For three decades between the mid 1970s and 2005, world farming was in the doldrums, and the real price of the main foodstuffs fell by more than 70 per cent. But, in the past couple of years, the scene has changed dramatically with the price of wheat doubling to a recent record of well over $400 a tonne. Even allowing for the fall in the value of the US dollar, this is still a huge upward movement. The prices of other crops have also risen strongly, with barley, soya beans, rice and palm oil also substantially higher, while the traded price of rice has exploded. This unusually strong movement in world prices has been caused, in part, by supply constraints – such as bad weather in Australia reducing cereal yields – but mainly by increasing demand.
In the US – one of the world's largest producers of soya beans, maize and other cereals – the government is encouraging farmers, through generous subsidies, to produce crops for ethanol. This means that land previously used for growing feed crops is being used to produce energy. This is particularly true of land previously used to grow soya beans, with substantial areas now being devoted to production of ethanol.
The powerful global moves to increase energy supplies from sustainable crops has been environmentally and politically motivated, although serious questions have been raised during the past few months about the justification for many of the governmental actions taken in North America and Europe.
Increasing prosperity in the huge and fast-growing economies of Asia – particularly China and India – is leading to growing demand for meat. And that, in turn, means that a much greater area of arable land is dedicated to the production of grains for conversion into meat. It is reported that, over the past 20 years, the average Chinese person's annual meat consumption has risen by around 150 per cent to approximately 50kg. As a result, China is now a major importer of wheat and soya beans, with the value of the latter commodity escalating 35 times between 1999 and 2008.
What drives crop production?
The main factors determining total crop production in any given period include the area of land available for farming, the productive potential of the soil, improvements in technology, farming profitability and, of course, the weather. In the short term, the area of land available and suitable for arable cropping is relatively inflexible, but over longer periods fallow land can often be quickly brought into cultivation and government controls on production, as in the EU, can be removed.
The basic statistics for global land use collated by the United Nations Food & Agriculture Organisation (FAO) reveal that, on average, approximately 10 per cent of the global arable area was classified as fallow in 2005. Although this estimate is extremely rough, as the largest agricultural nations such as China, Russia and the US do not provide data for the area of land in fallow, it does indicate that there may be more potential for raising production than some commentators imply.
A further major determinant of total farm production is the level of gross profit margin that individual farmers can reasonably expect to achieve. In this respect, the rapid rise in output prices has in many cases been substantially diminished by the huge percentage increase in the cost of essential inputs such as fertilisers, fuel, seeds and equipment.
Technology is also a basic driver of higher yields on a sustainable basis, resulting in appreciably higher yields of the major cereals thanks to improvements in seeds, fertilisers, planting regimes, weed and pest control and other management practices. And the application of genetic modification is capable of further raising yields, where farmers are allowed to employ the technology.
More generally agricultural production at all levels responds fairly quickly to upward price movements, while also being vulnerable to both climatic and political changes.
The investment opportunities
The opportunities for investors to participate in what may be a genuine shift in the terms of trade in agricultural products lie mainly in the established plantation companies and, to a lesser extent, in annual cropping businesses. There are also a growing number of other ways to participate, via commodity funds and exchange-traded funds (ETFs) for example.
The problem with most of the leading collective investments, such as the high-performance JP Morgan Natural Resources Fund, is that the main focus is on gold and minerals with only 10 per cent directed into soft commodities. On the other hand, the ETF market offers the opportunity to take a position directly on the future price of specific crops such as wheat, maize and soya beans, as well as a basket of agricultural commodities. A specific example of the latter is ETFS Agriculture, a fund that allows investors to cover seven major soft commodities, including wheat, maize and soya beans.
