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I can hear the singing, courtesy of the cast of "Oliver":

Food, glorious food! Hot sausage and mustard! While we're in the mood -- cold jelly and custard! Pease pudding and saveloys! What next is the question? Rich gentlemen have it, boys -- In-di-gestion!

I think of food as the most consistent and overlooked investment sector one can make, on both the consumption and the production side of the food chain. Today I will look at production; tomorrow, consumption.

In the developed world, commodity prices have been falling relative to income for more than a century, this trend being interrupted only by war, prompting people to eat more and better food, spending more overall but less of their income each year. This pattern is now happening in "emerging economies" -- China, India, and Brazil come to mind -- and is also happening in "recently emerged economies" such as Indonesia, Malaysia, much of South America, and Asia. Just these five countries have a combined population of 3.2 billion or 45% of everyone on the planet. This change is uneven -- not everyone is moving in lockstep into the middle class -- but the number of people entering the middle class is at least 80 million per year around the globe. That is the foundation for investing in agriculture.

Worldwide Demand

Core demand for foodstuffs around the world is growing faster than the population and faster than GDP growth. While people in the developed world know they are too fat and trying to shrink, they are buying more expensive food to do so and most of the rest of the world wants to get fatter and is on the road to doing so. People around the world -- including emerging what are colloquially known as emerging economies -- are, at a minimum, spending their extra income on high quality food. This is especially true in China, more on that in a minute.

The bottom line for investors: When a few million people want to buy more and better food, it is a nice little trade.When more than three billion want to do so, and are on a track to do so, it is time to, and I am now stealing a line from Jim Rogers, “trade that Mercedes for a tractor.”

Demand from emerging markets, and demand for specialty foods in developed markets, has been boosted by government policies that have farmers growing corn to burn in gasoline tanks. Ethanol mandates are the singular reason for a mini-boom in agriculture in the last decade but the impact of these mandates is a) lessening and b) misunderstood on Wall Street. Wall Street has caught on within commodity markets but has yet to understand the secular nature of this change in food consumption in places like China. Demand for more and better food should increase for the next 50 or 100 years, The only other industry where this can be said is energy -- but substitution among energy sources will keep prices down. This kind of substitution does not apply to agriculture on a large scale. When the price of corn goes up, the price of wheat typically goes up as well. Let’s start with corn - forget other crops, in the farm belt it is all about corn.

Corn prices hit all time highs this past year, retreated and are climbing back toward all-time highs, This volatility, based to a large extent on well founded fears the ethanol subsidy program in the U.S. is going to be cut back, has not made farmers nervous -- they are flush and feeling it. I was recently in the Midwest – it pays to drive in corn country and visit Tractor Supply (TSCO) and talk to Deere (DE) dealers. There are no real fears about cutbacks in the ethanol program. These fears are, however, still lingering on Wall Street. The cutbacks in the ethanol program are already being replaced by rapidly growing demand from China.

Bottom line: The Street is ignoring a fundamental change in demand worldwide due to record imports of corn by China that is not a one time event. Once you eat better pork and chicken, you are not going back to soup even if it means delaying purchase of that moped because the factory is cutting back. Chinese imports of corn are at record highs and will go higher over the next 12 months. This is a new, predictable phenomenon not predicted by Wall Street.

A Worldwide Industry

Farms may be local, but the industry -- agriculture, from the ports used to export grain to tractors -- is truly global. Increased pork consumption in China means more corn production in China and greater demand for tractors but also means more corn production in the U.S. and that also means more purchase of tractors and fertilizers and pesticides.

Worldwide demand has impacts on suppliers around the world. The size of agriculture as a worldwide industry is huge -- in the U.S. alone the import/export trade will be more than $200 billion in 2012 and overall production will probably come in around just shy of $400 billion including transfer and some non-cash revenue equivalents. There is a family of names for investors to consider for their portfolio.

