Mother Nature (Not Speculators) Changes the Agriculture Game

So far in 2009, the agriculture markets haven't witnessed the same sharp rebound as other commodities have; in fact, compared to oil or copper, humble ags seem downright sensible. And there's still plenty of room for upside, says Shonda Warner, founder of Chess Capital Partners—that is, if Mother Nature plays along.

Ms. Warner is the founder of Chess Ag Full Harvest Partners, an investment firm that focuses on purchasing undervalued farmland in the U.S. With over 20 years' experience in hedge fund environments, she has worked as co-managing director of U.K. based fund-of-funds Montier Partners and as an executive director for Bear Stearns and Goldman Sachs.

HAI Associate Editor Lara Crigger caught up with Ms. Warner at last week's "Inside Commodities" conference to discuss the coming global agriculture boom, including where she's looking for farmland now, how ethanol will influence futures prices, and which technologies could change the ag markets forever.

Lara Crigger, associate editor, HardAssetsInvestor.com (Crigger): What's your outlook for agricultural commodities for 2010?

Shonda Warner, founder, Chess Capital Partners (Warner): I think that's kind of a difficult question, because it really depends on what's going to happen with the rest of the world. And if you look at pure fundamentals for 2010, it's all going to come down to weather. If weather in South America is good, you could see beans come off a little bit; maybe we might not have so much of a volatile year. And the same would hold true when we get into spring planting season in 2010 in the U.S. for corn.

So if we don't have a financial meltdown—and some people are definitely calling for it—the risk is weather related. I know several academic meteorologists who keep "doubling down." Actually, this year, they're "tripling down," saying that we haven't had a drought in the Midwest in 15 years, while the average is every 11 years, so we're way, way, way overdue for one.

But who the heck knows? I think if the world's financial markets are stable, that's going to be the most important contributing factor to what agricultural commodity prices do.

Crigger: Of course, several people at this very conference have predicted we're heading for worse economic times ahead, including Nouriel Roubini and Peter Schiff.

Warner: Medium to long term, I think there's no way out of our nasty fiscal mess that we've gotten ourselves into, other than inflation. Although, I do think it's not going to happen tomorrow—I think we're in for more of a deflation over the next 12-24 months.

Right now, global macroeconomics is playing a much greater role in agricultural commodity pricing than they typically do. So I'm concerned that we're even seeing some speculation in these agricultural commodities. If we see a general selling off of the market and a widening of credit spreads, you could see ag prices come off somewhat.

Personally, I think that would be a fantastic buying opportunity—I'm kind of hoping that happens, because I'll be there with my dump truck scooping it all up. Corn at $2.75 sounds like a very good buy to me; if we should dip down there, I think that's a very exciting opportunity. So that's my short-term outlook.

Crigger: So then what makes a bigger difference in the agriculture markets: Mother Nature or speculators?

Warner: Mother Nature. I think there can be speculative froth in the markets, but Mother Nature can really change the game fast and seriously. A speculator can't cut the U.S. production by 25-30 percent. Weather is a much bigger force than even your top 10 hedge funds putting 5 percent of their asset allocation into agricultural commodities.

Crigger: How does the supply/demand picture look moving forward? As emerging market countries like China and India keep growing, can worldwide production keep up with demand?

Warner: I think that, in the medium- or long-term view, China and India will be huge—and Southeast Asia too, for that matter. Indonesia and Malaysia have huge populations all experiencing the same climb out of poverty that China and India are experiencing. But I think there will probably be some hiccups along the way, which will be felt very quickly in the soft commodity markets.

There's just this whole idea of very, very fast money supply growth in China, and real wages are going nowhere. Remember: In the U.S., the cost of a bushel of corn in relation to our overall income is much lower than for a Chinese person. Basically, their wage pays for their food and their lodging, and maybe they send 15-20 percent home to family in rural China. So when they have 20 percent food inflation, that's a much bigger headache for the government than it would be for us here in the U.S. So we can't discount the impact of that. Demand may well fall for a year or two.

