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DAVID KRUSE

By Staff | Nov 26, 2010

I was in Boston recently hearing how global investment funds intend to expand portfolios into the ag sector. They understand the story how the combination of adding a billion people in the next 14 years and growth in the global economy turning another billion from subsistence peasants into bonafide consumers will change the demand structure of commodities forever.

Some are calling it a new era, but bulls understand that nine out of 10 calls for new eras result in reversion to the old one.

I would call it an inflection point, where what happens next will have huge ramifications on the future of agriculture. There are hundreds of billions of dollars right now held by institutional investors that are looking as hard at the ag sector as they have ever looked.

This is not dumb money. They are not walking in with abandon. They have been looking at agriculture for 30 years and most are just putting a toe in to test the temperature of the investment.

They are not farmers. They have no heritage in agriculture. They do not like ag markets’ unpredictability. It has taken them a long time to get comfortable with investing in agriculture. The situation is that they understand global fundamentals enough to find investigating investment in agriculture compelling.

They also understand that they have to do it right as they have so much money that they can alter the landscape skewing valuations. They don’t understand it all and some things, not at all. One fund expert from Europe shared her opinion with the group that ethanol was a political and environmental disaster. I bit my lip, knowing she was simply reporting what the “smart” people at Exxon or Tyson Foods had told her.

While I have been reading headlines about ag land bubbles, I don’t buy into that premise as of yet. Ag prices, farmland values have climbed to new highs and at high values may get overdone. We may even see prices fall but that’s just a market.

A bubble is something else, where eventually it is overextended, overleveraged in a speculative mode, like no money down, sub prime mortgages with condos being flipped and the result is a collapse like the Ag Depression of the mid 1980s.

Agriculture is no where near like that today. The assets are not leveraged. Debt-to-asset ratios are conservative. Cash is most of the purchase and it is real buyers not speculators that are driving the market. I saw the potential fuel that could create a bubble some day out in Boston, but the fire is not hot yet, no inferno.

I believe the ag sector bull market is nowhere near its maturity. The funds are coming in cautiously, carefully and thoughtfully. They prefer investing in farm real estate with cash rent from tenants. Value added operations, like livestock, doesn’t interest them. Some, like the Optima Fund, have begun investing in U.S. farmland.

The Optima fund manager gave a list of risks that they don’t like to assume when investing in the ag sector. They include: Title issues, product storage, infrastructure, political and corruption risks. To avoid that, it keeps them in the U.S. To get a return they demand, they are limited from some regions, but have diversified holdings in 12 crops.

State investment laws against corporate ownership and a need for returns have many funds looking south where they have a greater variety of crops they can grow and land is cheaper with potential for irrigation. They are also looking north to Canada.

One fund claimed to be getting an 8 percent return buying farmland and leasing it to tenants in Saskatchewan. The province changed its investment laws and the funds have come in.

I don’t see the need to change Iowa’s corporate farming law. The way to evaluate whether farmland prices are high or low is the rate of investment return they produce. If they can get 8 percent in Canada, then prices are very low. Farms here in Iowa selling for $7,000/acre would require $560/acre cash rent to produce an 8 percent return. That’s not being paid by a long shot, so Iowa farmland values are doing well without fund investment contributing.

Like Will Rodgers said, “Buy land, they are not making any more of it.” That’s a true statement in the U.S. but globally, there are large tracts of developable farmland yet in Eastern Europe, Africa and South America. The problem is that some of all those risks cited by the Optima Fund go with it.

Funds would like to stay above the risk profile while still participating in the sector. That’s not easily accomplished and hit their return model which has resulted in more interest from funds in investing in the ag sector than actual investment.

Right now, they are pushing the bowl in front of “Mikey” to see if he likes it. There are many potential fundamentals that could fall on the ag sector like a ton of bricks, like a currency war becoming trade war, or Chinese recession producing a double dip or interest rates or whatever but the underlying trend, the super cycle is very bullish to commodities and ag investment.

I can’t even conceive of anything better than the ag sector to invest in with the world shaping up as it is today.

I believe that funds are now being pulled into the sector by the compelling demographics of “how” we feed more people with the finite resources that exist.

The “how” is by investing a lot more into agriculture.

David Kruse is president of CommStock Investments Inc., author and producer of The CommStock Report, an ag commentary and market analysis available daily by radio and by subscription on DTN/FarmDayta and the Internet.

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