Quick Market Update
 

Flourishing Farmland and Bumper Crops

November 22, 2013

H. Cameron Hinds, CFA®
Regional Chief Investment Officer  

Luis D. Alvarado
Investment Research Analyst

 

vertical rule

In this Quick Market Update:

An update on agriculture, farmland, and commodities

  • Farmland has seen strong returns through the last decade.

  • Agricultural commodity performance has been more mixed.

  • Despite some near-term headwinds for agricultural assets, our longer-term outlook is positive for this sector.

 

It’s as basic as survival and as complicated as modern-day derivatives markets. Long ago, societies formed as people began to understand how to gather seeds, use soil, and develop irrigation techniques in order to control their food production. Yet agriculture has become so much more than simply growing food for survival’s sake. The production, harvesting, and distribution of agricultural commodities eventually evolved into large-scale businesses with one big uncertainty—the weather. The uncertainty of prices and yields contributed to the creation of the Chicago Board of Options Trading (CBOT) where “futures” contracts are traded. Today, through the advent of options trading, farmers wishing to hedge their risk, speculators hoping to make a trading profit, and investors wishing to enhance their portfolio returns all have the capability to invest in agricultural commodities. Investors can also participate in the agricultural markets through direct or indirect ownership of farmland. In this QMU we look at the attractiveness of agricultural assets as part of a globally diversified investment portfolio.

Farmland vs. agricultural commodities

In recent years, investors have become more interested in both farmland and agricultural commodities—perhaps as a reflection of the stability and consistency of returns relative to other asset classes, such as traditional real estate investments and equities. Through the end of August of this year, farmland prices in the U.S. were up 9.4 percent on a year-over-year basis.1 The increases in farmland values have been considerably stronger in the heart of the U.S. agricultural community. As an example, farmland prices in Iowa rose 20 percent year-over-year as of August, with a three-year average annual return of 23.1 percent. Nationally, farmland price performance since 2000 has been especially strong, rising from an average of $1,000 per acre in 2000 to over $3,000 per acre this year.

Farmland Prices Rising: Average Farm Real Estate Values, 1950-2013


Average farm real estate values per acre since1950 through 2013. Contact your Relationship Manager for more information.

 

Source: U.S. Department of Agriculture (USDA), National Agricultural Statistics Service, 11/13; not inflation adjusted
 

Unlike farmland, the prices of certain key agricultural commodities have fallen significantly this year. The current year’s corn crop, for example, is likely to be the largest in U.S. history—but such success can bring with it certain challenges. The large supply of corn, combined with a modest slowdown in demand, has pushed corn prices down more than 34 percent over the past 12 months. While lower agricultural commodity prices might be expected to hurt farm income levels, it appears that this year’s abundant harvest will offset most of the price drop.

Agricultural Commodity Performance Has Been Mixed


Agricultural commodity performance, YTD and over a 1-, 3-, and 5-year period. Contact your Relationship Manager for more information.

 

Source: DJ-UBS Commodity sub-indices; Bloomberg, as of 11/20/13
 

Farmland outlook

Typically, farmland prices and agricultural commodity prices are closely related, but, as we’ve seen recently, there are periods of time when commodity prices and land prices do not move in tandem. However, diverging price trends are most likely unsustainable on a longer-term basis. So why have farmland prices been rising so rapidly while key commodity prices have been tumbling?

There are several specific factors that we believe are contributing to higher farmland prices:

  • It is difficult to measure a “pure” farmland price, as approximately 20 percent of farmland is subject to “urban” influences, resulting in higher values due to city proximity.
  • Farmland prices have benefited from the trend of declining interest rates over the past 30 years. From 1978-85 and from 2005-08, farm income was not sufficient to service debt; this is not so today.
  • Farm income gains have largely kept pace with farmland prices over the past few years. Technological advances have led to gains in productivity and efficiency. The potential for future gains in farm income levels is sizable.   
  • Perhaps most importantly, farmland often only changes hands when a landowner who does not have the ability to transfer the property within the family dies or retires. It has been estimated that farmland turnover in the U.S. is potentially below one percent per year. That is akin to a 100-year holding period for stocks. Even equity index funds typically have higher annual turnover rates than farmland. This creates a “scarcity” value for farmland not seen in other asset classes.

Farm Sector Net Income, 1950-2013 (Forecast)


Farm sector net income from 1950 and forecast for 2013. Contact your Relationship Manager for more information.

Source: USDA, Economic Research Service, 11/13; not inflation adjusted

While these factors appear supportive of current farmland prices, we acknowledge that there are some near-term headwinds. For example, policymakers in Washington D.C. appear ready to make cuts to farm subsidies which could dampen farmland prices. Also, our current outlook for modestly higher interest rates in 2014 may have a negative impact on farmland prices. But even this risk may be offset by a reasonable level of outstanding loans on farmland (especially relative to the high agriculture-sector debt levels of the late 1970s and early 1980s). Despite some short-term uncertainty, we believe the longer-term outlook for the agriculture sector looks healthy.

Commodities outlook

From a long-term perspective, the most significant positive factor for the outlook of commodity prices is the continued growth of demand from emerging market economies for food-related products. The USDA estimates that over 80 percent of additional food demand will come from emerging economies over the next 10 years. That growth is in excess of emerging countries’ internal production growth potential. Therefore, the U.S. farm belt is expected to provide much of the supply for this demand. In particular, the USDA estimates that as emerging-sector income grows, demand for meat will increase substantially, positively influencing commodity prices as well as land prices. 

