The Ag Trade

In Capitalist Viewpoints, Mark, Other by Mark9 Comments

Our friend Scott had an interesting blurb in his latest letter on the ag trade, and I wanted to elaborate. You may remember Scott from his recent post on the student loan debacle. He’s a sharp young guy, the kind we are glad to support in these pages.

I’ve re-posted his commentary below, with a few notes therein from yours truly. At the end I’ll give you my take on it all…

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The failure of the “Green Revolution” in agriculture may lead to the greatest trade of the century. The Green Revolution, coined by William Gaud of the USAID, began in the 1940?s with the transformation of chemical manufacturing facilities once used to make bombs, to producing nitrogen fertilizers. With the widespread application of these fertilizers crop yields surged.

Then, in the 1970’s genetically modified organisms (GMO’s) were introduced allowing crops to resist attacks from insects, and enabling another quantum leap in yields. As a result, the world saw the largest increase in human population in the history of the world. (Mark note: Maybe that wasn’t so great in retrospect..?)

Unfortunately, with stellar yields has come the destruction of topsoil, setting in motion a death spiral that is helping to reverse the yield improvements. Over the past seven decades the introduction of monoculture and nitrogen fertilizers has caused topsoil to lose its productive powers. According to numerous geological studies, it can take up to 500-years for one inch of topsoil to be formed. While this is well-known, farming practices have not changed, resulting in an estimated loss of 2 billion tons of topsoil per year. (Mark note: Some farmers think very little of the future, despite their obvious attachment to it!)

Nitrogen fertilizers continuously applied to farmland causes the pH of soil to decrease, making it more acidic. This strains crops as they are not suited to grow in acidic soil, resulting in a decrease of yields. The average farmer, however, will react by applying additional fertilizer to compensate for the decrease in yield, further destroying the soil. This over-application combined with over-tilling the land renders it inoperable. When the land is no longer suitable for farming nature gains the upper hand, and erosion and desertification follow. Over the past several decades chemical fertilizer application has soared and farmland productivity has decreased. (Mark note: There’s that inverse yield problem…)

back to discussing Genetically Modified Organisms. Where pests once destroyed thousands of acres of crops, they are now sentenced
to death by gene splicing ‘poisons’ and implanting them into seeds. Unfortunately, (Mark note: Or, fortunately, depending on your perspective) evolution has dealt a sizable blow to this industry, as pests are developing resistance to GM seeds. This creates an evolving battle where seed companies must create ever more ‘toxic seeds’ to thwart off resilient pests. (Mark note – Warning.. Rant: It’s unsustainable, I don’t care if you’re an organic advocate or not, give me a good argument for continuing with GMO’s? But, don’t give me a bunch of bogus about how organic or sustainable methods cannot feed the world, as that argument is bullshit, organic agriculture can feed the world, and has been proven so. Laziness is not an excuse for why something won’t work.)

As a result, chinks in the armor of this once iron-clad industry are starting to show. It was recently reported in Illinois that rootworms, an insect which kills corn by eating its root system has been observed in a number of fields. It surmised that rootworms have built up a tolerance to Monsanto Bt corn. Lee Quarles of Monsanto was quoted saying that, “Monsanto’s SmartStax corn introduced last year is engineered to produce a second Bt insecticide that, when used with crop rotation and a refuge of non-Bt corn, will extend the usefulness of the insect-fighting technology.” This was according to a Bloomberg article. Mr. Quarles comments hint at the understanding that this product may very well be near the end of its life cycle and a more potent seed will need to be developed. (Mark’s note: Yummy.. can’t wait. The pests will also develop resistance to the next product, and the next, and the next, into infinitum. Short Monsanto.)

In the depths of a global food crisis the agricultural system of ever-increasing toxicity will not change quickly enough. As human nature is to react, it can be expected that the seed and fertilizer game will intensify until enough land is destroyed to further accelerate the food shortage. The domestic stocks-to-use ratio for corn was recently reported at barely above 5.0%, the lowest since 1996. As a result, corn is on the verge of breaking out of a multi-year cup with handle technical pattern. Soy is already racing toward its all-time high of $16.63/bushel as supplies remain tight.

The time to invest in agriculture is now. With global supplies dangerously low and continuing to shrink, current farmland is inadequate to supply a growing population. Combined with an inefficient supply of new fertile farmland to put under the plow, a great trade is upon us. Gaining exposure through futures contracts on the CME, investing in water rights or farmland itself (Mark note: In places like Chile, Uruguay and Paraguay.) are likely to all be winners in coming years.

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Mark again…. Thanks Scott!

How do we play the inevitable increase in prices for foodstuffs? Scott suggested a few ways, and I agree with them all. I’ve been buying “bull call spreads” (options on futures) on wheat, soy, corn and sugar for the last couple years. Establishing a bull call spread involves the purchase of a call option on the commodity, while simultaneously writing a call option on the same commodity with the same expiration month, at a higher strike price. It’s not complicated and it can be done by anyone with a futures account (I like RMB in Chicago, personally).

In a bull market this is a solid strategy. Try to add new positions on dips. The nice thing about this strategy is that I limit my risk to the premium I spend on the spread, which is usually less than $1,500 in most cases. I’ve also been doing this, with much success, using gold and silver spreads. It’s been like shooting fish in a barrel.

An example of a trade that I have on right now is the March 2012 wheat $8 – $8.50 bull call spread. If the price moves within the range I will make money. If it stays below the range my options will expire worthless. I’m betting that wheat is between $8 – $8.50 by March of next year. If it gets there quicker I still make money, but the closer we are to that March expiration the more the spread will be worth. That spread can be created today for about $750.

If you want to actually grow the stuff, I also like productive farmland in South America. I live in Uruguay most of the time, and I just looked at a very nice 27 hectare piece, 30 minutes from the heart of Punta Del Este, for about US$ 180k. It’s suitable for a very nice small farm and house, with streams, lots of trees, interesting topography and a LOT of water underground.

If you want to go bigger you can pay as little as $2,000/hectare, sometimes less, but those are big pieces. Paraguay is cheaper still, and a bit warmer and more “rustic.” Chile is a great alternative, everything will grow there, the soil is rich and volcanic, and the climate in the valleys is excellent. I mentioned our friend Simon Black’s sustainable community plan in a previous post. He chose Chile after careful consideration of many factors. We respect his opinion, and as a result will be going there in December to check it out for ourselves.

Don’t like either of those ideas? Here’s another strategy to consider: Create a food storage area in your home. Buying canned and dried foods, grains, legumes, sugar, etc. is an investment not only in food security for your family, it’s also an inflation hedge. Food prices are going up. If you pay $1.00 for a can of something today, and that same can is $1.10 in a year, you made 10% on the dollar you spent. Pretty simple.

In summary, we can pretty much guarantee higher food prices for all the reasons Scott outlined above. Add to that the decimation of fiat currencies, and you will certainly have inflation in dollar/Euro/Yen/Franc/whatever terms. As Scott pointed out, the technicals and fundamentals are lining up, which in our opinion will result in an upwards revaluation of most ag-related commodities sooner rather than later.

– Mark

“Agriculture not only gives riches to a nation, but the only riches she can call her own.” – Samuel Johnson

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