Agriculture: A Tale of Human Development

What Is the Agricultural Story?

The true agricultural story is not what you most often hear. The stories you hear focus on the need for ethanol and biofuels to reduce our dependence on oil imports, or on the one-time droughts that are leading to short-term spikes in grain prices.

What is missed is the core of the real story. Bill Doyle, the CEO of Potash Corp (POT), has described this story as a 'human development story'. It is a story of a shift that is occurring for a large percentage of the world's population to higher protein diets.

Finally Getting It Right

I have written in a previous post (Why China and India will Continue to Grow) on why the growth going on today in the developing world will continue. This is, to some extent, a historically unique proposition. In the past, spurts of growth in the developing world have most often been followed by crisis and collapse.

Why? Because the growth was driven by large scale, subsidized infrastructure projects or transplanted industries to barren economic environments. Neither of these approaches addressed what is required to produce an internally sustainable economy.

However, the economies of China and India today are developing upon a different model. This model incubates the local production of a wide range of goods and services, and is born out by diverse and chaotic city landscapes and the small and medium sized businesses that dot them. The analogy for this model can be seen in the early development paths of Japan, Korea, and Taiwan. It can also be seen in the development path of the United States.

The consequence of such development is the inevitable rise in the standard of living of the population. And with that rise comes the expectation of a better diet. History has shown that when people move to an income above $3000 per year, they begin to spend a disproportionate amount of their discretionary funds on improving their diets and moving up the food chain to higher protein foods.

We are now at a point where a large percentage of the world's population is approaching and exceeding that $3000 per year threshold. As Doyle describes it, "We are going to go through this process to meet the protein demand of hundreds of millions of people that are coming into the time when they can afford to eat protein."

Dealing with the Demand

Up until recently, the world has done little to adopt improvements in agricultural productivity. Agriculture has so often been in surplus that it has come to rely upon government subsidies for its existence. In such circumstances, improvements to productivity were, if anything, counter-productive.

Thus, the recent rise in demand has not led to a quick productivity response. Instead we have been drawing off of our savings. As a result, global grain inventories are at the lowest levels for a decade. In January, the USDA lowered its world grains stocks-to-use ratio for the 2007/08 crop year to a record-low 14.1 percent.

As Jeff Jubak pointed out recently:

Rice stocks have fallen this year to about 70 million tons, the lowest level in 25 years and less than half the total held in global inventories in 2000. Wheat inventories, called "carry-overs" in the trade, are at 30-year lows even though world wheat production was actually up 1% last year. In the past year, reports show, wheat inventories in the European Union have plunged to 1 million tons from 14 million tons.

A Lack of Land

The obvious solution, to bring on new planting acreage, is not going to work. To quote Bill Doyle:

The only acreage really available globally of any substance is in Brazil…China has no more acreage, they set the redline of 296m acres that they will not go below.

Moreover, the acreage in the developing world is decreasing per capita as these countries expand and more acreage is required for infrastructure and cities. It is clear that we should not look to increases in acreage as a solution.

The Worry of a Crisis

As Donald Coxe, BMO Global Strategist, has pointed out, our inability to meet the rising demand requirements could have dire consequences.

We're drifting towards a global food crisis in the next very few years… All we need is a crop failure in the Midwest - not that I'm predicting that but we're overdue for one - and then we're going to have the worst global food crisis that we've ever seen.

$10 wheat, $13 soybeans, and $5 corn may be just the beginning.

The Solution

If acreage isn't the solution, then what is? It is clear that as more of the world develops, at least part of the long-term solution must be a re-evaluation of what is a sustainable diet. But this is not going to occur overnight. So in the short-term, we must rely on productivity increases.

How do we increase productivity? In three ways:

1. Improvements to the nutrition of crops
2. Improvement to planting techniques
3. Improvements to the species we plant

Fertilizer. Precision agriculture. Biotechnology. These are the only immediate solutions available.

Some of these solutions might be controversial. Biotechnology, for example, carries quite a negative stigma. Nevertheless, the overarching concern has to be the avoidance of a crisis in food production. All potential alternatives must be considered.

The Investments

As an investor, you want to be aligned with the companies that facilitate such productivity improvements. Yes, the stocks of these companies are expensive. But they are expensive based on current and past price assumptions. What is occurring is a change to the underlying assumptions. The recent historical precedents no longer apply.

If the human development story in China and India continues to play out along the lines that it did in Japan, Taiwan, and Korea, past prices will not be an indicator of future performance. Future performance will far exceed anything that has taken place up until now.

I would invite you to go and listen to Doyle talk and to draw your own conclusions. His speeches are on the PotashCorp website. As he speaks about where we are in this story, and how much further we have to go, the conclusion that he draws is clear:

The movie hasn't even started yet.

Comments

[ramankandola]

POT is in a middle of a long cycle of long upward trend. The AG cycle would bring countries like India, China and Brazil for more production, as consumers demand would be more than the intake they had more than a decade ago.

[Real Grit]

If POT has a $100 upside from here, wouldn't you want to consider it seriously? I personally think that POT can become a 3-bagger from here in a few years.

[phinsuntanning]

long cycle of long upward trend? sure, same as internet stocks 7 years ago, m3 bubble, good to ride as money is cheap, and it will be that way in election year...here and in india, so buy the commodity dip, we are in 1999 but nowplaying with food... tibetans are the first price elastic people, others will follow...

[Lane_Olafson]

raman and real grit - I personally think POT is going to go much higher. It is the largest position I have by far. I plan to write-up POT on seekingalpha shortly, because the mis-pricing in the stock, IMO, is ridiculous. Earnings estimates of POT have consistently been based on potash prices that do not reflect the current and future supply / demand. The absolute lack of supply, and the virtual inelasticity of demand make the analyst estimates of $300/t potash unrealistic, just as it was unrealistic last summer when analysts were telling us all that POT was expensive but using $150/t potash to justify the claim.

[ShanghaiAdvisor]

If you listen to all the conf calls and run the numbers, global production of potash over 5 years is likely to grow 50% or so. The human population consuming "non-poverty levels of food will likely at least triple over the same period. This means all AG will sustain at least current price levels if not spike much higher. Low risk to buy here. Shanghai Advisor.