While the longer-term outlook for agricultural commodities is very attractive, just as with farmland, there are some potential near-term negatives. In particular, the Environmental Protection Agency (EPA) has proposed a reduction in the required ethanol blend targets on a national level, potentially denting future demand for corn and other grains.

Conclusion

At present, we are tactically underweight commodities. Our outlook remains cautious for agricultural assets in the near term, but more positive over the longer term. Currently, agricultural commodities may be suffering from oversupply and the potential for adverse regulatory policies. These negative factors are contributing to our tactical underweight of the broader commodities sector. 

Furthermore, it is certainly plausible that farmland prices today may be modestly ahead of their underlying fundamental price levels and the recent trend in declining commodity prices. Yet fundamentals in the agriculture sector remain healthy from a longer-term perspective. Farm income continues to grow, technological advances are positively influencing production levels and debt levels do not appear excessive in the sector. Interest rates are likely to trend higher but remain attractive from a historical perspective. Strong global demand trends should ultimately have a positive influence on both agricultural commodity prices and farmland prices. We will be closely monitoring the trends in interest rates, farm income, news from Washington D.C. on farm subsidies, and emerging market growth to determine the potential future trends in both agricultural commodity and farmland prices.

 

All data for this Quick Market Update was sourced from Bloomberg Finance, LLP, unless otherwise noted.

 

Disclosures

Wells Fargo Wealth Management provides products and services through Wells Fargo Bank, N.A. and its various affiliates and subsidiaries.

The information and opinions in this report were prepared by the investment management division within Wells Fargo Wealth Management. Information and opinions have been obtained or derived from sources we consider reliable, but we cannot guarantee their accuracy or completeness. Opinions represent Wells Fargo Wealth Management’s opinion as of the date of this report and are for general information purposes only. Wells Fargo Wealth Management does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses.

Past performance does not indicate future results. The value or income associated with a security may fluctuate. There is always the potential for loss as well as gain. Investments discussed in this presentation are not insured by the Federal Deposit Insurance Corporation and may be unsuitable for some investors depending on their specific investment objectives and financial position.

This report is not an offer to buy or sell, or a solicitation of an offer to buy or sell the securities or strategies mentioned. The investments discussed or recommended in the presentation may be unsuitable for some investors depending on their specific investment objectives and financial position.

Investing in foreign securities presents certain risks that may not be present in domestic securities. For example, investments in foreign and emerging markets present special risks, including currency fluctuation, the potential for diplomatic and potential instability, regulatory and liquidity risks, foreign taxation and differences in auditing and other financial standards.

Fixed income securities are subject to availability and market fluctuation. These securities may be worth less than the original cost upon redemption.  Certain high-yield/high-risk bonds carry particular market risks and may experience greater volatility in market value than investment grade corporate bonds.  Government bonds and Treasury bills are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and fixed principal value.  Interest from certain municipal bonds may be subject to state and/or local taxes and in some instances, the alternative minimum tax.

Real estate investments carry a certain degree of risk and may not be suitable for all investors.

Indexes represent securities widely held by investors. You cannot invest directly in an index.

The Dow Jones - UBS Commodity Index is designed to be a highly liquid and diversified benchmark for commodities as an asset class. The index is composed of futures contracts on 19 physical commodities. No related group of commodities (e.g., energy, precious metals, livestock and grains) may constitute more than 33% of the index as of the annual reweightings of the components. No single commodity may constitute less than 2% of the index.

Wells Fargo and Company and its affiliates do not provide legal advice. Please consult your legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared.

© 2013 Wells Fargo Bank, N.A. All rights reserved.

Investment Products. Not FDIC Insured. No Bank Guarantee. May Lose Value.
 


1 United States Department of Agriculture (USDA) Statistics Survey, 09/13

 

You need Adobe® Reader® to read PDF files. Download Adobe Reader for free.



Cameron Hinds, CFA®

Regional Chief Investment Officer, Great Lakes Region



Flourishing Farmland and Bumper Crops (PDF)
November 22, 2013

In this Quick Market Update, Regional Chief Investment Officer Cameron Hinds, CFA® and Investment Research Analyst Luis D. Alvarado look at the attractiveness of agricultural assets as part of a globally diversified investment portfolio.

 

Wells Fargo & Company and its affiliates do not provide legal advice. Please consult your legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared.

Wells Fargo Wealth Management provides financial products and services through Wells Fargo Bank, N.A. and their various affiliates and subsidiaries. The information and opinions in these reports were prepared by the Investment Management arm of Wells Fargo Private Bank, a part of Wells Fargo Wealth Management and a division of Wells Fargo Bank, N.A.

Investments discussed in these reports may not be insured by the Federal Deposit Insurance Corporation and may be unsuitable for some investors depending on their specific investment objectives and financial position. These reports are not an offer to buy or sell, or a solicitation of an offer to buy or sell the securities or strategies mentioned.

Brokerage services offered by Wells Fargo Advisors, LLC. Wells Fargo Advisors, LLC, Member SIPC is a registered broker-dealer and separate non-bank affiliate of Wells Fargo & Company.

 

Investment Products: Not FDIC Insured, No Bank Guarantee, May Lose Value.