In three out of the past four years, grain prices rallied during harvest, the opposite of what normally happens. In the one year they didn’t rally, 2008, prices were at record highs before dropping precipitously. Again this fall we are seeing prices rally through harvest. It is great for bottom-line profitability, but it can be a long-term marketing challenge. The longer we see crop prices at this very profitable level, the more upward pressure we will see on land and land rent prices.
Last month, Sheila Bair, chairman of the Federal Deposit Insurance Corp., said that U.S. farmland could be the next “bubble.” It’s no news that farmland value has been on the rise. Values remain 58 percent above their 2000 levels in inflation-adjust terms.1
Who buys farmland? Mostly, farmers do. According to Farmers National Company, a landowner services company, 70 percent of their farmland sales are to farmers.3 Corporate buyers, such as insurance companies, have long taken advantage of solid returns on quality farmland. U.S. farmland has produced an average return of 11.6% a year since 1951.2
Land values and rents are rising for multiple reasons, among them: population growth and the annual loss of acreage to development every year are often cited. In my opinion, the real reason in recent years is demand for the products the land produces. A big part of that is ethanol and improved quality of life globally. Fundamentally speaking, it appears that farmland prices should continue to hold or gain value.
As a consequence of higher land values, cash rents continue to rise. This puts more pressure on you to be as profitable as possible. I’ve long talked about the importance of consistently taking out of the market as much as you possibly can within a reasonable risk parameter so that you’re prepared for down years. The reason: Prices offered by the market over the years tend to average near your breakeven. Also, you need to maximize profitability to be able to pay competitive rents or risk losing the ground.
Will we see a boom and bust in land values like we’ve seen in the housing and stock markets? The potential is always there. A boom-bust cycle starts when values go higher on sound fundamentals. It gains momentum when people are willing to pay too much.
The more immediate concern is unrelenting price volatility, which has become normal. The recent spike in the price of corn occurred for a couple of reasons: surprise and supply versus demand. The market was “shocked” by the USDA acreage report. Adding to the price pressure was the fact that American farmers produce most of the world’s grain, and a significant revision downward in yield suggested lower global supply. That translated into higher prices.
According to an October 2010 article in the Economist, “price volatility could be a more permanent feature of agriculture. The concentration of farming in a few big countries means that a hungry world is dependent for its food on stable production patterns in a small number of places . . . problems in one country can send shock waves through global markets.”4 A Business Week Special Report on Risk Management used the phrase “permanent volatility” to describe commodity markets in the future.5
Peter Brabeck-Letmathe, chairman of Nestle, said that increased consumer demand, growing bio-energy demand, and speculative trading were behind grain price volatility in 2008. He said, "The market has become much more volatile, because you have so much speculation in it ... I think this has become a permanent shift.”6
If you’re feeling uncertain, it’s simply because nothing is certain. No longer can we talk about “what normally happens” with any conviction. A myriad of factors influence price and can change prevailing sentiment at almost any time. Rather than allow yourself to become complacent with corn, and other crop prices on the rise, make sure you’re planning ahead for what you will do when it changes course.
Scott Stewart is president and CEO of Stewart-Peterson, a commodity marketing consulting firm based in West Bend, Wis. You may reach Scott at 800-334-9779, email him at email@example.com.
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1FDIC Chair Warns of Possible U.S. Farmland Bubble. Reuters, October 18, 2010.
2Farmland: The Next Boom? The Wall Street Journal, September 24, 2010.
3Is the farmland ‘bubble’ ready to burst? Ken Anderson, Brownfield Ag News, October 27, 2010.
4As high as an elephant’s eye. Another agricultural commodity surges. The Economist. Oct. 14, 2010.
5How companies are coping with unstable commodities. Business Week Special Report. Sept. 30, 2010.
6Food price volatility has become permanent –Nestle. Reuters. Nov. 13, 2010.