The Global Agricultural Boom: No Bubbles Here

by: Michael Pento April 18, 2008 | about stocks: DBA / MON / MOS / POT    

Michael Pento

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Many investors have become contrarians and are now apparently experts in being able to spot bubbles. Hence, they all are fully aware that a bubble exists in agricultural commodities at this juncture. Really, you can listen to just about any financial source and hear some commentator warning about the epic bubble that is evident in agricultural commodity prices. However, some of these same folks were completely blindsided by the collapse of the tech bubble in 2000. And they also were shocked that real estate prices could ever decline in value. Of course, this new class of maverick investor is also currently incapable of viewing the real bubble occurring in the Treasury market (it doesn't bother them that real yields on government debt are negative). The only thing they are sure of is that agricultural prices are poised to plummet.

This sophomoric conclusion focuses on just the increase in commodity prices, yet ignores some key factors that must be present for a bubble to exist. For an investment to reach bubble territory there must first be a dramatic increase in the quantity of the investment in question. Once demand contracts, an environment ensues where a massive oversupply imbalance in the investment out strips intrinsic demand by a great degree.

The two most recent actual bubbles offer great examples to this phenomenon. The tech bubble produced massive increases in stock issuance that exceeded the real demand for such equities, and the creation of new shares had a virtually unlimited supply constraint. Likewise, new home construction companies increased production rates to over 2mm units per annum, which grossly oversupplied the intrinsic demand of just 1.15mm units needed to house the growth in population. Once demand returned to historic levels, the excess inventories become a massive overhang on the market pushing prices down precipitously-an environment which persists today.

The question investors must ask themselves is whether a condition of oversupply now exists in agricultural commodities. In fact, the evidence shows just the opposite situation exists. If there was a bubble, the amount of land available for crop production would be expanding rapidly. In actuality, China has lost 6.6% of arable land in the past 10 years. Globally, we have less than half the amount of arable land per capita available for production since 1950. If crop prices were poised to fall, then inventories would be surging, yet we find that inventories for most crops are at or multi-decade lows while stock to-use ratios are also extremely thin. That hardly represents an environment where investors should fear pricing pressures.

The fact is that the food supply cannot be readily increased in short order, and the World Bank would is estimating that 33 countries face civil unrest and riots due to food emergencies. If the price and quantity of agricultural commodities could be easily manipulated, then we would not be seeing shortages breaking out on a global level. The truth is that the demand for these commodities is far more genuine then it was for house and stock flippers.

Although the world's productive agricultural capacity will one day catch up, land and infrastructure challenges around the globe will make it much more difficult for growers to increase the crop supply as easily as Wall Street was able to flood the market with new homes and equities.

On the demand side, we see that the Global need for food is projected to increase by 50% in the next 20 years. Outside of cutting subsidies for ethanol production, which seems highly unlikely, this projected future demand for food cannot be decreased substantially. Plus, there is no evidence that today's demand for food is artificial or temporal in nature, nor is there evidence that a major supply of crops is about to hit the market.

Ask the citizens of Egypt, Cameroon, Ivory Coast, Senegal and Ethiopia if their demand for food is real or speculative. Bottom line is people don't riot when all they want to do is speculate, they riot when they are hungry and cannot find or afford food to eat.

No, the increased demand for agricultural goods is real, as is the supply constraint facing the market. Investors may want to ignore the massive growth in earnings that are being reported by Monsanto (MON), Potash (POT), Mosaic (MOS) and others that service the agricultural industry.

But sorry, no bubbles will be found there.

Disclosure: Long

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This article has 24 comments:

  •  
    Apr 18 09:20 AM
    Exactly...and there is not ceiling for fertilizer under current conditions

    Yield per $1 fertilizer expenditure is over $3 in produce in most situations...but even if fertilizer triples in price it can still go higher because the AG commodities will go higher because there is a shortage and demand is the most inelastic for food

