agri-business, annual reports, Archer Daniels, bank debt, BRF-Brasil Foods, contango, correlation, Deere & Co, emerging markets, ETFs, ETNs, ETPs, farmland, fertilizer stocks, food wastage, frauds, frontier markets, Gain on Biological Assets, inflation, JP Morgan, livestock, Market Vectors Agribusiness ETF, Monsanto, MOO, picks & shovels, plantations, soft commodities, Syngenta, United States Oil Fund, Wilmar, Yara
I don’t believe there’s any need to rush into Agri stocks as an inflation play right now. First, I suspect inflation will take far longer (than many currently seem to expect) to overcome the current wave of de-leveraging. And second, the primary real asset conduit for inflation, via the banks, is always Property - which eventually spills over into Natural Resources, and finally into Agri stocks (inc. soft commodities). Regardless, I still think Agri’s always an attractive asset class, and I’d be perfectly happy to increase my exposure if the right opportunities come along. Let’s recap the attractions of Agri:
- Steadily increasing demand due to global population growth (but isn’t everything..?!)
- Higher demand also (via increased consumption & waste*) due to rising global per capita incomes – basically this is an emerging/frontier markets growth story
- Rising incomes also prompt people to trade up to, and increase demand for, protein (specifically, meat), which requires far greater agricultural resources to produce
- It’s pretty insensitive to the economy: Food’s a high priority in emerging/frontier markets, and developed market food spending (as a % of income) has declined dramatically in the past 30 years. And remember, people avoid reducing calorie intake in downturns, they just make substitutions
- Obviously it requires capex & operating expense investment, but biological growth provides a wonderful (& uncorrelated) investing wind at one’s back
- Finally, of course, it offers a great (later stage) inflation play
* Shocked to learn up to one third of global food production’s wasted? Less shocked to discover the US is the worst offender? This global food waste chart sheds light – similar waste levels in global food production & distribution suggests inevitable & unavoidable wastage within the supply chain, but still highlights a huge opportunity for waste reduction. The pronounced difference in consumer wastage, however, is pretty…sinful! But where goes America, everybody follows – hard to believe food wastage will be a long-term aspiration for emerging/frontier market consumers, but unfortunately I’d bet on it…
So, Agri stocks offer relatively uncorrelated exposure (on an underlying basis) to pretty favourable secular growth (and emerging/frontier market) trends. What’s not to like?! Well, like any great/compelling investment theme, there’s two key challenges/risks – we need to find stocks that genuinely offer the desired exposure, and then we need to avoid over-paying!
[Then, of course, there's the risk of hucksters/con-men who'll utilize any viable investment theme to try strip you bare. And agri investments really seem to have a fatal attraction for gullible investors... Ostrich farming, exotic farmland, forestry, bamboo plantations, etc. - the list keeps expanding, and we're just seeing the tip of the iceberg here. I expect 'opportunities' will expand exponentially as promoters exploit people's fear of actual/expected inflation.
Why on earth do people ignore listed stocks, and instead plump for private investment 'schemes' which promise higher fees, negligent governance, no liquidity, and poorer returns..!? Not to mention the eventual loss of some/all of their principal! Yes, listed companies aren't perfect either - but at least on an exchange, over-hyped stocks (with rapacious & duplicitous management) tend to be far easier to spot & avoid - at least for investors with a modicum of common sense. Avoiding sub-10/20 million market cap stocks is usually another good shortcut for avoiding the dross. In fact, thinking about all this:
Attention Readers: If anybody's shared a special/private 'investment opportunity' with you, or a friend/relative, I'd love to hear about it & possibly rip it apart! Er...if the investment's already made, probably best not to tell me - I'm not looking to upset you! And I'm only interested in facts/figures, financial projections, and/or contracts - no marketing materials, please, I can't analyze pie-in-the-sky! Just email me at email@example.com]
Anyway, I’ve become a lot better with the first challenge, but avoiding paying up for theme stocks is a far tougher challenge. I’ve learned over the years that buying cheap doesn’t necessarily work, buying growth (at any price) certainly doesn’t work, it’s got to be buy growth at a cheap price! If you exercise the necessary patience, another slump always comes along & then you can take full advantage. After all, if we’re talking about investing in some compelling decade(s)-long trend, what the hell’s wrong with missing out on a year or two?
