Introduction

Without modern agricultural techniques, current population levels could not be sustained and projected near-term population growth would create stresses that would destabilize the current global social and political order. Relatively recent innovations in seeds, chemicals and fertilizers have enabled agricultural producers to meet the ever-growing demands of a hungry world population. Even with the rapid increases in agricultural productivity, however, challenges for the agriculture industry to supply the growing global economy with sufficient supplies of agricultural staples are greater now than ever before. A new green revolution similar to the one that took place during the latter part of the 20th century is taking place all over the world to meet the expected demand by the growing world population and its increased standard of living.

Recent Market Dynamics

The overriding market dynamic that have governed the price behavior of global agriculture commodities have been factors of supply and demand. Growth in global demand over recent years has outpaced supply throughout the world, sharply reducing global commodity inventories. This trend of tight market conditions is projected to persist for many commodities into the next decade, sustaining relatively high agricultural commodity prices.

On an historic timescale, agriculture products are still near all time record prices. Demand is forecast to increase due to several key factors. First and foremost, the world population is expected to increase by approximately 1.2 billion people by the year 2020 (United Nations, constant fertility variable). At the same time, per capita daily caloric intake for the world’s population is now 2800 kcal, compared to 2280 kcal in the early 1960’s, and continues to rise (FAO, 2006 and the State of Food and Agriculture Report 2007, FAO). Simply put, more people times more caloric intake equals more food consumption. To compound matters, an increasing percent of world food consumption is meat, which exponentially increases grain demand. (It requires at least seven pounds of grain to produce one pound of beef protein!) In China alone, annual per capita meat consumption has increased a 150%, from 44 lbs in 1980 to 110 lbs in 2007 (Time Magazine, May 19, 2008).

Along with an increasing global population, worldwide robust economic growth has and will continue to increase demand for agricultural products. Most of this global economic growth is occurring in non-OECD countries where increasing per capita incomes lead to a movement away from staple diets such as rice to more diverse, higher calorie diets which include fruits, vegetables and meat. The developing world’s increasingly diverse diet impact on global agriculture demand is compounded by the fact that population growth rates in developing countries are nearly double those of developed countries (economic research service, USDA).

Related Market Factors

While the main factors governing price movements are stated above, several additional factors contribute to global supply/demand imbalances. These include cyclically poor harvests related to weather, restrictive trade policies and the increasing diversion of crops for bio fuel production. Many locations are experiencing climate driven events such as floods and droughts, which some observers ascribe to climate change induced by CO2 emissions. Australia’s wheat output, for example, has decreased substantially in recent years due to a persistent lack of precipitation in the region. Restrictive trade policies, such as India’s decision to temporarily stop rice exports, only put further strains on prices.

The price of oil is also a principal driver of the price of agricultural commodities because oil is a key ingredient in most fertilizers, is required to run modern agricultural machinery and is needed to transport goods to market. Production of various bio-fuels diverts a large volume of global cultivated corn and grains to the production of ethanol and likewise greatly reduces the supply of corn and grains for human consumption, adding to price pressures.

Industry Developments

Over the past forty years there has been a significant change in the composition of agricultural production. The global output of cereals, oil crops, sugar, vegetables, eggs and meat has increased more than the global population, while global output of pulses (annual leguminous crops yielding from one to twelve grains or seeds of variable size, shape and color within a pod, e.g. Lima bean, pinto bean, lentil), roots and tubers (ex. Potato) has declined relative to total population growth. While cereal production has increased faster than the global population, it has failed to keep pace with historical production growth rates. The opposite is true for oil seeds, which have exploded in production due to demand in developing countries. The production of meat and eggs has grown even faster than oil seeds due to the increased standards of living (State of Food and Agriculture Report 2007, FAO).

While international trade of animal products remains dependent on exports from developed countries, there is strong support for policies in developing countries to produce domestic meat. This is likely to have the effect of increasing the amount of grain imported by developing countries, especially to countries with lack of harvestable land such as the Middle East, North Africa and Southeast Asia (economic research service, USDA).

Industry Outlook

The traditional exporters of staple agricultural goods, such as Australia, Argentina, Canada, the European Union and the United States will remain important suppliers in the future, but other countries such as Brazil, Russia, Ukraine, and Kazakhstan are making significant agriculture investments that should over time fill the supply demand gap (economic research service, USDA). Accordingly, as agriculture prices increase, agriculture production is likely to rise through technological innovations and increased amounts of cultivated land. Still, significant challenges remain, based on constraints on the expansion of land under cultivation due to agro-climatic conditions and the fact that the world has a fixed size and area.

Rising prices of agricultural inputs, such as oil, fertilizers, seeds and equipment, serve to raise the amount of investment required to expand global agricultural production, thereby threatening to lower production and threaten future supply (economic research service, USDA).

Agriculture Industry Exposure through Equities

The value of a portfolio of agriculture equities is often influenced, although not determined, by the prices of the agriculture commodities. In fact, correlations between the prices of agricultural producers and the commodities they produce tend to be low. Like other equities, agricultural companies will be influenced by a number of factors unrelated to agriculture commodity prices, such as earnings, operating efficiency, regulation, management expertise and interest rates.

Furthermore, producers of packaged food products tend not to benefit from rising commodity prices, as their margins often come under pressure as their input costs rise, while resistance to higher prices at the consumer level constrains demand. The equity price trends of “primary” agricultural producers, on the other hand, tend to follow or exceed the price trends of the underlying agriculture commodities, especially when agriculture commodity prices are strongly trending. “Primary” agricultural producers include suppliers of seeds, traits, fertilizers, chemicals, equipment and irrigation systems.

Over time, demand for agricultural products is inelastic – driven primarily by rising populations and improved diets. Agricultural producers, in keeping up with this demand, may suffer the vagaries of commodity market pricing, experiencing substantial price swings based on weather and the size and substance of the current harvest. On the other hand, there is a degree of certainty in that the world will require and ever-growing amount of primary agricultural products.