    So if the underlying AG commodities were to double again..then the ceiling for fertilizers would double theoretically...so fertilizer would be able to go up 6 fold in this case.
    Reply | Link to Comment
  •  
    Apr 18 10:18 AM
    Excellent article. Thank you for enlightening/reminding us of the mechanics behind a bubble. These days the word 'bubble' gets thrown around non-stop and no one really realizes what constitutes a bubble. It is simply presumed that if a stock has had a stellar season, it has reached a bubble.
    I like agriculture stocks because as you stated, there are positives from both the supply AND demand side- something not always easy to find in a sector.
    Reply | Link to Comment
  •  
    Apr 18 01:04 PM
    Excellent summary of the AG business without being too detailed.Really gives a good idea of the world picture wrt food commodities.I too believe that there is a long way to go for these products before a bubble can be declared.The only downside is a decline in world population!!
    Reply | Link to Comment
  •  
    Apr 18 04:38 PM
    Keep raising fertilizer and food crops 200% and 300% and see who's going to pay for it. People have to eat, but there's $3 Billion poor people who can't afford a 200% or 300% hike in food prices, so they are most likely to starve, and prices will come down. Despite what they say about growth in India and China, income is not growing by 100%, even if it grows by 30-50% it does not justify a 100% Increase of 200% to 300% in Food Prices, Demand will fall, and Prices also. Despite Less land being harvested, yields are higher, and there's no shortage of food out to justify these outrageous increases. Gasoline Demand is already down 7% in the U.S. and the U.S. uses 25% of the world's output, Prices will crack soon, and will go back to more normal levels. This has been a parabolic move, and when the Bubble in Commodities pops, more money will be lost than in the U.S. housing crisis. Futures in commodities were made for hedging and ETF's are taking crops of the market, and not for physical delivery, those Derivatives, are creating artificial demand that no one can support, Margin rates should be raised in order to avoid a CDO meltdown in Commodities.
    Short Oil Double Down DUG.
    Short Potash too. See how long those increase in prices keep holding when the crop prices fall like crazy.
    Reply | Link to Comment
  •  
    Apr 18 05:33 PM
    Not in the AG = Bubble camp, but always good to be skeptical.
    So, did people start eating more in the last 2 years ?

    Apetite does NOT increase, though taste may change as a result of increased wealth (India, China). I remember just a year ago Farmers doing suicide in India 'coz they could NOT survive (get good price for there crops).
    Can somebody explain why the Demand for Food (a perishable commodity) has suddenly increased ?
    Reply | Link to Comment
  •  
    Apr 18 06:42 PM
    population would be one big reason for the demand of food to be in increased, as well as less land in some areas.
    Reply | Link to Comment
  •  
    Apr 18 06:44 PM
    How childish to ask if people started eating more lately? World population is increasing, and the quality of diet expecially in China is moving up which increases demand for fertilizer, along with ethanol/corn. Add to this that Mosaic removed 20% of their production capability in phosphates just before the boom to shift the balance of supply and demand even further. Add that this is an incredibly capital intensive business, and that you can only mine minerals where they exist naturally, there are huge barriers to entry--and there is a major new production facility under construction in Saudi Arabia keeping others from jumping in (the Saudi project is scheduled for 2012 at the earliest--probably later). There is no bubble--quite the opposite--Mosaic, Potash Corp, and CF have dramatic increases in earnings to report in the next few quarters, and are still undervalued.
    Reply | Link to Comment
  •  
    Apr 18 07:29 PM
    Michael:

    With due respect, I disagree with you and I think you have NOT presented a case directly relevant to POT, a fertilizer company, not a food producing company. You need to concentrate on the supply/demand of fertilizers, not food, if you want to discuss the fundamentals. You have not talked about potash fertilizer in your article.

    But let me sidetrack a bit to answer User176952. There are many factors in the food price raise. People's appetite do improve. As people in countries like China and India gets more wealthy they eat more meat. So more food is consumed to raise animals in order to provide the meat. Population also grows, and food production declines due to deteriorating environment, pollution, loss of arable land, climate change, La Nina which causes production loss etc. Some of these factors are long term, some are temporary.

    I do believe we are seeing a bubble situation in fertilizer players like POT. But we are still in an early stage and I would not recommend shorting these stocks. I am saying they already exceeded their fair value.

