Will the Agriculture Sector Bust?

If the definition of a bubble is a speculative, rapid run-up in price, the agriculture sector definitely has half of the definition covered. Just check out these returns:


Year-to-Date Return

1-Year Return

Monsanto (NYSE: MON  )



Potash Corporation of Saskatchewan (NYSE: POT  )



Mosaic (NYSE: MOS  )



Agrium (NYSE: AGU  )



Syngenta (NYSE: SYT  )



Source: Capital IQ, a division of Standard & Poor's.

Whether we're in an agricultural bubble partially depends on whether we're in an energy bubble. All you have to do to get an answer is to follow the money trail. Oil goes up, which pushes development in ethanol, which pushes up corn prices, which persuades farmers to plant more, which allows agricultural facilitation suppliers to sell more of their products at higher prices.

If the price of oil comes down or the chain gets broken because investors finally realize that ethanol may not be all it's cracked up to be, expect ethanol producers such as Archer Daniels Midland (NYSE: ADM  ) to face even more serious headwinds than they're dealing with now.

Ag's backup plan
The seed makers have a growth plan that doesn't hinge on energy prices. Revenue growth won't be tied to the amount of land that's planted, because the seed makers will be able to increase revenue by raising prices as a result of developing seeds with increasingly high crop yields. The more of the end product that farmers can get from a seed, the higher price the seed companies can charge for the input supplies.

The development of these super seeds will come from rivals joining forces to stack multiple traits on top of one another. For instance, Monsanto and Dow Chemical have partnered to create SmartStax. Due out in 2010, this corn seed will combine both companies' weed-control and insect-protection traits into a hybrid that can produce up to 10% more corn per acre.

Where does that leave fertilizer makers and farm-equipment suppliers such as Deere (NYSE: DE  ) that don't have such benefits? Well, they could benefit indirectly from the seed makers' research-and-development investments. In addition to making seeds that increase yield, the seed makers are also pushing the envelope in developing seeds that can produce decent results in suboptimal conditions -- think areas prone to drought conditions or disease. Once those seeds hit the market, land in borderline areas could begin to be planted, and more planting area would benefit the entire farm-supply industry.

What's a Fool to do?
For Fools who have enjoyed the nice jump in stock price, it's tempting to say that the top of the commodity market is near and take some money off the table, if not sell out completely. But calling the top of a bull market isn't easy, and doing so could cause you to miss further escalating returns.

Here's a radical idea for long-term-thinking Fools: Do nothing. Yes, the agricultural sector may drop from its highs, but removing the growth of the commodities bull market isn't going to kill all of the growth in the industry. We all have to eat, after all, and the world's population isn't getting any smaller. It is, however, getting wealthier, and its willingness to spend more for food is rising as a result.

For Fools like me who got interested in agriculture only after the run-up in price, the choice is a little harder. If you think the commodities bull market has no end, then jump on board.

As for me, even though I love high-growth opportunities, I'm sitting this one out and will buy in after the market inevitably overreacts to grain prices stagnating or even dropping.

In either case, be prepared for a bumpy journey. The agricultural industry may be in for a roller-coaster ride, but the projection should generally be upward.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Dow Chemical is a Motley Fool Income Investor recommendation. The Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (11)

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  • Report this Comment On July 01, 2008, at 11:11 AM, Megagem wrote:

    I disagree with your whole thesis

    1). I refer you to the excellent annual report of Potash Corp- Yes it is the company's view but the stats are for real

    2). I refer you to the report of The UN World Food Agency

    3). The US Department of Agriculture

    Conclusions -

    There is a world wide increase in demand for food - this will NOT go away no matter how hard you wish for it to do so. Only a more liberal use of fertilizer will provide an answer in the short term. New sources of fertilizer will take time to develop and will require significant captial investment that can best be financed from higher product prices.

    The stock piles of grains are at an all time low - in fact dangerously low.

    Yes a reversion to the use of corn as food instead of using it for fuel would have an effect - but not as great as some people believe. And there is also the political dimension and political resistance to the change. Which politician will admit he was wrong? Not George Bush. It will take years to revert corn back to food use- and by that time the demand will have increased to take up all that slack.

    There is no getting away from it - this is not a bubble - a bubble arises where there is a large increase in price when a surplus actually exists or potentially exists. This time fertilizer production is serverely constrained while demand and price are rising rapidly.

    In economic speak - supply is inelastic.

    The only thing that can bring fertilizer price down in the short or medium term is a world war - Israel might just start this-or a global disease pandemic that decimates the world population.

    Other wise we a have a future of high potash and phosphate prices for some time to come.

    In the long term we can expect an amerlioration in prices for potash and phosphorus.

    As to the POT and MOS share prices - are they really so outrageous given the very low forward P/E?

    PS. do not be fooled by an apparent statisitcal co-variance of oil price and fertilizer price. Appart from NH3 and Urea there is no causal relationship between oil and potash or phosphorous. prices.


  • Report this Comment On July 01, 2008, at 12:02 PM, DoubleCorona wrote:


    Clearly, you are uninformed. Tying oil to ag is a bit like tying tech to transportation. If people can't listen to their iPod's in the terminal waiting for a flight, they won't fly?

