Potential near-term implications for agricultural performance
The global economy emerged from what was hoped to be the worst of the COVID-19 pandemic as pent-up consumer demand was unleashed but quickly pushed up against a severely constrained global supply chain. Our report describes how this situation was exacerbated by geopolitical risks brought to the fore by Russia’s invasion of Ukraine, driving inflation to multidecade highs, and how this economic environment is likely to influence agriculture investment performance.
Inflation has proven to be pervasive across regions and more stubbornly persistent and elevated than anticipated, forcing central banks to begin a strong and abrupt monetary tightening cycle. This has considerably raised the near-term risk of a global recession, with central banks embarking on the exceptionally challenging task of trying to temper historically high inflation without pushing economies into recession. While this economic backdrop presents both challenges and opportunities for the agriculture sector, the growth opportunities from robust underlying demand fundamentals and the positive past performance of the sector in inflationary environments should allow the sector to overcome these near-term challenges. Despite myriad supply-side issues, including rising input costs, adverse weather and climate conditions, and geopolitical tensions, underlying demand fundamentals will continue to be bolstered by rising incomes in developing economies. This should drive strong and stable growth in food consumption and demand for agricultural products, which are expected to play a role in extending the relatively stable historical return performance of the asset class and allow it to maintain its position as a potentially attractive option for investors during the current risk-off environment.
Rising input costs present challenges to farm operating profitability
Monthly Producer Price Index for major agricultural production operating cost categories (January 2015 = 1)
One of the leading challenges currently faced by the agricultural sector is the rapid rise in input costs, which is expected to weigh on the sector’s profitability in the short term, suppressing U.S. farmer sentiment. The USDA’s forecast of production costs for corn and soybeans for the crop year 2022 show rising costs for key production inputs, including fuel and energy, chemicals, and fertilizer. These three major cost categories account for a significant percentage of total operating costs for major crops such as corn (60.0%), soybeans (49.0%), and wheat (61.0%) and are forecasted to rise by 8.6% for corn, 7.7% for soybeans, and 8.4% for wheat in 2022. Fertilizer costs were already trending higher due in part to trade restrictions China imposed on fertilizer exports in 2021, before spiraling upward in early 2022 following Russia’s invasion of Ukraine. Russia is a major global supplier of fertilizer, and subsequent sanctions and trade restrictions effectively removed a substantial volume of global fertilizer supply. More recently, fertilizer-related pressures appear to have begun to moderate as prices in the United States eased from recent highs, primarily driven by falling demand from farmers due to elevated price levels. Farmers have attempted to mitigate high input prices through numerous measures, including switching to crops that are less dependent on fertilizer and reducing other inputs, which is complicating yield projections for the coming marketing year.
U.S. major crop prices remain elevated
Monthly crop prices in the United States (nominal, $/bushel)
Global agricultural crop prices have experienced significant increases in the past two years, due mainly to supply-side shocks. These shocks have depleted inventory levels and kept agricultural markets tight. This situation seems likely to persist and, as the northern hemisphere begins the 2022/2023 marketing year, inventories (as measured by stock-to-use ratios) are expected to remain low for major crops. These tight market conditions have allowed U.S. crop prices to remain elevated since late 2020, with corn and soybeans comprising 53% of 2022 forecasted cash receipts for all crops ($131 billion of a total $249 billion), hovering near the historical highs last witnessed during the commodity boom of 2012/2013. Wheat, the third largest row crop by cash receipts, closed 2021 with its highest quarterly average price in nine years, before spiking to new highs in the aftermath of the Ukraine-Russia conflict in February 2022.
Strong crop prices may help offset higher input costs
Correlation between farm products price index and cost index during 2013–2022
During the past decade, prices of agricultural products have largely kept pace with increasing input costs, measured by the correlation between monthly price indexes of farm products and major input cost categories, including energy, chemicals and fertilizers, machinery, and transportation. This positive correlation demonstrates the historical capability of crop prices to keep pace with rising input costs and should allow farmers to pass along at least a portion of the rampant increase in input costs through higher crop prices, protecting profit margins to some extent and providing investors at least partial relief in today’s inflationary environment. Looking forward a couple of years, while prices of major crops are expected to moderate from current highs as supply chain constraints dissipate and global markets regain balance, prices are projected to settle at moderately elevated levels relative to history. Crop prices will be supported at these somewhat higher levels as trade flows realign and input costs, such as energy and transportation, remain higher for longer. While the current exceptionally tight market conditions show signs of easing, it'll likely still take some time for markets to rebalance, keeping the sector extremely sensitive to potential shocks and supporting a positive income outlook for farmland investments. In addition, increasing demand for nature-based climate solutions is poised to create another avenue of growth for sustainably managed farmland and is expected to play an increasing role in generating strong returns for the asset class. We believe agriculture remains uniquely positioned to traverse the near-term cyclicality, volatility, and uncertainty prevalent in today’s markets.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
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