    As michael said, the arable lands dropped, causing a drop in food production. So why more fertilizer is used on less arable land? You see a problem here. As far as potash fertilizer is concerned, the production has been growing, but the demand is also growing. The growth of supply so far lags the growth of demand, that's why fertilizer prices have gone up.

    But the growth potential of the demand is pretty limited and may probably peaked already. There is less arable land where fertilizer is needed. The demand growth is largely due to farmers apply more fertilizer in the hope of producing more food per acre of land. But you can only push per acre production so much. As fertilizer price goes up, farmers tend to use less. Because if they use more fertilizer it increases their cost, and they don't know whether the crop price may collapse by the time of the harvest season, and they may not be able to recope their fertilizer cost. That is a risk they are not willing to take.

    On the suppy side, the earth has plenty of potash element. There is tremendous amount of resources to allow supply growth. And the annual production has been going up quickly. The ocean of the earth is a giant reservoir of potash, at certain point of price it may become economical to produce from the ocean.

    For this and other discussions on resource investment, please read some of my articles. I plan to write the next series on fertilizers. I currently have no position in POT. My favorite is PGM metals, platinum and palladium:

    seekingalpha.com/autho...
    Reply | Link to Comment
  •  
    Apr 19 08:56 AM
    Mark-

    I actually think you and Michael are on the same page. His article and supporting arguments are entirely pointed at ag goods. He doesn't even mention ag service providers until the last paragraph where he says we may want to ignore the massive growth in earnings. Now he should have added that one extra sentence to complete the thought... ag service providers have a bubble forming...until of course someone figures out that potash can be used to seed clouds and solve global drought ;)
    Reply | Link to Comment
  •  
    Apr 19 10:36 AM
    Yes, people do have to eat. But as I increasingly say when I find a food product (or group of products) with what I consider unreasonably high prices, "I don't have to eat THAT." I also increasingly say, "I don't have to eat THAT MUCH of that." So yes, we can buy less, and differently, and that will affect the prices.

    As for fertilizer, people grew food and raised food before without all that fertilizer. In fact, those that raised food (animals) used the byproducts (waste) as fertilizer. Recycling at its best.
    Reply | Link to Comment
  •  
    Apr 19 12:09 PM
    What makes "DSX Lover" think that 3 billion people starving around the world is going to make an iota of difference to food market prices elsewhere? Where is the logic, past or present in that observation? Where or what are the historical facts to support such a conclusion?
    Reply | Link to Comment
  •  
    Apr 19 08:13 PM
    Anyone ever wonder about the food riot in Egypt, an oil rich country? Food shortages are beginning to happen all over the world, including China and India. People are dying all over fighting for food!

    America is no longer the world. There is a bigger world outside the USA. People - OPEN YOUR EYES AND STOP BEING IGNORANT!!!!!!!!
    Reply | Link to Comment
  •  
    Apr 20 06:55 AM
    My take is that there are more and more people competing for commmodities (especially food). It is ever-harder for production to keep up with demand. There is no answer in sight, at least for many years.

    Thus, I have bought many LEAPS options on DBA and DBC.

    My recipe:

    Buy many 2009 and 2010 calls on DBC (commodities) and half again as many on DBA (agricultural products). (I realize that DBA and DBC overlap to a significant extent.)

    After buying DBA/DBC, stick in the "oven" and wait out the big swings.

    Roll over to farther strike dates as needed.

    Lower return-on-investment expectations if the US government decides to strengthen the dollar.

    Do not freak out if there are big sell-offs by big funds selling off their DBA/DBC holdings (or related commodity holdings) because they need to raise cash in a hurry to cover margin calls or whatever (as occurred a few weeks ago). Instead, buy more DBA/DBC on the dips.

    If there is a big sharp spike upward in DBA and/or DBC (subjective assessment, to a considerable extent), sell off some of the options, and move them over into good, low-correlation-to-com... trades, or just stay in cash. Re-deploy the money back into DBA and DBC when the spike subsides.

    That's my "recipe" (e.g. strategy).


    ********************

    Added thoughts:

    If the US gets its act together and starts throwing in its lot with nuclear energy in a big way, this could affect the scenario -- but not for several years. (My understanding is that the quickest the US can get a nuclear energy plant up and running is within four years, by buying them from France, who, using our technology, now cranks out about 80-90% of their energy needs from nuclear. Huge political forces make that best case scenario essentially impossible. Massive ignorance about the risks of nuclear energy is horr hobbling the US.

