Agricultural Smackdown - South Asian Style

“Food is an important part of a balanced diet.” Fran Lebowitz

There was an interesting article in yesterday’s New York Times discussing the developing spat/misunderstanding between the U.S. and India about responsibility for the rise in food prices. The whole to-do started a couple of weeks ago with some comments by Condoleezza Rice and was exacerbated by President Bush a couple of days later (shocking).

I’ve looked over a number of articles discussing this issue and, as usual, most of them just pick and choose which quotes to offer or simply paraphrase what Rice and Bush (hereafter referred to as Brice) said. To paraphrase the paraphrasing, a good portion of the commentary has gone something like, “Brice blames rising food prices exclusively on the irresponsible growth in India and China and their lack of willingness to continue starving for the benefit of the West. To address this travesty, the U.S. is now developing a secret program to sterilize all of the women in both countries to ensure a continued orgy of steak, ale, Oreos, and Hummers for the best, brightest, sexiest, most shaved, and most smiled-upon people ever to grace the face of the planet – Americans.”

Let’s actually take a look at exactly what our beloved leaders said. First off, Rice was offered the following question at a recent Peace Corps Conference:

Many of us are in countries where the predominant source of food is grain, rice, et cetera. And I’m wondering about your thoughts about the US government’s thoughts about the skyrocketing prices of grain worldwide?

Her reply

We obviously have to look at places where production seems to be declining and declining to the point that people are actually putting export caps on the amount of food. Now, some of that is not so much declining production as apparently improvement in the diets of people, for instance, in China and India, and then pressures to keep food inside the country. So, that’s another element that we have to look at.

Now let’s look at exactly what Bush said a few days later.

Worldwide there is increasing demand. There turns out to be prosperity in developing world, which is good. It's going to be good for you because you'll be selling products in the countries, you know, big countries perhaps, and it's hard to sell products into countries that aren't prosperous. In other words, the more prosperous the world is, the more opportunity there is.

It also, however, increases demand. So, for example, just as an interesting thought for you, there are 350 million people in India who are classified as middle class. That's bigger than America. Their middle class is larger than our entire population. And when you start getting wealth, you start demanding better nutrition and better food, and so demand is high, and that causes the price to go up.

So…………they’re basically saying that declining production, trade restrictions, and the increasing demand for more and better food from a wealthier developing world are contributing to the rise in food prices. Sounds like a no-brainer to me. The problem with it, apparently, is simply that Brice didn’t explicitly state that these were SOME of the factors impacting food prices rather than ALL of the factors.
Because of this, we’ve seen an outpouring of hostility and disbelief from a portion of the developing world, most notably India, which is screaming that the U.S. is the real culprit behind rising food prices. Here’s an example from the NYT article,

…Pradeep S. Mehta, secretary general of the center for international trade, economics and the environment of CUTS International, an independent research institute based here, said that if Americans slimmed down to the weight of middle-class Indians, “many hungry people in sub-Saharan Africa would find food on their plates.”

He added, archly, that the money spent in the United States on liposuction to get rid of fat from excess consumption could be funneled to feed famine victims.

Explaining the food price increases, Indian politicians and academics cite consumption in the United States; the West’s diversion of arable land into the production of ethanol and other biofuels; agricultural subsidies and trade barriers from Washington and the European Union; and finally the decline in the exchange rate of the dollar.

Mr. Mehta just gave me my newest million dollar idea. Let’s re-package all of that cellulite into 8 ounce plastic containers and market it in the developing world as a high-calorie snack called YoGurth! Everybody wins!

Ok. Now let’s look at who has the upper hand in this argument. I’ve thought short and soft about this, and the winner is………..well, it’s a tie. We can debate the relative importance of each factor, but most of the points that both sides are making are valid.

• As wealth in India and China increases, demand for more and better food increases. This higher demand is one factor leading to rising food prices.

• The average American has enough fat to live off of for two entire years (note: this statistic has not been scientifically proven and was pulled from the author’s nether-region in the interest of editorial expeditiousness).

• Export barriers and tariffs may temporarily limit price increases internally, but they exacerbate global supply problems, lead to higher prices globally, and will likely result in lower domestic supply.

• Americans are the largest per-capita consumers of many things: oil, food, liposuction, therapy, fatuous TV programming, lust, gluttony, greed, sloth, wrath, etc.

• Some farm land has indeed been converted from food production to feed the ethically-bankrupt subsidized beast of ethanol.

