The Daily Reckoning (Australia) | 22 January 2009
By Chris Mayer
The unfolding credit crisis just gets worse and worse...
It seems like every day we get some news of a new bank failure, or takeover or some revelation that reminds us that all is not well. And the markets keep sinking...
The U.S banking system lies in shambles, like the U.S. fleet at Pearl Harbor in '41. This is no garden-variety downturn, no little dip in the road to higher prices.
I've given a lot of thought to what might be a good spot to hide out - and even prosper - during this crisis. Precious metals immediately come to mind: Owning some gold or silver is a comforting thought. But what else?
I keep coming back to something really basic: farmland.
Recently, I spent a few days in an old chateau in the countryside of Normandy, France. There is a tiny town about a mile from the chateau, but otherwise, it is a picture of things pastoral - green meadows... cows cropping grass and taking in the sun... a Jacobin farmhouse... miles of farmland all around... Since I've been writing and talking about farmland, I had a deeper appreciation for just how useful such land is.
Really, I can think of no better asset to own during any kind of financial crisis. In some ways, farmland is even better than gold or silver. At least farmland is an intrinsically useful thing. It provides a tangible yield in the form of good things from the earth. We all have to eat. As consumers trim their sails, they'll give up a lot before they give up their calorie intake. In fact, worldwide, the per capita calorie intake is likely to rise, as I'll get into shortly.
The problem with farmland is that it's not an easy thing to invest in as an individual investor. But I've found a fund that invests directly in farmland in Canada. The name of firm running these funds is Agcapita, based in Calgary, Alberta.
I'll get to the details below, but first, I want to flesh out this idea of investing in farmland, specifically Canadian farmland. I think you'll be surprised to learn how cheap it is and how well it's performed in the past...
First, we're essentially talking about three provinces in Canada's grain belt - Alberta makes up the western bookend, Manitoba the eastern one and Saskatchewan is between the two. While Canadian farmland in general looks cheap, it's Saskatchewan that really stands out.
Hard to believe that Canadian farmland is so much cheaper than even Brazil's or Argentina's. It's not as if yields are uncompetitive. Canada's wheat yield (in metric tons per acre) is about 1.0, which compares with 0.6 in Brazil and 1.0 in Argentina. The infrastructure in Western Canada is also very good. The whole economy there is geared around agriculture. There are miles of railroad tracks and grain elevators across the prairies.
So why the price disparity? Here we get to a quirky driver unique to these Canadian markets. For the longest time, there were all kinds of restrictions on who could own farmland. In the last several years, these restrictions have gone away.
For instance, in 2003, Saskatchewan finally allowed unlimited ownership by all Canadians. At one time, you had to be a resident of Saskatchewan to own farmland. No longer. Similar restrictions existed in the other markets. The governments loosened these restrictions or have done away with them altogether.
No surprise, then, that farmland prices started to tick up noticeably as these restrictions fell away.
Suddenly, you've got a much larger potential pool of buyers in a market in which agricultural assets are still in demand. In Saskatchewan, in particular, after years of going nowhere to down, prices immediately began increasing year over year after 2003. In 2007, prices increased 11%!
I've written to you several times before about the boom in agricultural markets. The dynamics of this change are pretty simple, though we might lose sight of them during these crazy markets. As the wand of prosperity has touched China and India and the rest of the emerging markets, so have the diets of the people changed. They tend to eat better, which puts pressures on the grain markets.
So what we see is grain inventories falling to lows not seen in more than 40 years. So at some point, we should expect to see rising prices for grains - and for the farmland that produces them.
Meanwhile, the amount of arable land per person is falling. I wrote about this in my newsletter Capital & Crisis ("The Topsoil Crisis"). The gist of it is that we are losing quality topsoil faster than we are replacing it.
There is a growing scarcity of good farmland. And you see countries that import grains - such as Saudi Arabia and China and South Korea - trying to lock down farmland.
Agcapita points out that the per capita amount of arable land on the planet has dropped sharply over the last 50 years, and is likely to continue dropping. From 2.8 acres per person in 1960, the amount of arable land has dropped to slightly more than one acre today.
Now, we don't need 2.8 acres per person anymore, because of advances in agriculture over time. But gains in yield per acre are slowing. Over the last 40 years, we've increased the yield per acre by 2.1% per year. But the pace of those gains is slowing. Since 2000, the increase in yields per acre has averaged less than 1% per year.
We may see new innovations in seeds or other technology that we can scarcely imagine now. But it also seems that any solution would take some time and money to implement.
Meanwhile, the world's agriculture markets just get tighter and tighter...
Demand is strong. In 1974, cereal crop consumption was about 1,500 bushels per second. Today, it's 2,600 bushels per second. So we have a double effect here. We have increasing population and increasing consumption per person. Agcapita estimates that cereal crop consumption will double again over the next 20 years. The amount of pressure on the global food supply network is enormous. This, again, is a reflection of people eating better and eating more meat - which requires exponentially more grains to produce.
There is another wrinkle to the story: Most every oil-consuming country has put in place biofuel targets that will kick in over the next five years. These places include the U.S., the EU, Canada, Japan, Brazil, India and China. To meet their targets, according to work by Agcapita, we'll have to commit some 240 million acres to biofuel production. That represents about 50% of the arable land in North America and about 6% of all the arable land in the world.
As you can see, the biofuel craze puts further pressures on farmland demand.
So that's where we are in a nutshell. For these reasons, I'm bullish on agriculture assets in general, and farmland in particular.
The other appealing aspect of farmland is how well it did in the inflationary environment of the 1970s. I think we're headed to another 1970s-style inflation. Right now, we're in the midst of a (temporary) deflation wave sweeping over commodity-land. But the dollar, as we know, is not hard to reproduce.
Governments, particularly in times of crisis - like now - have a tendency to flood the system with money in an attempt to "goose" the economy. Mostly, such efforts have succeeded in destroying the value of the currency in question.
Anyway, if you believe that we will continue to feel the bane of inflation, then farmland's performance in the 1970s will give you some comfort.
So you see that while you lost half of your money in the S&P 500, your farmland kept its value nicely. Again, I think that's rooted in the fact that farmland is intrinsically useful. It produces useful and needed things.
Now imagine what farmland might do in today's climate, in which you have not only the likely prospect of inflation, but also a tightening supply of farmland and rising demand for crops. I imagine you'll do quite a bit better than the 1970s.
[See also: Agricultural Funds Up 9.5% in 2008]