    *************

    There has recently been a huge oil find in the ocean off BRazil. However, I don't see that "messing" with the cost of oil in any significant way any tiem soon -- it will maybe just slow down the upward march in prices over a many-year time frame. No way will it affect the more "near-in" prices fundamentally, though there could conceivably be some knee-jerk "herd" downward price movements, not lasting long.

    As long as nuclear continues to not be understood to be the only viable long-term answer to the huge baseload 24/7/365 needs of the planet (especially the US), agricultural products will continue to be cannibalized for energy needs (corn and sugar, for ethanol, for example). This will definitely put the continued 'hurt' on food supplies.
    Reply | Link to Comment
  •  
    Apr 20 10:52 AM
    I totally disagree with this article. The tech bubble was not caused by over-issuing stock. That's ridiculous. It was caused by the entire country, from the bathroom attendent to the highest executive, believing that Yahoo was worth a thousand bucks a share, that "this time is different", "we're in a new era", "normal valuations need to be discarded" etc.... Can anyone say the Tulip bubble was caused by oversupply of tulips????
    I can't say that agricultural commodities is in a bubble, but from the attitudes I see, including this article, it will be.
    And concerning gold, I'm starting to hear people who have no interest in investing, telling me they're buying gold. My friend, THAT is what causes bubbles.
    Oil? we're close to the classic bubble. I don't think it's a supply question. It's a speculator question. Everyone thinks they'll buy futures and there will always be someone to buy at a higher price. THAT is what causes bubbles.
    At this moment, i read a million reasons to buy commodities, and a million reasons not to buy stocks. That's why i'm going long in financials and homebuilders. That's how it's done right. Been doing it for 40 years, and I'm doing quite well, and i'm not a particularly bright man either.
    Reply | Link to Comment
  •  
    Apr 20 01:26 PM
    I think you all are trying to be far too academic here. Making money is always about the S/D equation and the earning expectations. Now, with regards to specific ag products, one must watch prices and quanities shipped. While I see higher stock prices, the best route is to hedge any long position with some insurance , known as puts. Overall, I am heavily weighted towards the short side, with puts on Financials, retailers, builders, and lenders, but AG is far too powerful to touch as a short.
    FWIW, the dot com bubble burst becasue the companies could not sell their services, earnings did not materialize, and the whole time owners were selling stock to the sheep.

    In that case, demand was largely created via channel stuffing.

    The present forecast in USA is for a drought this summer. All the conditions suggest we have a very hot, dry summer, so those who sell out of this Ag trend, will be wishing they were a bit more patient.

    FWIW, my 2007 return was not in the 4 digits, like John Paulson, but very high 3 digits. I accurately anticipated the the implosions in ETFC, NEW, LEND, AHM, DSL, FED, BKUNA, WM, CFC and BSC. I predicted those implosions based 100% on earnings erosion.
    c and BAC will also be story stocks for shorts in 2008.

    I see no such action coming soon to CF, POT, MOS.
    Reply | Link to Comment
  •  
    Apr 20 05:03 PM
    The shortage of food is quite real and will be with us for some years to come. Whether the real shortage is solely responsible for the surge in ag prices, I don't know.

    For those rare few that want to know something about a subject before they opine, this weeks Economist has an excellent article on the entire ag sitution. I guess it would also be OK for soeoene to read it after they've opnined.
    Reply | Link to Comment
  •  
    Apr 20 05:18 PM
    While I can not say for sure whether there is bubble or not,I
    will be cautious here due to following reasons.

    1. Fertilizers price can not go up for ever.Whoerver thinks that there is no limit(including CEO of fertilizer companies)
    is ignorant.I am from ASIA and I know that the price is reaching the point where poor farmers can not afford it.
    Dont forget, just putting more potash will not increase the yield,there need to be good irrigation system as well ,and
    India and China lack that.Farmers in part of Asia have been using alternative means like natural ferilizer( From animal
    waste, tree leaves,wooden ,ash etc.) for years.They will simply switch to those alternatives.