Yeah yeah, I know, impatience is a terrible beast! But I swear, much of my success these days in stocks is down to not buying – if you know what I mean! I look through my portfolio, and blog write-ups, and see so many stocks I’ve tracked daily & weekly for (literally) years before finally pulling the trigger at the right time & price.
OK, so investing in agriculture’s a big investment theme, and there’s obviously a large universe of individual stocks to consider… For most people, investing in funds is always going to be the simplest & most practical investment solution, so we’ll cover fund options available, their pros, and (particularly) their cons in the rest of this post:
Closed-End Funds/Investment Companies: There are a number of cheap & attractive funds listed in London. They’re all quite specialized, however, and maybe not the first/best port of call I’d suggest for an investor building exposure. I do hope to write more about some of these in future posts. In fact, off the top of my head, I really can’t think of any closed-end fund that offers an investor general/diversified agri exposure.
Therefore, I think we can quickly move on to Exchange Traded Funds (ETFs). I guess I should more correctly say Exchange Traded Products (ETPs), as there are some crucial differences in funds. I’ll focus exclusively on US ETFs, as they mostly have the larger market caps & have been around that much longer – but note UK/European ETFs are v similar.
Commodity ETFs: Aren’t commodities great? No annoying P/Es or other painful ratios, no boards, no unexpected results/updates, no loans/no bankruptcies… Sheer bliss! Just a price & a chart, eh? Which means (as any broker will remind you) the price can go absolutely bloody anywhere! But if you’re so enamoured, why not go the full hog (?!) – sign up with an FCM & learn to trade futures properly. At least then you’ll have some inkling of what happened when you lose all your money (well, presuming you’re not defrauded first). On the other hand, investors in futures-based ETFs often never figure out what hit them…
To put it simply – soft commodity (i.e. futures based) ETFs are truly the work of the f***ing devil! I’m not even going to nominate an example – I won’t be held responsible! Just think of ETFs offering exposure to commodity baskets, or even a single commodity – like hogs, coffee, cocoa, wheat & the like. Now, investors really should have grasped these are designed for traders, not investors. But I can sympathize when they’re duped by the ETF industry. Because, even with a v strong view on price, I struggle to see how one can make money with these vehicles. And I’m talking with foresight, not hindsight… It’s not difficult to determine the usual contango on futures & other assorted ‘roll‘ costs might easily cost you 5%, even up to 25%, annually. There’s no way you can beat that kind of drag over time, even with a great price call, or two…
And every ETF provider knows this, and can easily model it! So I’d expect it to be plastered across the cover of all such ETF prospectii, and commented upon in every report. But no… All you get is an enticing spot price graph, plenty of waffle about uncorrelated returns, and little explanation why your ETF NAV’s rapidly heading south – regardless of underlying price developments! I know it’s an energy ETF, but the United States Oil Fund LP (USO:US) [love that 'United States' - the subtle lure of patriotism for US investors?!] is a fine example. I just bet investors never expected a 71% price collapse! Gee, did you realize the oil price had fallen so far?! I think bloody not, monsieur… Of course, the wretched industry has a ready answer to this kind of bait & switch:
- We’re just offering a useful product, you don’t have to buy it!
- Didn’t you read the dozen pages of fine-print boiler-plate risk disclosure we included in the prospectus?
- We can’t model/provide hypothetical returns (‘heavens, that’s pretty much akin to fraud!’) – so, although we know you’ll pretty definitely lose money, we simply can’t/won’t give you any clear warning of that
- SEC guidelines & supervision are v rigid, so additional disclosures, forecasts & commentary are far too problematic for us
The first three responses are part & parcel of the new ‘ethical‘ landscape we’re all being subjected to, but personally I find the fourth is the most pernicious. In fact, it pretty much deters me from investing in any open or closed-end US funds these days. I mean, have you tried to read a goddamned US fund report recently? Christ on a f**king cross – most of their disclosure’s useless and/or unreadable, their commentary’s anorexic & boiler-plate, and you’ve virtually zero chance of ever reading any decent stock analysis, or market outlook. Shame on all concerned! Compare that to the joy of reading a decent UK investment trust annual report – or, even better, a Swedish report – go on, try one, they’re v tasty!