What are the key points from all of this?
• The economies of China and India are growing quickly. It’s reasonable to expect them to want to improve their diets. Given that they’re moving from the starvation level to one of mere malnutrition, we Americans should take care not to speak too indelicately with our mouths so full.

• We’re never going to out-run the Indians and Chinese if they ever invade us. It’s in our own best interest to fatten them up.

• It’s hard to get the full story from the press. They write with the short attention span of the average American in mind and therefore feel the need…………….what were we talking about?

• YoGurth – Saturate Your Diet with the Taste of America!

• The fertilizer stocks are still looking good. Still a buyer of POT, AGU, and MOS.

An Entry From My Dromediary About POT and MOS

Commodities are clearly in the midst of a bull market. On a daily basis, we're being deluged with stories of rising gasoline prices, rice shortages, soaring demand for steel, etc. These high prices will certainly encourage the development of new supply in time. A nearer-term impact will be product substitution when feasible. If steak costs too much, buy chicken instead. If the price of rice is too high, substitute potato. If the cost of cocoa soars.....bad example. I'm still buying cocoa.

The following example of the substitution effect is from a recent article in the Financial Times. It has me seriously thinking of swapping my Accord for some sled dogs.

Farmers in the Indian state of Rajasthan are rediscovering the humble camel.

As the cost of running gas-guzzling tractors soars, even-toed ungulates are making a comeback, raising hopes that a fall in the population of the desert state’s signature animal can be reversed.

“It’s excellent for the camel population if the price of oil continues to go up because demand for camels will also go up,” says Ilse Köhler-Rollefson of the League for Pastoral Peoples and Endogenous Livestock Development. “Two years ago, a camel cost little more than a goat, which is nothing. The price has since trebled.”

The shift comes not a moment too soon for a national camel population that has fallen more than 50 per cent over the past decade, to about 450,000, according to government figures.

Market prices for these “ships of the desert”, which crashed with the growing affordability of motorised transport, are rising again as oil prices soar.

A sturdy male with a life expectancy of 60-80 years now fetches up to Rs40,000 ($973), compared to Rs5,000-Rs10,000 three years ago, according to Hanuwant Singh of the Lokhit Pashu-Palak Sansthan, a non-profit welfare organisation for livestock keepers. Entry-level tractors cost around $4,000.

As far as I know, there are no camel futures or ETFs, and I'm not suggesting you mail order a caravan of camels in the hope of reselling them for a tidy profit . Remember, you have to pay for shipping, feed them, and pick up after them. And then there's the spitting. Oh, the spitting!

The point, as usual with commodities, is that the end of the bull for any particular commodity will eventually come from falling demand, rising supply, or both (2 years spent getting an MBA for that insight). Product substitution is just one factor to keep an eye on. In the short-term, we're more likely to see it in the agriculture space than metals or energy, given their relative fungibility.

If you really know what you're doing and have a great handle on the fundamentals of different agricultural commodities then you can do very well in the futures market. This can also be a bit dangerous since not all crops move together and significant retracements should be expected.

My preferred way to gain exposure to the agriculture space has been through the fertilizer space, which has been enjoying and is likely to sustain favorable supply/demand fundamentals. With these firms, we don't have to worry too much about product substitution. Yes. Different crops have different fertilizer needs, but there's nothing in the immediate future likely to totally replace potash and nitrogen use.

This past week, I added to positions in Potash (POT) and Mosaic (MOS). Both of these stocks have pulled back roughly 15% in the past 10 days as investors began rotating out of the the commodity space in general. I believe these names (and AGU which I also own) are in a secular (rather than cyclical) bull market. Their earnings growth is terrific, their valuation looking into 2009 is attractive (low double-digit P/E for both), and they're generating a ton of free cash.

Key fertilizer supply is constrained and demand continues to grow given the rising populations and dietary demands of the developing world. The rising prices of agricultural commodities is increasing the demand for fertilizers in order to maximize crop yield and also increasing the ability of farmers to pay higher fertilizer costs. These are the types of names that institutions will want to own given their fundamentals, valuation, and stock performance. This share demand support is likely to limit downside barring a significant adverse change in fertilizer supply or demand.

My strategy with these names has been to lighten as they've gone parabolic or become too large a portion of the portfolio and to add when we get these 10-20% pullbacks. A core position has been maintained regardless of price action. Should the stocks continue to fall in the coming weeks, I fully expect to keep adding.

The author currently has no camel position.