But in the medium to long term, if global economies continue to grow, protein demand will continue to grow too. And I don't know if we can keep pace with production, like we have in the past. But I think there are some exciting technologies out on the horizon that might make a big difference, and if so, then maybe we'll flat-line in production increases over the next few years, but then take a big jump up.

Crigger: Which technologies do you mean?

Warner: Well, there are a lot of seed technologies coming out on the market, like seeds with a shorter growing cycle, so that they can grow in places that they were never able to grow before. My favorite technology that's out there—and they keep rolling it back, but it's definitely coming—is drought-resistant seeds. That would be huge for the entire world. I'm sure it will be very, very expensive, but nonetheless, it's on the horizon. I'm sure that within five-10 years, that would push our average yield up.

Crigger: With commodities, there's always the question: Should you use stocks or futures? But you approach the agricultural space from the perspective of the land itself.

Warner: I do the land, although I do use futures to take risk off the board; I don't take risk on with futures in our fund. I think it really depends on what someone's outlook is.

If you have time on your side, I think the land is the safest, least volatile way to play things. Earlier [at the conference], Ashmead Pringle said that "technology accrues to the capital appreciation of the land," and that is so incredibly true. Any farmer will probably tell you that you can make money by farming and renting the land, but you get rich by owning the land.

So the really important thing is leverage and what your investment horizon is. We use a tiny bit of leverage—we really don't use much leverage. If we have to sit there for a couple of years with negative markets, it doesn't really matter. The land is there, and it's going to continue to be there; it's not like it's going to somehow disappear, or that it's a company that can go bankrupt.

But if you do have some time horizon, or you have constraints on illiquidity, then I think futures are an interesting way to play things. You can get into trouble with the cost of rolling and contango and that type of thing. You should be aware of it.

Crigger: Nowadays, are you looking at farmland in new or different places than you were before?

Warner: Although we're medium to long term bullish on ag—due to inflation, global food consumption patterns and so on—we look for land that, if the market doesn't do what we think it's going to do, may still be capable of a capital appreciation jump, due to technological advancement. Right now, in our view, some of the traditional land might be slightly overvalued in relation to more marginal land, where people haven't really put on their thinking caps and thought about what could happen. They're still in the initial, "I want ag!" phase, not really thinking about the why.

Crigger: How does ethanol, and other biofuels, play into the outlook for agricultural commodities in the near future?

Warner: Ethanol's really complicated. For me, the white elephant in the room is the Blender's Credit. That government subsidy doesn't go to the farmer, like everyone thinks it does; it doesn't even go to the ethanol producer. That $0.42 goes to the Enrons and the Valeros. They control the price of ethanol. So that's really frustrating to the farmer.

Having said all that, I think the ethanol plants will run. People are buying the ones that have folded at $0.50 on the dollar, and that's not because ethanol is stupid. It's because people paid way too to build these plants, and took on way too much leverage. And like with most bubbles, it all has to get de-leveraged. So they're being sold at the right price now.

That ethanol they're making, it directly underpins the price of corn, but it also indirectly influences other commodities, because farmers take away acreage from other crops. It has to come out of another commodity, which will tend to raise the price.

As I see it, ethanol is a great thing for people who live in the Midwest, who are close to these ethanol plants. But the people who live in California, maybe they should have electric cars. There are a lot of different alternative energy sources that we're going to have to try and work through before we get to a completely efficient source that, 25 years from now, will be our end game.

Crigger: Do you really think there exists one end-game solution, that one alternative energy can replace oil?

Warner: Maybe not. Maybe in different regions, we'll have different energies. But maybe we'll all have fuel-cell cars, because they will have perfected that and it will just be so much better than the rest of the stuff. Maybe we'll come up with some hot technology that's just head and shoulders more efficient than anything else, and that's what we'll gravitate toward. But I don't see that in the next five-10 years.