Exhange Traded Notes (ETNs): No matter how tempting the exposure, I hope I never succumb to these! I mean, I’d never dream of buying bank debt ordinarily – second only in depravity to buying bank shares, in my opinion. So why would I ever buy a piece of crap like this? Regardless of exposure, or returns, this is just a piece of debt in the end. If, and when, disaster rolls around again, and you’re praying agri/commodities prove a safe-haven, you may just end up stuck with a piece of paper whose value is rapidly diverging from its NAV. Sometimes all the way into bankruptcy… Please, just don’t do it! [Which reminds me: ETF complexity's getting worse, not better. Even if a fund isn't an ETN, more & more ETFs are creating exposure in various other synthetic ways. This may perhaps offer more limited risk, and (some) collateral. But again it means investors risk owning an ETF that throws up counter-party and/or market risk all over them at the v worst time.]
Physical ETFs: Actually, these aren’t such a bad idea! Oh Lord, have I just fallen in with the paranoid nutter crew..! They’ve really got some odd ideas (& a strange obsession with JP Morgan (JPM:US)). But it’s relatively easy to identify the storage/expenses involved, so you can expect these ETFs will actually track spot prices, minus a predictable expense drag. This works really nicely with (precious) metals, but unfortunately it’s not so easy with soft commodities! In fact, I’m not sure if a provider has even attempted this? I just read a Barron’s prediction re surging global milk prices - anybody fancy a milk lake ETF?!
Stock ETFs: Not surprisingly, this is where the majority of Agri ETP capital is invested. Which makes sense, they offer convenient & diversified portfolios of agri-business stocks. But what are they really offering,when you really look under the hood? Right, let’s pick on the Market Vectors Agribusiness ETF (MOO:US) (just charming..!), simply because (I believe) it’s the largest such ETF, with about $5.7 billion in assets. Here’s the geographic allocation:
See a problem? North American stocks comprise over 50% of assets, not exactly a good representation of global agri-business exposure & opportunity! On the other hand, one could commend them – this level of foreign exposure’s far better than many other US ETFs. In general, UK/European ETFs have an edge here,usually offering a more global portfolio. But there’s a much bigger problem here – let’s look at the Top 13 stocks/tickers, which comprises 67% of the portfolio:
OK, let’s break it down. For convenience, I’ll assume a similar allocation for the rest of the ETF portfolio. Therefore, the %’s below are an estimate of the total portfolio ‘sector‘ allocation:
Seeds & Pesticides (22%): Monsanto & Syngenta. These are the ‘big pharma‘ of the agri world, but they’re priced v differently! Every time I look at them, I like their intellectual property, their business model & their prospects – and then reluctantly decide they’re just too expensive, and move on… Today, it’s the same story: They’re priced at an average 21.6 P/E, and a 3.0 P/S ratio. Too rich for my blood..!
Fertilisers (44%): Potash, Uralkali, Mosaic, Agrium, CF Industries & Yara. This sector’s traditionally a lot cheaper, with a current average P/E of 10.9 & a 2.7 P/S ratio. Interestingly, Yara‘s the only stock that’s consistently caught my eye – what luck, it’s also the cheapest, with a 6.4 P/E & a 1.0 P/S! But the trouble with this sector, it’s totally boom-and-bust!
I clearly need to study up more – so far I haven’t really figured out the cycle here. Then again, I’m not sure who has!? Because I see constantly changing (& completely wrong) estimates of demand (& supply), both at the analyst & the industry level. This is compounded by the nature of the key input costs – you’re essentially investing in a mining industry, that’s also v heavily dependent on energy! Put all this together, and it’s difficult to assume fertilizers are such a smooth & easy bet on agriculture. I also consider their portfolio allocation absurdly high, particularly in light of what’s missing elsewhere in the portfolio.
