This has been a painful year so far for Latin America's farmers. From Colombia's coffee heartlands to Argentina's rolling pampas, farmers are being hit by falling prices. Sugar is down around 50% from its 2010 peak, while coffee has fallen by more than 50%. Cereals, which are also down 24%, look likely to take another hit later on this year as analysts expect America to deliver a record-breaking grain harvest. It's been a rude awakening.
Unsurprisingly the price drops have scared investors. In times of a food crisis people often blame speculators', the non-agricultural investors who buy into soft commodities for pushing up the price. But it works both ways. When these speculators get cold feet they can often exacerbate price drops too. And that's exactly what's happening at the moment.
According to data from the US Commodity Futures Trading Commission, net-bullish bets across 11 US-traded agricultural commodities dropped 43% in June as nervous traders backed away from the sector.
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But I think investors are wrong to panic. In fact I think the sell-off gives us a great opportunity to buy into Latin American agriculture. And today I want to tell you about a stock I believe should do particularly well here.
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Why have food prices prices dropped?
For most Latin American farmers the sources of their problems are a long way away from their fields. Take Colombia's coffee growers, for instance. They produce variations of the Arabica bean, which is used for premium coffees and largely sold in the developed economies of Europe, Japan and America. Unfortunately for the Colombians, coffee demand in the West has been flat since the financial crisis. With struggling consumers looking for discounts, roasters have begun mixing Arabica with cheaper beans from Vietnam.
In Central America, which accounts for around 15% of Arabica production, the problem has been compounded by the spread of a coffee fungus known as leaf rust, or la roya in Spanish. Erasmo Sanchez, a former Minister of Agriculture in Guatemala, told me that the two problems of low price and rust are linked: "Because prices are so low, many farmers were not able to invest in the fungicides needed to combat the problem. That causes it to spread, which is a vicious cycle because then there is even less money for the fungicides."
For Argentinian grain farmers, the enemy is to the north, where the US's huge agricultural machine looks set to churn out a record harvest this year. High prices in recent years have encouraged US farmers to concentrate on grain. The country had planted the highest maize acreage since 1936 and, with weather conditions looking favourable, analysts expect a bumper crop. Farmers around the world are also getting in on the act and the UN's Food and Agricultural Organisation (FAO) expects world production of grains to rise by 7% to a record 2.5 billion tonnes in the 2013 2014 crop year.
Another reason for the sell off is China. As any regular MoneyWeek reader will know, the Chinese economy has been slowing for more than a year now. China is the world's biggest consumer of many agricultural commodities, including pork, poultry and rice, so when its economy slows the speculators get nervous and head for the exits.
Food prices could be set for a huge recovery
Agriculture is a classic cyclical industry. When demand outstrips supply, prices rise. That's a cue for everyone to get excited and raise production. Then, after a time lag, supply catches up and prices fall again.
So if you buy at the bottom of the cycle, you're going to make money when prices rise. Of course, while that sounds nice and simple, it's very hard to call the bottom exactly. So I'm not even going to try. Agricultural prices could well fall further. But, while we don't know if this is the bottom, we do know that prices are a fair way off the peaks that they've hit a couple of times since 2008. And I am prepared to take a punt that they'll get back up to those peaks at some point in the next few years.
One reason for my optimism is that world food demand looks set to rise. The World Bank estimates that total demand for food will increase by 50% by 2030, partly thanks to the rising population and partly thanks to rising demand for meat. As people get richer, they want to eat more meat, which is very intensive to produce. For every 1kg of beef you want to produce, you have to feed a cow around 7kg of grain. Of course the World Bank could be wrong. It would be nave to believe every prediction you read. But given that the world population is also rising quickly - it's expected to rise another 30% by 2050 I think it's fair to assume food demand will increase.
Even China, which has been unnerving commodity investors lately, is likely to push up prices in coming years. Last month the FAO brought out the latest edition of its annual report and was very bullish on China. It estimates that the country's imports of grain, which are normally used to feed to livestock, will double by 2022, as will beef imports. Meanwhile soybean imports will grow by 40%. Another winner will be dairy products. China is already the world's biggest importer of milk but imports should rise by 60% over the next ten years.
Latin America a breadbasket for the world
Obviously, Latin America isn't the only place in the world with good farming conditions. Thankfully, the world has several other breadbaskets the US, Eastern Europe and Australasia that help keep more densely populated areas ie Asia well stocked with food. But of all those areas, Latin America has the most potential to crank up production. According to the Inter-American Institute for Cooperation on Agriculture (IICA), Latin America has 42% of the world's agricultural spare capacity'.
Again, I'm wary of taking any one prediction completely at face value, but there are a lot of good reasons to believe there's some substance to it. One factor is spare farmland potential arable land that isn't currently being used to produce food. In total, the World Bank estimates that about a third of the world's spare farmland is in Latin America. It also has just under a third of the world's freshwater resources; more than any other region. This abundance of resources contrasts with the relative lack of people. With a population of around 600 million, there is plenty of food which can be exported.
Meanwhile, even where land is being farmed, it's often not being done efficiently. Whether it's small Guatemalan coffee farmers that can't afford to protect their crops, or Peruvian maize famers that still collect their harvest by hand, many of the region's farms rely on outdated techniques or machinery.
One reason that this potential has remained untouched for so long is that political uncertainty, or even war in extreme cases, discouraged investors. Peaceful countries such as Brazil or Argentina developed large, modern agricultural industries, but in places such as Colombia, Mexico and Central America, the business environment was far more challenging. That's changed now, and improved social conditions and regulatory frameworks in many Latin American countries especially those in the Pacific Alliance are encouraging investors to develop agriculture there.
Another boost is coming from improved local infrastructure. As I've detailed before,economies across the region are investing heavily in upgrading their transport infrastructure and this will reduce the cost of exporting agricultural products. The proliferation of free-trade-agreements (FTAs) is also helping to cut costs. Central America has just signed one with the EU, while many of the countries on South America's Pacific coast have FTAs with their Asian counterparts across the Ocean.
A million hectares across Latin America
Fortunately for UK-based investors, there are a number of large Latin American farming companies listed on US exchanges, so they are easy to buy. One of the most risky is Argentinian firm Cresud (Nasdaq: CRESY). The firm owns farmland in Argentina, Brazil, Bolivia and Paraguay and produces cereals, beef and milk
The firm is also involved in Argentinian real estate through its listed subsidiary IRSA. Cresud is a giant with one million hectares of farmland that's around half the size of Wales. What I like about its business model is that production supplies a steady stream of earnings, while its side business of developing and selling farms allows investors to gain from capital appreciation.
The other thing I like is that this stock is dirt cheap and currently trades on a price/earnings ratio of 4.8, compared to Brazilian peers that trade on multiples of 12 and 18. There's a good reason for this. On top of the general soft commodity woes, the firm also has to deal with a volatile political situation in Argentina, where President Kirchner frequently clashes with farmers. Its real estate business is also exposed to the struggling Argentinian economy. But despite these risks I think Cresud still looks pretty cheap, and offering a dividend yield of 5.93%, it could be a good bet.
I think the market has more than priced in the risks and I believe that rising global demand for food will outlast the challenges that come with Argentina's current government.
