Farmland Is Not a Bubble

by: Roger Nusbaum

Later this morning I am due to be interviewed by the WSJ about "scarcity" as an investment theme which I think means water and ag-related equities. As an amusing coincidence Robert Shiller is calling out farmland as the next bubble. Pragmatic Capitalist Cullen Roche has more detail on Shiller and he is sort of in agreement, he is focused more on commodities as a bubble in the making. The two are related but not precisely the same.

Farmland is not a bubble and I am quite certain it will not become a bubble.

Bubbles are all encompassing events that take many things down with them. For example the U.S. housing market turned out to be a bubble taking down many world stock markets, many world fixed income markets and many world GDPs. As the bubble was inflating there were astounding statistics about equity extraction, a proliferation of mortgage products requiring no money down, an abundance of house flipping television shows and anecdotally a couple of people I know actually thought it was impossible to lose money in real estate.

Ditto the tech bubble. Since that was more of a stock market-centric event I would add that there were dozens of publicly traded, unprofitable internet stocks with little to no revenue with market capitalizations well north of $100 billion.

A few years ago I was on CNBC and asked whether solar stocks were a bubble. I think I was on to discuss this because of a couple of bearish of articles I wrote about solar for but either way it most certainly was not a bubble. At the time the total market cap of the Market Vectors Solar ETF (NYSEARCA:KWT) was less than $100 billion. Here I am talking about the sum of all the market caps of the stocks in the fund not the AUM in the fund. So the comparison was dozens of unprofitable companies each with market caps above $100 billion versus an entire industry worth less than $100 billion. The market cap of KWT now is only about $40 billion (I didn't realize it had dropped that much and stayed down until I just looked for this post).

The SPDR Gold Trust (NYSEARCA:GLD) which we own for clients is by far the largest exchange traded commodity product in the U.S. at $55 billion and I am quite certain it is by far the largest exchange traded commodity product in the world. I am fairly certain (but did not look up every ETP) that iShares Silver is the second largest at $12 billion. PowerShares DB Commodity Index Tracking Fund (NYSEARCA:DBC) is a relatively big one at $6 billion. The The iPath Dow Jones-UBS Commodity Index Total Return ETN (NYSEARCA:DJP) used to be a very popular one and it has $3 billion AUM.

I would be surprised if all of these added up to $100 billion but there is no way they all add up to $150 billion. As for related equities , the materials sector currently comprises 3.62% of the S&P 500 and 10.99% of the EAFE Index which are both a long way from the 20% level that becomes a flashing yellow light for reducing exposure.

As for farmland the numbers for the bubble case are a little more plausible. According to this from Thomas Hoenig, 1/6 of U.S. jobs and U.S. economic activity are farm related (these numbers surprise me) and the value of of all U.S. farmland is up a lot to now $2 trillion dollars. In doing some Googling I found a couple of estimates for the total value of all U.S. real estate to be $20 trillion but I have a low confidence in that number.

If farmland goes down a lot in value it would be for one of two reasons as best as I can tell; one would be that food prices would drop which would be a net positive for most of the economy or due to serious distortions with interest rates making the business of farming difficult/impossible/money losing but higher rates would be bad for the entire real estate market and the entire economy for that matter and very unlikely to originate in the farming industry -- so farmland hurt by the economy not farmland hurting the economy.

I would also think that a decline in commodities would have several economic benefits and that it would not be a decline in commodity prices that would hurt economic activity, more like a downturn in economic activity hurting commodity prices.

This is not to say that both farmland and commodities are not manias that will see huge price declines because anything can drop a lot in price. Not everything that drops a lot in price is a bubble. Bubbles truly hurt many people and take many things down with them. The question of whether solar was a bubble a few years ago was a popular one at the time. The industry then went supernova (whether because of it own fundamentals or the bigger economic picture) and no one cared. When the real bubble surfaced, solar as a bubble was thoroughly disregarded.

This post is neither bullish or bearish so much as an exploration of a misused term. If you are worried about commodities and/or farmland imploding, then make sure you don't own so much that a massive decline could do you in. If gold somehow went to $400 in the next week, I promise you there would be tales of people being wiped out for being 100% in gold on margin.

There are obvious fundamental tailwinds for commodities and farm-related investments ranging from modernization to lack of supply but there are always fundamental tailwinds for these things. A large price decline is far less of a problem than being wildly over exposed when the bottom does fall out.

On an unrelated note, some of you may recall I like to watch college lacrosse, among many other sports. This season one of the big advertisers for ESPNU's coverage is Select Sector SPDRs, which is very funny as my wife tells me I am the only person watching.