Farmland Outlook: Still Overcast - Bezek's Daily Briefing

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Includes: CORN, FPI, SOYB, UUP, WEAT
by: Ian Bezek

Summary

Markets remain subdued; yesterday's drop likely to be short-lived.

I'm still not bullish on farmland.

I'd highly recommend avoiding the US farmland REITs that have sprouted up over the past couple years.

The Dow Jones (NYSEARCA:DIA) broke its nine-day winning streak Thursday, putting in a 78-point drop. Markets took what appears to be a slight breather after the powerful rally over the past two weeks.

Futures are, however, up again this morning; don't look for this drop to get any legs. On the bearish side, oil (NYSEARCA:USO) is struggling to hold the $45/level and may be setting up for another big push lower. The energy stocks (NYSEARCA:XLE) are finally showing some weakness after appearing immune to oil price declines in recent months.

Additionally, the US dollar (NYSEARCA:UUP) is rallying again. I think this will be one of the big stories in the back half of 2016; the dollar is up more than 5% off the May lows and could well be heading for a retest of the 101 level on the dollar index. That is just 4% away from the current level. A break over that level on the dollar would mark a new 13-year high for the greenback.

On the bullish side, earnings have been good enough to avoid causing major trepidation so far. Certain hard-hit sectors, such as biotechs (NYSEARCA:XBI) are showing some real strength at last. The IPO pipeline is also flowing, with many new tech deals finally coming after a very slow start to the year. Twilio (NYSE:TWLO) was well received, Line (NASDAQ:LN) not so much; however, Impinj (NASDAQ:PI) was added to the winners' circle, up 28% yesterday on its debut.

Overall, this remains a slow market, and there's still no rush to short things here. Stay patient, this rally is overdone, sure, but that doesn't mean that we're imminently about to decline either.

Stay Away From Farmland

There have been several articles at the top of the homepage here lately about farmland as an investment theme. I'm not quite sure why this idea is back at the top of people's attention span, but I'm happy to update my thoughts. I previously wrote Farmland's Fall: Another Classic Wall Street Hustle last fall. Let's see if anything has changed.

Photo Source

My general theme at the time was that this was a typical Wall Street play. Wait until a sector peaks in enthusiasm, and then roll out new products to sell to people that want to trade on the hype. Not coincidentally, the Farmland Partners (NYSE:FPI) IPO came out the precise year the market (this is a chart of midwestern farmland) topped and went into decline (chart from ValueWalk):

One could say it was nice timing for Farmland Partners' management, which engaged in numerous related-party transactions with the company, to have a partner onto which it could offload property. These transactions, where FPI bought land from the management, occurred without any third-party judging whether the prices paid were fair or not. See this article for more information.

Besides the unsightly related-party transactions, add in the fact that FPI's rent collected per acre (on properties owned 12 months or more) outright declined in 2015, and that the company is heavily indebted with near-term maturities, and you've got an easy avoid from me. And the market has agreed, the stock trades around where it IPOed and has done nothing since last summer - badly trailing most REITs which have generally plowed higher lately on the me-too interest rates trade.

But more generally, is there a case for farmland as a long-term investment? Yes, there is one - it falls along the same lines as the case for gold (NYSEARCA:GLD). You buy gold without any expectation of yield or sizable real capital gains. Instead, it serves as an inflation hedge; no more, no less. Over centuries, gold tends to track inflation, making sure your purchasing power won't decline over time. However, gold is something you buy to maintain your position; it rarely makes its owners wealthy in the way that investments in stocks or other profit-generating enterprises do.

Similarly, since 1915, the real value of US farmland has increased by just 1.1%/year. If you exclude the unusual spike over the past decade, the real returns were essentially 0% over the past 90 years - again, like gold.

Yes, farmland offers a "cash yield"; the money you get from rent paid to use your land. However, after paying property tax, interest on debt used to purchase the land (Farmland Partners has a large debt load), and management fees/overhead, there's not a whole lot of net income coming from here either.

If you buy farmland at cyclical lows, you can lock in decent yields, however, farmland has just enjoyed one of its two biggest speculative manias of the past century; the opportunity to buy cheap disappeared a decade ago.

The world has more than enough arable land. Fly over the US or Canada, and you'll see vast stretches of rural area with the occasional town here and there - the idea that urban sprawl is eating up the countryside is really blown out of proportion. The USDA reports that as of 2007:

The United States has a total land area of nearly 2.3 billion acres. In 2007, the major land uses were forestland at 671 million acres (30 percent); grassland pasture and rangeland at 614 million (27 percent); cropland at 408 million (18 percent); special uses (primarily parks and wildlife areas) at 313 million acres (14 percent); miscellaneous uses (like tundra or swamps) at 197 million acres (9 percent); and urban land at 61 million acres (3 percent).

That's right, the US has five times as much parkland and protected wildlife areas as urban areas. It has three times as much tundra and swampland as urban area. You could triple the country's level of urban development and still have 91% of land left for other uses.

If you've traveled abroad much, you'll see that outside developed countries, the opportunities for greater agricultural yields are vast. Take a long-distance bus in much of South America, and if you're like me, you'll think, man I could buy this land at $1,000-2,000/acre and some serious money implementing first-world agricultural practices on it.

On top of that, the world is awash in food. The US wastes fully 50% of the produce that the supply chain provides. The average American family of four throws out $1,600 a year of spoiled food. Food is so cheap that we burn corn as an inefficient and environmentally questionable substitute for gasoline. Food is so cheap that we throw away vast quantities of it without thinking twice. The much talked about global food shortage is an artificial creation of bad politics, uneven distribution, and backward trade policies rather than actual scarcity.

Rising yields from farmland have far exceeded the rate at which farmland has been urbanized. We produce more calories from our existing farmland stock than ever before, putting a fundamental and unbending downward pressure on farmland's value.

Between 1920 and 1950, the price of farmland fell in nominal terms. Not even accounting for inflation, you lost money for a three-decade span holding US farmland. Again, between 1980 and 1996, prices were flat in nominal terms. Adjusted for inflation, a buyer in 1980 had to wait until 2007 to get a positive return.

There's no reason at all to chase farmland at near-record high prices after a massive speculative boom. Rents on these properties are now falling as corn, soy, wheat, etc. prices have been in freefall. At the end of the day, the price (and rent received) of the farmland is highly determined by the price of the major grains. The past boom in grain prices brought a lot of new supply into the market and now we're witnessing the long ensuing bust.

The farmland REITs debuted at just the right moment to cash out near the top. To answer the question - Is It Too Late To Invest In Farmland? - I'd answer with a clear yes. Avoid the sector until a major correction in prices hits. I'd remind readers that corn (NYSEARCA:CORN), soybeans (NYSEARCA:SOYB), and wheat (NYSEARCA:WEAT) are all down 20% or more over the past month; this is turning into another ugly year for farmers; a fact wholly unreflected in the farming REITs' share prices thus far in 2016. Here's a five-year chart of wheat - it's been a massive bust. Make no mistake this will hit farmland's value soon.

WEAT Chart

WEAT data by YCharts

Finally, I'd note that the argument presented in the bullish article I linked to - that farmland is worth more since interest rates are low - doesn't resonate with me. Farmland has high transaction costs and limited liquidity.

When interest rates recover, it will be hard to sell farmland that was bought as an interest rate play, and as such, prices will face a sharper decline due to market structure. Farmland Partners and others will face high debt loads they used to buy aggressively priced land. When interest rates rebound, they'll have to refinance at higher rates while their land ends up being worth less; terrible for the equity holders.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.