While many have been enjoying the period of simulative market expansion that generally occurred in its most aggressive fashion from 2012 on – and record high stock market prices resulted – there is one part of the country that has not enjoyed the fruits of stock market gains. In part, this is a subject of a Bank of America Merrill Lynch report on the plight of the agricultural economy in 2017.
Agricultural economy boomed in 2012
When markets are free from significant noneconomic or market-based interference, they tend to move in cycles, historical statistics show. In 2012, for instance, the farm economy was booming. Measured by farm income resulting from high supply numbers in planted row crops and equally high commodity prices — two traditionally negative correlated factors — the farm economy and related economic interests were booming leading up to the US Presidential election of Barack Obama.
For much of the past decade, Crispin Odey has been waiting for inflation to rear its ugly head. The fund manager has been positioned to take advantage of rising prices in his flagship hedge fund, the Odey European Fund, and has been trying to warn his investors about the risks of inflation through his annual Read More
Then, “following the prior decade-long super-cycle,” that trend peaked and the farm economy is now suffering.
How long will it last?
Bank of America Merrill Lynch, in a February 24 report from the firm’s Global Agricultural Chemicals team, looks at the generally disruptive period from 1968 to 1972 and points to a five-year agricultural downturn. Then the conservative era during the Ronald Reagan years, from 1983 to 1991, when trickle-down economics reigned supreme, the resulting period was generally negative for the farm economy with that downturn period lasting nine years.
Before these unusually long periods of farm sufferage — they were statistical outliers — is the periods of history previous to 1960, when agricultural credit cycle downturns lasted only 2 years on average.
Judging from the recent trend after 1968, the decline cycle, currently in its fourth year, might have some room to run. But there are economic variables from China, the weather and lack of regulation that are in play when asking an important question:
What is causation for the pain on the farm?
Technology growth leads to lower prices across the board, making the product more of a general “commodity” rather than a unique economic offering
Farm productivity gains are an interesting statistic to consider relative to their correlation with new technology.
On the surface productivity gains might be considered an aide to farm profit margins. The numbers tell a slightly different story.
The report pointed to inflation adjusted crop prices declining for over 100 years. This negatively correlates with gains in productivity, which averaged +1-2% per year, improving supply. Also improving supply was acreage expansion, which improved 0-1%. The supply improvement was outpaced, however, by demand reduction of -1-2% during the period.
Looking into the future, BAML appears to use trend probability path analysis as they consider what new technologies such as precision agriculture and gene editing will do to productivity.
Into this formula, analysts considered that with an increased demand for protein could be coupled with reduced supply resulting from acreage reduction or potentially significant weather events.
While the 38-page report did not use the term “global warming,” it did consider significant weather events, those that might be relative statistical outliers, on the horizon and how this impacts supply.
Without regulation, China’s mega pig farms flourish; with regulation, they become more competitive with US farmers
To understand how technical and systematic advances in farming work on farm profitability, look at the advent of new mega pig farms in China. Working under a regulatory structure that has resulted in pollution reaching all-time highs, the Chinese are looking to take on US pig production.
There is a correlation between low-cost production and proper regulation. When an environmental crackdown of sorts occurred in the Chinese farming sector, for instance, bringing standards closer to that in the US, this resulted in 3% drop in 2015 production and a 5% fall in 2016, allowing US farmers to enjoy slightly less Asian supply entering the market.
Regardless of the production and management of 1 billion pigs in a lightly regulated China and its impact on the hog market, the relative value impact on corn demand might be positive. Pigs eat corn, which is pushing demand higher.
The environment is another factor in agricultural pricing, as “weather remains a risk” while the return of “El Nino,” part of an unpredictable trend, could impact agricultural supply, the report noted:
Historically La Niña correlates with colder than usual winter temperatures in most of the Northern Hemisphere, which can lead to higher winter wheat kill. It also correlates with dryness in Latin America, which can adversely affect corn and soybean yields during the current growing season. High moisture favors fungal disease and high temperatures favor insect outbreaks, generally speaking, however growers are generally able to respond with crop protection chemicals.
“Unfavorable weather conditions” could impact corn prices by -3% while favorable weather could translate into a -1% decline, the report noted.
And there are current trade conditions which could impact pricing. President Trump has demanded an examination of all trade agreements and is expected to pounce on any perceived indiscretions that might tip the scales away from US farmers. There could be both positive and negative impacts from such action, with the report generally noting the negative implications:
Meanwhile, the changing political climate poses its own risks to agricultural prices. President Trump has threatened to impose import tariffs on China, the largest buyer of US soybeans and wheat, and renegotiate the free trade agreement with Mexico (NAFTA) which is the second-largest buyer of US corn. Any trade war that leads to higher tariffs on US agricultural exports will likely hurt US prices. China has already imposed tariffs on dried distillers grains (DDG), a byproduct of ethanol used for feed, and has stated intentions for an ethanol import tax. It is unclear how the administration will react, but the outcome remains highly uncertain.