Here is a short list:

  • Agrium (AGU)
  • Archer Daniels Midland (ADM)
  • Brasil Foods (BRFS)
  • Caterpillar (CAT)
  • CF Industries (CF)
  • CNH Global (CNH)
  • Compass Minerals (CMP)
  • Deere & Company (DE)
  • Intrepid Potash (IPI)
  • Kubota (KUB)
  • Monsanto (MON)
  • The Mosaic Company (MOS)
  • Potash (POT)
  • Syngenta AG (SYT)
  • Terra Nitrogen (TNH)
  • Tractor Supply (TSCO)
  • Yara (YAR.PK)

The core inputs to farming -- other than land, labor and water -- are seed, fertilizer, pesticides, tractors and combines and energy. Companies tend to specialize in one of these components: Potash sells fertilizer, but not pesticides, Monsanto sells seed and pesticides, not fertilizer and so on.

What Should an Investor Do?

Long term, investing in agriculture is very simple, driven by fundamentals in turn driven by well-known demographic and income trends. Shorter term -- and this is important for picking entry points for a stock -- are a totally different matter. Some factors influencing agricultural stocks are as follows:

  1. Demand as reflected in commodity and crop prices
  2. Energy prices, impacting farm income and the cost of manufacturing fertilizer
  3. Currency values, as they impact commodity prices and have a ripple effect on energy and fertilizer prices
  4. Government policies, from direct subsidies and tariffs to paying millionaire farmers to grow corn to burn in your gasoline tank
  5. Weather

There is another factor that is harder to quantify -- confidence, among farmers, and how it drives planting and the purchase of supplies and equipment.

Confidence: A Firsthand View

I worked in agricultural marketing for several years in the 1980s and had the good fortune to visit with farmers throughout the Midwest and the South. You learn a lot listening to why people spend money -- and farmers spend money when they can see where prices are going and spend more money when they see prices going up. Simple stuff. Last fall I drove from my home in Washington, D.C., to Muskegon, Mich., then on to Northfield, Minn., up through northern Wisconsin and back down through Indiana, Illinois, and Ohio. I went back to Minnesota a few weeks ago. The trips covered a lot of ground but everywhere I went the story was the same. I had never seen so much corn ready to harvest last fall and I have never seen so many fields planted for corn as I did this spring. Every state -- from close in farms in Maryland to fields on the approach to the airport in Minneapolis -- had corn everywhere. Everywhere: right to the roadside, with far less visual evidence of fields lying fallow or planted with legumes or other crops as part of a crop rotation program. Simply put, farmers were cashing in on strong corn demand.

In the past Wall Street saw a good part of this demand in the U.S. coming from ethanol production -- and they were right. But now it is China, not ethanol, that is giving farmers confidence. And the Street is missing this change, big time.

Agricultural Stocks

What does all of this mean for agricultural stocks?

Let’s go back to short vs. long term. Long term, investors in agriculture are in terrific shape -- and by long term I mean at least three years, preferably five or more. Short term and you need to be aware of this to create entry points, there can be meaningful gyrations in stock prices.

First, be aware, they often -- not always, but often -- trade as a group. Analysts tend to lump them together and given the plethora of agricultural statistics -- even the Chinese try not to lie about their agricultural data, astounding -- so investors need to be aware of this before entering a position.

Second, on a day to day basis, they are susceptible to swings in commodity prices, these in turn driven in a given day by currency valuations and oil prices.

Third, crop reports and other critical data points move commodity prices and therefore move stock prices.

Given these variables and the long term fundamentals, what do I like right now? Terra Nitrogen (yield of 8.19%), Deere (yield of 2.4%), and Brasil Goods.

Terra Nitrogen

When you think of intensive corn production, you think fertilizer -- for each acre of lousier and lousier land farmers put into production, the more fertilizer those farmers need to get the best yields from that lousy land. And since this is the largest number of acres being put onto production in generations -- increasingly intensive cultivation is the trend. That means more fertilizer and that means Terra Nitrogen. A very fine company, a stock that may scare you because it ran, sold off and is now running again, the stock’s chart is masking the underlying fundamentals of the company -- this is not a bubble stock. The current dividend yield is 8% or more. Am I being too optimistic about agriculture? In 2012, the value of farmland is at a thirty year high -- making farmers very liquid -- and I said previously plantings for corn will be at an all time high. That is the demand side.