Equipment (15%): Deere & Kubota. Let’s just focus on Deere: They boast of being global, but 74% of their sales are in W Europe & N America. Yes, that’s the W Europe which has, on average, the highest farmland prices in the world. And the US is rapidly catching up – in fact, it has all the makings of another glorious bubble, with $15 K+ an acre price reports now coming out of Iowa. Yes, farms in these parts of the world are highly productive, but that means they’re also heavily dependent on capital, fertilizers & irrigation. Not to mention out-sized subsidies from financially stressed governments. That presents a potentially v fragile situation. In addition, farm equipment expenditure’s actually quite vulnerable to the general economic climate – the fact that the majority of this capex funding must come from the banking industry, directly or indirectly, dictates that. This all presents some potentially alarming revenue risks for Deere & other big-name farm equipment providers.
Processors (12%): Archer Daniels (ugh, bad taste in my mouth…) & BRF-Brasil Foods. These guys are (basically) processors. Their aim in life is to keep input prices down, and turn a decent profit. And they always aspire to move up the value chain into branded/processed food products. If input prices rise, they quickly pass it on (plus inflation) through their supply chain to end-consumers. In the developed world, we’ve been hoodwinked over the years into mostly eating processed crap. Fortunately, this means the actual food component of food pricing is now dramatically lower, thereby muting price increases. People in emerging & frontier markets aren’t so bloody fortunate… But then again, they enjoy far lower rates of obesity, heart disease & diabetes!
I really struggle to see the agricultural exposure here – these guys might as well be processing widgets. In fact, if they were in the widget processing business, I’d really expect v little difference in their business model(s), prospects, and/or their stock-market ratings!
And. finally, we have:
Plantations (7%): Wilmar, a palm-oil plantation owner & refiner, which owns/manages over 700,000 acres of plantations.
Well, you probably know the punchline here… MOO, and its like-minded peers, fail abysmally in providing me with I’m looking for. I want exposure to agriculture – for me, that boils down to exposure to uncorrelated returns & real assets. Which is essentially exposure to biological assets & growth. Like farmland, plantations, forestry, crops, livestock, dairy, chickens/eggs, fishing & aquaculture. I think water’s also an essential component of such a portfolio. And look, only a paltry 7% of MOO’s entire portfolio appears to offer such an exposure! The rest of the portfolio’s irrelevant (i.e. offers no real agricultural exposure, and/or its performance is dictated by other/more important factors), or at best can be considered a picks & shovels portfolio…
That’s not what I’m looking for, and I don’t think you should be either if you want genuine diversification of risk & return within your portfolio. There’s also the question of price – as I noted, theme stocks are often expensive, and ETFs are generally stuffed with popular/large-cap stocks… I calculate MOO‘s Top 13 stocks are currently sporting an average 16.2 P/E & a 2.0 P/S ratio. Nothing too cheap about those ratios! Even if they actually offered the promised agricultural exposure & secular growth trends…
Unfortunately, if stock research isn’t your cup of tea, ETFs may be the only solution. Or maybe I’ve scared you off completely?! But every fund’s different, new funds are being launched constantly, and prices & markets change, sometimes rapidly. An ETF may prove better than nothing, but please pay v close attention to all the cons/pitfalls I’ve written about here. At the v least, before buying any ETF, understand exactly what type of fund it is, how it’s structured, and then look a little more closely at (even) its Top 5 holdings on Bloomberg, and on their individual websites. Who knows, a particular stock may just jump out at you as a better buy - there’s no such thing as plagiarism in investing!
Of course, more comprehensive research & the buying of individual stocks is always going to be the ultimate & best solution. I’m confident there’s plenty of stocks globally that offer the right kind of exposure, and sometimes they even offer the right price also! I’ve written about some of these on the blog before, and hope to introduce some new ones in the future. And PS: The agriculture section here is another wonderful place to look for ideas. Good luck!