    2. Food shortage is Nonesense: This is highly hyped word and so is "Indians and Chinese need more meat".There is no real shortage of food.The prices of food grains have gone up
    because of speculators.I can't believe people just can't do the logic" How come 300 % more people started eating meat in one year.I do not know who is hyping
    this phrase and who is being served by this hype.I know that government in India regularly raids warehouses where commodities are stored illigally to artificially raise the prices.


    3. Bubble In commodity :There is clearly bubble forming in commodity space caused by speculators ,hedge funds/Index funds.Once they realize that
    other sectors performing well.this bubble is going to burst.AG sectors will also get hammered.


    4 Dollar weekness: Any sign of strength in dollar will put commodity in free fall.


    5 Ethanol Policy: Every body knows that ethanol policy is a flawed policy.They will abilish it one day and that will be disastrous to
    ferilizers.


    6.I am seeing it being a bit over crowded right now ,which is not a good sign for any sector in any market.

    However,I am not being a bear here,I am still holding long position ,however,I am also buying some put options ,just i case.....
    Reply | Link to Comment
  •  
    Apr 20 06:11 PM
    Oil production has PEAKED, I am talking about the LIGHT grade, the medium,heavy,sour are available in massive amounts...Oil futures however reflect the light variety.

    Fertilizers produce more food from less land but this also creates a huge demand for clean water. China has the biggest problem with 90% of all rivers/lakes polluted. Nitrogen fertilizers suck oxygen out of water rendering it unusable. Only a high tech society can use nitrogen safely...Brazil learned this the hard way...a lake totally devoid of life. The problem is the runoff. Not all fertiizers can be used safely everywhere.

    4 years to build a Nuc. plant...gimme a break.....try 8 years in the US......China/Russia could get away with 4 but not the US......The proposed Plant in Arizona has approvals from the State down to the local level from voters...everyone wants it...this paperwork process was started over 4 years ago...construction has not begun...EPA regs...from the State down to the local levels.

    What a bunch of ...How much oil we spend to find another barrel of oil is somewhat quantifiable by each oil firm if they find any to begin with....However, how much oil will be used to get it back where it can be refined is not. Nor is it feasible to assume that the oil found is refinable by the majority of refiners.

    About 6 years ago the Saudi's offered to build 2 $10 Billion refineries, each refining 1 million brls a day...state of the art...all grades...all the US had to do was provide building permits...it was rejected...

    The people of the USA deserve what they are getting now...the EPA combined with the "not in my back yard" syndrome has led us where we are today. And Politicians have decided to get re-elected rather than to do what is best for the long run.

    Reply | Link to Comment
  •  
    Apr 20 06:23 PM
    dear aginvestor...the dollar did show some signs of strenght last week...gold reacted, oil rose over 4% and the cost of food is strongly related to the oil sector..fertilizers to harvest to shipping to processing to deliveries....up and down the line...the US started the imbalance by using food as an energy source. The imbalance was enhanced by floods and draught worldwide...arable land is one thing...getting clean water to it is another.
    Reply | Link to Comment
  •  
    Apr 20 11:48 PM
    mark:
    i think you might be off target here.

    >>>>>&g... the growth potential of the demand is pretty limited and may probably peaked already. There is less arable land where fertilizer is needed. The demand growth is largely due to farmers apply more fertilizer in the hope of producing more food per acre of land. But you can only push per acre production so much. As fertilizer price goes up, farmers tend to use less. Because if they use more fertilizer it increases their cost, and they don't know whether the crop price may collapse by the time of the harvest season, and they may not be able to recope their fertilizer cost. That is a risk they are not willing to take.
    there is one more vital reason why fertilizer, esp potash is in demand. countries like china, india, kenya,vietnam, mexico are fast trying to increase their wheat and paddy production. although arable land might be coming down, it is expanding on crops that need more fertilizer. so the fact that arable land coming down (that too not at any alarming levels) is not a factor at all.

