperative, Agland Co-op Approve Merger
February 17, 2017
Agland Co-op and Heritage Cooperative stockholders have both approved the merger agreement between Agland Co-op and Heritage Cooperative. Now begins Read More
LegislationARA Fly-In: Ag Retail Descends on Capitol Hill, Lawmake…
February 15, 2017
More than 100 agricultural retailers, distributors and suppliers headed to Capitol Hill Tuesday morning for the Agribusiness Congressional Fly-in, according to a Read More
Untreated soybean seed Heartland Coop
Seed/BiotechMarrone Bio Innovations, Groundwork BioAg Bio-stacked M…
February 13, 2017
Marrone Bio Innovations, Inc. and Groundwork BioAg, Ltd have announced successful seed treatment field trials of the world’s first all-biological Read More
NL5000 With G5 Technology
SpreadersNew Leader Introduces NL5000 Dry Nutrient Applicator Wi…
February 13, 2017
New Leader, a division of Highway Equipment Company (HECO), has announced the next generation of spreading technology with the NL5000 Read More
Fertilizer Storage
Crop InputsThe State Of The Fertilizer Industry
February 9, 2017
He’s all hat, no horse.” It’s a humorous way of describing a person who tells a good story, but is Read More
CropLife 100Pinnacle Agriculture Agrees To Credit Agreement Amendme…
February 9, 2017
Pinnacle Operating Corp. has entered into an amendment (the “Amendment”) to its First Lien Credit Agreement that will provide for, Read More
ManagementUpdates on Upcoming Trips, Dow-DuPont, and the Des Moin…
February 9, 2017
Editors Paul Schrimpf and Eric Sfiligoj review a few future travels, along with the latest on big company mergers and Read More
Championship Tractor Pull
EquipmentNational Farm Machinery Show Highlighted By Championshi…
February 9, 2017
The scream of monster engines, the stench of burning rubber and the ground-pounding vibrations of the country’s largest, loudest and Read More