    Ethanol production in the US accounts for a minor portion of the corn plantings - about 5 to 6%. The balance of crop plantings - wheat, soybeans, etc., utilize fertilizer but are generally not turned to ethanol.

    Further evidence of error in your theory is that like most Americans, you are USA-centric. Do you truly believe that the US is the largest buyer of fertilizers? If you take some time to do some research on CanPoTex, you will see that the majority of the output gets shipped overseas. Where ethanol doesn't matter.

    Simple fact: The amount of land to farm per person on the planet is shrinking. (population increases and arable land decreases). Yield must be increased. The governments of every major country understand: Buy fertilizer or your people will starve. That is why the Agreements made with China and India and CanPoTex were made at the governmental level.

    I hope that the ethanol program and subsidization in the US go away. I truly do. Regardless, Maslow long ago identified the hierarchy of needs. I will be very happy to pedal my bicycle to the grocery store because oil is out of sight.

    I will eat and obtain food for my family, long before I feel compelled to drive anywhere as gasoline prices head to the moon. The relationship between oil and ags is thin, at best.

  • Report this Comment On July 01, 2008, at 1:21 PM, bhopaljustice wrote:

    See for deeper, more revealing information on various abuses perpetrated by Dow Chemical around the world and the truth about how they dodge any corporate responsibility.

  • Report this Comment On July 01, 2008, at 7:30 PM, KShaine wrote:

    On the issue of whether the value of these agricultural stocks have peaked or not is an interesting on that I've considered. Food demand is increasing as world income increases and in fact, the type of food is changing with more emphasis on meat and biofuels, thus, more demand for corn, soybeans, and related inputs which require more nitrogen and other fertilizers, pesticides, and fuel. The higher prices of crop commodities should lead to more investment in more efficient equipment and farming practices, including land aggomerlation (small plots join together into larger acreage), better seeds, better equipment, and more importantly, better management. We already see more investment in Central and South America, Africa, and Asia as corporate ag commodity firms invest in more efficient structure (distribution, marketing, storage, and yes, even corporate farming).

    Clearly crop commodity prices have increased since energy prices rose for a variety of linkages. When petroleum prices go up, fat and vegetable oil and corn goes up as related substitutes. Nitrogen is an essential component of ag production and is clearly linked to natural gas which is linked to petroleum (btu substitution). Transportation is also a factor in higher commodity prices. The supply of potash and other fertlizer component can increase but will take 2-5 years for the investments to come to fruition. Crop production costs have increased because of energy prices. But more telling is the fact that crop supplies are currently tight and stocks for several crops are dangerously low, and exacerbated by trade policies. 5% of world stocks is not enough when world supply swings by much more than that year to year.

    These presently lofty crop commodity prices will remain for at least another year if not 2 (but should soften slightly over these two years), but then, as world stocks are replenished, their prices will come back into line with historical values, although a premium will be added because of the biofuels(ethanol and biodiesel) demand.

    Your assumptions about Monsanto's value is correct, it stock value should continue increasing but not at the same pace. The rapid rise in Monsanto's value is partly because the present value of future sales has increases. The present value of these and related stocks are reflecting DECADES of increased sales and higher prices. Most of that present value has been incorporated in this last year, but better quality products and services are likely to continue to provide more modest stock price increases. Higher crop prices and declining crop land leads to higher yields and thus, higher fertilizer demands. Thus, the rapid price increse in fertilizer stocks include some present value of at least a decade of higher fertilizer demand, limited production capacity, and higher prices. Farming world wide is changing, moving from small landowner plots to more agglomeration of land and more efficient land uses and lower production costs. So we should see increases in implement sales, such as Deere, but there are lots of competition for those sales. I think that Deere will remain a solid investment with historical returns.

    Ah, but what if petroleum prices fall back to $60-90/barrel? So what, we already know that corn, soybeans, and wheat will already fall in the next two year regardless of petroleum prices, as long as there isn't a major weather crisis on more than one continent at a time. The question is, will this cause MON, MOS, POT, and others to fall in value because present value theory works both ways?

    Any permanent increase in petroleum and energy costs will be embedded in higher crop and food prices. Higher transportation costs increase the risk of food security because international trade (e.g., competitive advantage) has become more expensive. There is a growing concern about the global warming impact on crop production which is a real risk to future yields. World leaders have taken a fresh look at food supply risks and are reevaluating policies and investment strategies. Since higher food prices will remain for at least 2 years, this period will be reemphasized by these leaders and major structural changes will occur to reduce food security.

    I do not expect same or similar returns next year on MON, CF, POT, MOS, and the others as we saw this last year (to date). So if your focus is on HIGH returns, then you'll have to look elsewhere. But if strong returns in the 10-25% range for the next five years fits into your portfolio, then I'd stay in the ones that appear to be the strongest with the least competition and the strongest plans for future reinvestment of their windfall profits.

    In the long run, investment in energy is sound since supply and demand are clearly matched and energy production will become more expensive to keep supply growing at the current levels of demand. The same theory can be applied to food demand and supply, we're not making any new cropland (ignoring the burning of the rainforests). So any long term portfolio should have stocks in both industries.

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