Big Investors Running to Agriculture Plays

The New York Times describes how some big-money players are skipping the commodities market and going directly to being hard asset players by buying farmland and grain elevators. This is hardly new (I know of one global macro fund that was making ag related investments two years ago) but the Times piece gives the impression that quite a lot of money is suddenly chasing this theme.

While in theory having more capital deployed in food production would be a Good Thing, the equation isn’t necessarily that straightforward. Yes, 70% of the world’s farms are not at the highest level of productivity that modern techniques can produce, so more gains are possible. But this isn’t a linear equation where farmland + more dough = more output at a higher profit. Modern agricultural techniques are both energy intensive and fertilizer intensive, and both are increasingly costly. A land grab may produce an input squeeze that erodes much of the hoped-for return.

Needless to say, owning storage facilities also allows these investors to take position directly in commodities, actually stockpiling raw materials, rather than playing them via the futures markets.

The Times story also quotes some traditionalists who wonder what kind of stewards these investors will be if things don’t turn out as planned, and what their exit strategy might be (oh, given the eagerness of the Chinese to own farmland, maybe this will turn out to be the agriculture analogy to having a front do a real estate assemblage). Roger Ehrenberg made the observation that hedge funds should not mark illiquid, hard to value holdings at anything more than cost until they had had a liquidity event. One has to wonder how these assets will be valued in an investment portfolio and whether investors are at risk of flattering marks.

From the New York Times:

Huge investment funds have already poured hundreds of billions of dollars into booming financial markets for commodities like wheat, corn and soybeans.

But a few big private investors are starting to make bolder and longer-term bets that the world’s need for food will greatly increase — by buying farmland, fertilizer, grain elevators and shipping equipment…

“It’s going on big time,” said Brad Cole, president of Cole Partners Asset Management in Chicago, which runs a fund of hedge funds focused on natural resources. “There is considerable interest in what we call ‘owning structure’ — like United States farmland, Argentine farmland, English farmland — wherever the profit picture is improving.”

These new bets by big investors could bolster food production at a time when the world needs more of it.

The investors plan to consolidate small plots of land into more productive large ones, to introduce new technology and to provide capital to modernize and maintain grain elevators and fertilizer supply depots.

But the long-term implications are less clear. Some traditional players in the farm economy, and others who study and shape agriculture policy, say they are concerned these newcomers will focus on profits above all else, and not share the industry’s commitment to farming through good times and bad.

“Farmland can be a bubble just like Florida real estate,” said Jeffrey Hainline, president of Advance Trading, a 28-year-old commodity brokerage firm and consulting service in Bloomington, Ill. “The cycle of getting in and out would be very volatile and disruptive.”

By owning land and other parts of the agricultural business, these new investors are freed from rules aimed at curbing the number of speculative bets that they and other financial investors can make in commodity markets. “I just wonder if they need some sheep’s clothing to put on,” Mr. Hainline said.

Mark Lapolla, an adviser to institutional investors, is also a bit wary of the potential disruption this new money could cause. “It is important to ask whether these financial investors want to actually operate the means of production — or simply want to have a direct link into the physical supply of commodities and thereby reduce the risk of their speculation,” he said.

Grain elevators, especially, could give these investors new ways to make money, because they can buy or sell the actual bushels of corn or soybeans, rather than buying and selling financial derivatives that are linked to those commodities.

When crop prices are climbing, holding inventory for future sale can yield higher profits than selling to meet current demand, for example. Or if prices diverge in different parts of the world, inventory can be shipped to the more profitable market.

“It’s a huge disadvantage to not be able to trade the physical commodity,” said Andrew J. Redleaf, founder of Whitebox Advisors, a hedge fund management firm in Minneapolis.

Mr. Redleaf bought several large grain elevator complexes from ConAgra and Cargill last year for a long-term stake in what he sees as a high-growth business. The elevators can store 36 million bushels of grain.

“We discovered that our lease customers, major food company types, are really happy to see us, because they are apt to see Cargill and ConAgra as competitors,” he said.

The executives making such bets say that fears about their new role are unfounded, and that their investments will be a plus for farming and, ultimately, for consumers…

Financial investors also can provide grain elevator operators the money they need to weather today’s more volatile commodity markets. When wild swings in prices become common, as they are now, elevator operators have to put up more cash to lock in future prices. John Duryea, co-portfolio manager of the Ospraie Special Opportunity Fund, is buying 66 grain elevators with a total capacity of 110 million bushels from ConAgra for $2.1 billion. The deal, expected to close by the end of June, also will give Ospraie a stake in 57 fertilizer distribution centers and the barges and ships necessary to keep them supplied with low-cost imports.

Maintaining these essential services “helps bring costs down to the farmers,” Mr. Duryea said. “That has to help mitigate the price increases for crops.”…

Last October, the London branch of BlackRock introduced the BlackRock Agriculture Fund, aiming to raise $200 million to invest in fertilizer production, timberland and biofuels. The fund currently stands at more than $450 million.

Braemar Group, near Manchester, is investing exclusively in Britain. “Britain is a nice, stable northwestern European economy with the same climate and quality of soil as northwestern Europe,” said Marc Duschenes, Braemar’s chief executive. “But our land is at a 50 percent discount to Ireland and Denmark. We just haven’t caught up yet.“…

For Gary R. Blumenthal, chief executive of World Perspectives, an agriculture consulting firm in Washington, the new investments by big financial players, if sustained, could be just what global agriculture needs — “where you can bring small, fragmented pieces together to boost the production side of agriculture.”

He added: “Investment funds are seeing that this consolidation brings value to them. But I’m saying this brings value to everyone.”

I’m not so confident. Modern financiers have not shown themselves to be good stewards. Wall Street’s increased influence over Corporate America has led to burgeoning CEO pay and rampant short-termism. The industry has been so reckless that is it now on life support thanks to the ministrations of the Fed and other accommodating central banks. But faith in the money-driven paradigm nevertheless persists.

A simple thought exercise: Gary Becker at the Milken Global Institute Conference said that agriculture prices would be substantially lower in two years because adaptation in those markets would occur quickly. Farm subsidies to keep field out of production would be cut or eliminated, the US ethanol subsidy would be eliminated, and there would be strong incentives to get higher productivity out of existing acreage. I view Becker’s forecast as way too optimistic, but what happens with these hot-money investors if he is proven correct? You can see a whipsaw in both directions, as prices of assets move up with the influx of funds, then overshoot on the downside as they try to make their way through a crowded exit.