Why TNH and not other fertilizer outfits. TNHI does all its production in North America. The core feedstock is natural gas. Natural gas is going to be cheaper in North America than anywhere else in the world with free market prices for between 25 and 75 years.

You have heard about fracking? Well, natural gas is TNH’s feedstock to make their fertilizer. Natural gas was once north of $12. It is now struggling to stay above $2. Not much more to say on the cost side. And if you think gas prices have to rise, well, it’s your money. They should stay low -- under $3.50 adjusted for inflation -- for one to three generations.

John Deere

The American Equipment Manufacturers Association thinks, as of the that sales of farm equipment will grow roughly in 2012 – higher than Street estimates and about in line with mine given reports on U.S. sales in April.

John Deere produces the world’s best large tractors and combines -- the small ones ain’t bad either -- and is exceptionally well managed as exampled by their manufacturing operations. They run what is arguably the most sophisticated and productive industrial facility in the world in East Moline, Ill., pays top dollar for extremely productive workers and is forthcoming with the Street, never too optimistic about anything.

The argument for Deere is as simple as the argument for agriculture in general -- even in the face of weakening economies, demand for foodstuffs is increasing much faster than increases in GDP in developed nations and faster than population growth in emerging economies. That means increasing demand worldwide for Deere products well above economic growth -- and that is what Wall Street is willing to pay a premium for right now.

The company reaffirmed its forecast for the year as recently as a few weeks ago, well after the recession began in Europe.

Are there competitive risks? Deere makes the best of the best. You can buy a huge Deere tractor that is guided by satellite to plant when and where it is the best time to plant and to harvest where and when it is the best time to harvest, your acreage being organized to facilitate the automated movement of the equipment. Yes, automated -- who needs a driver in 2012?

The stock, like other agriculture stocks, has sold off 20% from recent highs and found a bottom. Bottom line: Deere continues to grow, here and in China and around the world, the stock sports a dividend of roughly 2.4% and if you sell calls against the stock you can generate 12%-18% a year return, your own personal dividend something I do all the time in my Options Income Blueprint Service.

Brasil Foods

Brazil? Am I nuts? No -- when there is cachaca in the streets, buy Brazil. (Cachaca is a very popular Brazilian, uh, alcohol product.)

Brasil Foods is an old fashioned aggressive growth story and the largest food processor in Brazil, the company controls more of the production chain than processors in the U.S. and Europe and is serving a huge population enjoying rapid movement into the middle class -- and eating more and better food. It is a pure play on Brazil and growth in that country but the company also exports a wide variety of products.

BRFS is gigantic in the Brazilian market -- and sells under its own brand -- so big Brazilian authorities told it to break some parts of too keep a semblance of competition in the market. I like the expert side of the business even more; this is a clever company and if growth for its chickens slows in Brazil, it will sell them somewhere else -- including China and Japan.

Never heard of it? The company did around $14 billion -- with a "b" -- in 2011 and hopes to hit $27 billion by 2015. It has higher profit margins than food processors in the U.S. and Europe. In its last complete fiscal year the company had $484 million in profits.

The stock has collapsed due to withdrawal from emerging markets by investors and the fall of the real -- the stock is an ADR and exchange rates do matter with ADRs. It has not yet found a bottom -- but if you think long term, it is a pretty good time to get in. The stock is an ADR and because Brazil is a “hot” investment area it is well followed on the Street. There are no dividends but with this kind of appreciation potential, look somewhere else for monthly cash.

Conclusions

If you have time horizons of three years or more for any or all of your capital, start with agriculture. Right now. Demand is rising faster than GDP or the population; prices are rising; income to the sector is rising; the stocks will follow. The Street is still too nervous about ethanol and oil prices and the dollar and the Super Bowl -- get in before they all wake up and pop the stocks. Tomorrow I will discuss the other half of the food chain -- where people buy it, where people eat it. A hint: Think personal.

Disclosure: I do not own these names and will not do for a period of three trading days after the publication of this article. I have recommended BRFS, DE, and TNH in my service The New Normal Investor and these and other names in Options Income Blueprint.

Source: Food, Part 1: Agriculture Means Growth And Income