Mar 08, 2017 – from Investor Insights

No Relief in Sight for U.S. Farmers

Cloudy farmlandNew projections from the U.S. Department of Agriculture (USDA) indicate that there will soon be fewer than 2 million farms in the United States—the lowest number since the Louisiana Purchase. By every measure, the U.S. agriculture sector has struggled in recent years thanks to falling commodity prices. To be sure, some are predicting that the sector will rebound this year in the absence of El Niño. But this forecast fails to take into account what we know about weather cycles and global demand. El Niño may very well re-emerge before year’s end, while global warming will be a long-term drag on commodity prices. Moreover, the United States is rapidly losing ground to emerging markets that have ramped up their agricultural production.

U.S. farms have been struggling by almost every measure since the Great Recession. A new USDA report reveals that the United States has lost more than 100,000 farms since 2009, with total farm acreage falling by 6 million over that period. As recently as 2013, U.S. net farm income was on the rise, temporarily buoyed by soaring commodity prices. But those days are long gone. USDA estimates that U.S. real farm income will drop 11 percent YOY in 2017, which would mark the fourth consecutive year of negative growth—the longest losing streak since the Great Depression.

Farming’s recent troubles have been compounded by a plunging top line. Prices of major food commodities fell for the fifth consecutive year in 2016, according to the U.S. Food and Agriculture Organization’s Food Price Index, a trade-weighted index tracking international market prices. Crops like corn and wheat have fared the worst. According to IMF data, corn cost $153 per ton at the end of 2016, down by more than half from its late-2012 peak. Wheat prices have dropped by nearly two-thirds over that time. Successive banner harvests have left farmers with such a supply glut that infrastructure companies like Great Bend Co-op are building massive bunkers the size of football fields to accom­modate excess output. The grain surplus is so pronounced that U.S. farmers recently planted the fewest acres of winter wheat in more than a century.

Yet plenty of farming insiders are optimistic that 2017 will be a rebound year for U.S. agriculture. Ag equipment manufacturer Deere & Company—which earns 58 percent of its revenue in the United States—recently raised its full-year profit forecast, citing strong orders in Q1 2017. Financial analyst Mircea Dobre says that “we are starting to piece together evidence” of a farming recovery. U.S. farmers are going all-in on soybeans, which are relatively more profitable now that corn prices have tanked: Polling indicates that farmers are poised to plant more acres of soybeans than corn for the first time since 1983.

What’s behind this optimism? The prevailing view is that recent harvests have been aided by favorable growing conditions brought on by El Niño—which ended last year. The El Niño Southern Oscillation (ENSO) is a variation in winds and sea sur­face temperatures over the Pacific that comes in two flavors. The first is El Niño, which sends warmer, wetter weather (i.e., favorable for crops) to North America—and cooler, drier weather to the Western Pacific. The script is flipped for La Niña. Of course, what’s good for yields is bad for prices: Since 1980, global corn and wheat prices usually are low and/or falling during El Niño periods, and are high and/or rising in be­tween. In the absence of El Niño, it stands to reason that prices would bounce back.

But the immediate and long-term future of U.S. agriculture is darker than it appears. ENSO does not repeat with much regularity, and thus a long El Niño cycle does not guarantee an equally long La Niña cycle. Indeed, the most recent National Oceanic and Atmospheric Administration data indicate that La Niña—which began just last sum­mer—is already over. So much for a sustained dry spell that boosts crop prices. Worse yet, consensus forecasts predict that El Niño conditions could return within the next few months, a conclusion reflected in meteorolo­gist forecasts calling for higher spring moisture over many planting states.

Systemic climate change is working against U.S. farmers as well. By plotting global temperature variations since 1990 against changes in food prices, natural resources expert Erico Matias Tavares discovered that the two are inversely rela­ted—that is, growth in food prices decelerates or turns negative as temperatures rise. To the extent that global warming is occurring, this relationship will guarantee ever-lower profit margins for U.S. farmers.

Just as dire are shifting global trade habits that could per­manently reduce de­mand for U.S. agricul­tural exports. Trade has been a boon to U.S. farms for decades. Since 1990, the value of agricultural exports to China (America’s biggest export market) has surged more than twentyfold. But over the past few years, demand has cooled considerably. The value of U.S. agricultural exports to each of America’s top markets (China, Canada, Mexico, and Japan) has dropped since 2014. U.S. exports to China peaked all the way back in 2011.

