Commodity risk frequently represents a gut check for investors. Be it equity or debt, retail or institutional, there are significant pools of capital that opt to remain on the sideline rather than confront commodity-related investment risks. This risk avoidance approach by some is understandable when you consider the relatively thin margins of most commodity-based businesses in relation to the risks they face. These risks range from adverse weather patterns, disease, insects and fungus, genetic flaws, trade policy, currency, and depletion/spoilage. These factors contribute to an ongoing tug of war between supply and demand, which in turn leads to the potential for significant price volatility.
The following tables provide a visual image of the historical volatility of a particular commodity chosen for illustrative purposes: eggs. If the depicted retail price volatility isn’t concerning enough through an investor lens, then consider the second table, which presents historical pricing for the primary cost of goods sold: soybeans (bean meal) fed to the laying hens that produce the eggs.
Clearly, there are market-proven risk mitigation mechanisms that allow sufficient investment capital to be accessed by the egg production segment, as rarely has there been a shortage of eggs. Regardless, the pricing and margin variability of most commodities and related businesses can prove challenging in building sustainable growth and profitability. The ripple effect is that some investors simply choose to invest elsewhere.
Shifting gears, it may be logical to assume that farmland, as the foundation of many commodities, would also be a relatively volatile investment. Not so fast. On the contrary, investors often view farmland as a relatively safe investment, with less price/return volatility, greater long-term appreciation potential, and consistent income-producing characteristics similar to a bond.
The following USDA table depicts farmland value appreciation over a 15 year period - and shows relatively consistent appreciation over time. This data range is meaningful as it includes the financial crisis of 2008-2009, and also the relatively different operating conditions in central US agriculture beginning in 2014. While there was a slight decrease in values in 2009, they recovered the next year. Also, values continued to hold and/or appreciate in 2014 and beyond despite the difficult operating environment.
It seems counterintuitive, farmland is a relatively safe investment with proven long-term appreciation versus the overlying volatility/risk of the crops grown on it. But it’s a fact, driven by solid fundamentals:
There is a limited amount of supply of farm ground – especially in the United States. On a global basis, the total amount of arable farmed acres remains flat to slightly decreasing.
Growing global population
It is well documented that the global population continues to increase and with it, the amount of global food production must also. Increasing demand for food from a slightly decreasing global farm acre base. A favorable investment thesis.
Not only does an investor benefit from potential appreciation from investment in farmland, but they also receive an annual rental income stream from the farmer/operator – much like a bond interest payment. This tends to stabilize and increase overall returns from farmland.
All taken together, the potential for farmland as an investment is significant.