    >>>>>&g... the suppy side, the earth has plenty of potash element. There is tremendous amount of resources to allow supply growth. And the annual production has been going up quickly. The ocean of the earth is a giant reservoir of potash, at certain point of price it may become economical to produce from the ocean.
    i think you may be wrong. on supply side, supply is indeed tight. only 12 places in the world has proven potash capacity and that's the reason why potash is in such demand. look at intrepid potash ipi and you can see why they are hot too.
    i have never heard of ocean potash. even producing potash from ground is a complex process + limited supply.
    some analysts, esp the analyst from canada is predicting 1000 figures per ton for potash. if china, india and vietnam wants to secure potash then there is another legup for prices.

    one thing that can supress demand is organic farming. if organic farming catches up big time in china and india, then these fertilizer companies are in trouble. but with china and india governments almost becoming corportaist organic farming will be killed as it grows.
    Reply | Link to Comment
  •  
    Apr 21 11:36 AM
    Great article Michael.

    As a recent promoter of Ag stocks and more specifically one that was touting MOS when some others were warning of the eminent downturn in the stock and AG’s in general, I agree in principle that we really haven’t reached a bubble in the Agricultural commodities such as fertilizers.

    However, on the flip side of these trades, I do believe that we are now in uncharted territory for many of the Ag’s and that it is time to back off until the stocks come off of the highs created by investment entities and investors looking for some safe trades.

    As I have stated in the recent past, I see no end to the demand for more food and more varieties is obvious and it is obvious that the demand will continue because of the transitions of 2nd and 3rd world countries to the next level of world economic markets. Supply and Demand is the key factor is fairly easy to measure in these sectors.

    The dark side of these trades is that the rapid and quantum leaps of most of the fertilizer stocks have reached uncharted and potentially dangerous territory for the individual investor. Modern investment history really doesn’t provide us with many benchmarks or historical measurements to determine where many of these stocks should be priced. We are just know beginning to see the bigger picture related to Agricultures, so we are in a sense, just know beginning to learn where the realistic ranges are for pricing these stocks for the volatile demands of the 21st Century.

    Major weather events, government policies, alternatives, and the ability to meet the demands of the markets play into these trades, and the tendency for the Dark Side of the Force (hedge funds) to manipulate the trades to their advantage. Hedge funds are a viable element of market dynamics and can play a positive role.

    Still, they are increasingly creating their own alternate market and trading realities that is analogous to Bipolar (if, or/or, or/and, uh, umm,&*^%&*$, what, where, when, how, who, help me), and Multiple personality markets. I don’t mean to be insensitive to people that have multiple or bipolar problems. The conditions are serious and I wish all of them the best, but let’s be honest, it is not a stretch to compare hedge funds and some other large investment entities do exhibit business personalities that can only be described as investors that live in altered states.

    Here is my bottom line call on these stocks…

    Most (not all, but most) of the Ag/Fertilizer stocks are past their realistic highs by 8% to 15%+. Every day most of them go up, add the additional increments to their overpriced percentages. The hedge funds will send in their shock troops, and the stocks will take a dive. Hopefully, they will find their realistic price ranges, but the hedge funds and other large investment entities will continue to use their considerable influence to move the markets in what is sometimes, an unreasonable and irrational manner.

    My advice, take a quality moment to look at your positions, and make a quality decision on how much, is too much because at some point, the bipolar and multiple personality hedgers are going to need to adjust or come off their meds and we know that the Hedge Empires always Strike Back.
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  •  
    Apr 23 08:00 AM
    Thats not true. Even at current prices for potash, a typical farmer gains about 4 dollars for ever 1 dollar spent on potash ash. Therefore, with a return like that the demand for potash will be great until it balances out. Which, is not no time soon.


    On Apr 20 11:48 PM greencapital ist wrote:

    > mark:
    > i think you might be off target here.
    Reply | Link to Comment
  •  
    Apr 23 08:00 AM
    Thats not true. Even at current prices for potash, a typical farmer gains about 4 dollars for ever 1 dollar spent on potash ash. Therefore, with a return like that the demand for potash will be great until it balances out. Which, is not no time soon.
    Reply | Link to Comment
  •  
    Apr 25 06:13 AM
    I think a POT bubble is forming. Read why:

    stockology.blogspot.co...
    Reply | Link to Comment
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