Why has demand slowed? For one, a rising U.S. dollar has made America ever-less price-competitive. More fundamentally, emerging markets have stepped up their farming efforts to take advantage of skyrocketing Chinese demand. It was always unnatural that the United States would forever remain the world’s top agricultural exporter, even as it ex­ploited its comparative advantage in high-tech pop culture and professional services. Sooner or later, lower-wage countries would adopt our same agricultural know-how and exploit their own comparative advantage. That finally appears to be happening. China is turning away from U.S. agricultural exports in favor of Brazilian and Argentinian goods. Argentinian President Mauricio Macri recently eliminated a 23 percent export tariff on wheat to incentivize production. Russia, meanwhile, overtook the United States as the world’s top wheat exporter last year. Interestingly, falling energy prices seem to encourage rising global agricultural production, considering that these new farming competitors are all raw materials exporters forced to find another revenue source.

In the years ahead, trade policies favoring U.S. manufacturing interests may com­pound the pain for U.S. farmers. One of President Trump’s first orders of business was to pull out of the Trans-Pacific Partnership (TPP). Yet TPP created as much as $5 billion in potential agriculture sales value by opening up Pacific Rim nations to U.S. exports. A “Trumponomics” fiscal stimulus plan could also send the dollar soaring further, which would (despite a proposed border-adjustment tax) have an adverse effect on U.S. exports. Trump’s tough talk with trade partners could also be detrimental to U.S. farming: Look no further than a proposed Mexican bill that would move the country away from U.S. corn imports.

All told, U.S. agriculture will likely get worse before it gets better—if it ever does. Well-diversified agricultural firms with a foothold in emerging markets may not have to worry. But farmers themselves may have no way to weather the storm.

Takeaways

  • Beware: The chances of a 2017 U.S. farming re­bound are slim. After years of plummeting farm profits, some industry experts are expecting a rebound this year. This scenario is highly unlikely. El Niño weather could soon return to the United States, bringing higher crop yields and lower commodity prices. What’s more, head­winds threaten U.S. agriculture for years to come. For one, global warming (to the extent that it occurs) will boost farm output worldwide, which will adversely affect prices. Additionally, new global competition and unfa­vorable trade policies threaten to permanently decrease demand for U.S. agricultural goods.
  • Keep in mind that El Niño/La Niña cycles are highly unpredictable. It’s clear that weather has a demonstra­ble impact on agricultural commodity prices. Much of the 2012 commodity boom can be attributed to a severe U.S. drought that hammered output. But the variability of El Niño makes these events tough to anticipate. ENSO does not repeat in a regular pattern: El Niño occurs every two to seven years, while La Niña typically arises less frequently. Both cycles can last anywhere between a few months to two years. Even the National Oceanic and Atmospheric Administration admits that the initiating causes of ENSO are not fully understood.
  • Don’t underestimate the impact of Trumponomics on U.S. agriculture. Much has been written about Trump’s plan regarding global trade, deficit spending, and taxation. But what often goes unmentioned is the effect on farmers. Restrictive trade policies, especially with China and Mexico (two of America’s top three agricultural export markets), would hammer U.S. farm revenue. Trump’s plan to deficit-spend the economy out of its funk would further crush an already weakening agricultural exports market. What about a border-adjustment tax, which should lead to big savings for agricultural exporters? This scenario would likely boost the dollar, which forecasters say would mitigate many of the tax’s benefits.
  • Short U.S. agriculture firms without a global foot­print. Massive “agribusinesses” like Monsanto and Dow Chemical lately have been globalizing through M&As to hedge themselves against risk. (See: “Big Agriculture Gets Bigger—and Smarter.”) Ironically, these very firms have brought agricultural technology and produc­tivity gains to emerging markets. Then there are agri­cultural machinery companies like Deere and CNH Industrial. While CNH earns money from many geo­graphic locations and business lines, Deere earns more than half of its revenue within U.S. borders—and more than two-thirds of its revenue from agricultural machin­ery and turf. Farm REITs like Farmland Partners, Gladstone Land, and American Farmland, meanwhile, are now competing for an ever-shrinking amount of U.S. farmland.