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Betting the Farm
New York: September 13, 2010
By John Stephenson

Higher prices and surging demand from overseas buyers have American farmers and commodity traders singing a happy tune. And it\\\\\\\\\\\\\\\'s going to cost you more at the supermarket over the next few years, since agricultural commodities have been on fire lately because a constellation of whacky weather, low ending inventories coupled with changing diets globally have pushed prices to levels not seen since their 2007/2008 peak.

Corn, the most important cash crop in the U.S. , is case in point. Higher temperatures in the Midwest have negatively impacted farmers\\\\\\\\\\\\\\\' yields and low inventories have helped push the price of corn to $4.64 per pound, a more than 49 percent increase from a year ago. For wheat, soybeans, dairy products, lean hogs and beef the story has been the same, prices are up, and up big, from the previous year.

For other agricultural exporting nations, rising agricultural commodities have been a bonanza. Nowhere is this more so, than in agricultural powerhouse Brazil , the world\\\\\\\\\\\\\\\'s largest coffee producer. Low ending inventories and steady demand for arabica coffee (the milder more flavourful bean favoured by most coffee lovers) has been one hot commodity lately, recently hitting $1.88 per pound—a 52.6% increase from last year.

Here at home, poultry, beef and hog farmers have been working overtime to keep up with the surging demand for meat. High temperatures in much of the country, coupled with the closing of several slaughterhouses and packing plants, have helped push meat prices higher. During the financial crisis of 2008/2009, American hog farmers were forced to cull some of their hogs as prices and demand for pork bellies and lean hogs tumbled. But today, hog farmers are struggling to keep up with the surging demand for U.S. pork from overseas buyers. Making matters worse, high temperatures have made it harder for the hogs to put on weight, a situation which has forced many farmers to keep their swine in the barns for longer than usual, resulting in less supply and higher pork prices.

While folks on Main Street are struggling with an uncertain economic future and signs of a weakening recovery, for U.S. farmers, their prospects have rarely looked better. Estimates by the Omaha branch of the Federal Reserve have suggested that exports of American agricultural products should top $107 billion in the fiscal year ending September 30 th . That\\\\\\\\\\\\\\\'s the second highest amount ever, falling just shy of the $115.3 billion recorded in 2008. The prospects for next year look even better with estimates for export revenue topping $113 billion.

Not surprisingly, farm incomes are up, with total net farm cash income clocking in around the $85 billion mark for the current year and up significantly from the ten-year average of $72 billion. But the data is skewed even more dramatically for the twelve percent of large scale farms (271,000 farms) which produce nearly 75 percent of total U.S. farm production. These farmers will see their net farm income for the current fiscal year soar to an average of $220,000 a 22 percent increase from the previous year.

With more money in their overalls, farmers are beginning to spend, creating a ripple effect along the whole food chain. Fertilizer prices are moving higher as are the shares of agricultural equipment suppliers as investors bet that the salad days are here to stay.

And while the United Nations Food and Agricultural Organization (FAO) is adamant that there is no new food crisis emerging, its own global index of food prices paints a different picture. The FAO index has increased to 180 from just 152 a year before, an 18 percent increase.

The economic debate in the U.S. and Europe lately has been focused squarely on the prospect that deflation, or falling prices, may be the order of the day. And while some of America \\\\\\\\\\\\\\\'s deflationary pressures at the margin may be related to its imports of low-cost goods from abroad, most of the problem is home grown. Sluggish industrial production numbers, poor capacity utilization and anaemic consumer spending have resulted in sluggish demand for many products and services.

But the same cannot be said of the developing world, where growth remains largely unbridled and consumerism is in its infancy. The surging price of agricultural commodities will have a more dramatic impact on the fortunes of these countries, where food prices remain an important contributor to the local consumer price index (CPI). Once again, we face the bizarre prospect that global inflation will rise, while the West grapples with staving off the ravages of a Japanese-style deflation that could destroy investment and competitiveness.

As I point out in my recently released book, The Little Book of Commodity Investing (John Wiley & Sons, 2010), commodities have the best fundamentals of any asset class. Demand is voracious, supply is struggling and while we have plenty of spare capacity around the world to crank out cars or iPods, the ability to increase a nation\\\\\\\\\\\\\\\'s beef cattle herd or to increase gold mine production remains an incredible challenge.

The developed economies of the West are extremely efficient at producing almost everything except commodities, the basic raw materials of industrialization and urbanization. For my money, I believe that investors should focus on the stocks of commodity producing companies, since these companies will ultimately have pricing power, since there are natural limitations to how quickly they can expand production. And even if the stock market does not quickly reward investors for a savvy purchase of a commodity producing company, others will. As BHP Billiton\\\\\\\\\\\\\\\'s hostile bid for Potash Corporation of Saskatchewan has shown, when the price of best-in-class assets drifts too low, a motivated buyer is sure to appear.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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