Diary of a Financier

Natural Resource Correction: A Surprise Ending

In Capital Markets on Fri 12 Aug 2011 at 02:36

I can accept that energy resources are scarce. This is our second bout with noisy contentions of peak oil, the other being the 1970s crisis. Yet, renewable resources like agriculture may in fact be overvalued because of a supply/demand mis-extrapolation.

Consider that population demographics are declining. Like a climber having just summited Everest, the world economy is contending with a treacherous descent from peak consumption. We’re tethered to the aging population, a force so powerful as to cast the entire world–developed and developing alike–into a rolling economic recession.

Take a look at the decelerating population growth rates of some major nations:

China- Population Growth Rate

US- Population Growth Rate

Japan- Population Growth Rate

In the face of poor demographics, economic (Real GDP) growth rates depend on current account appreciation and organic growth (i.e. innovation). A widely touted natural resource theme has captured the imaginations of many investors. They say it’s a secular bull already underway, and they point to the rising middle class in emerging markets. While it’s currently stalled due to the relapse of systemic matters, the natural resource theme still stands as a generally accepted, de facto standard. Accordingly, investors are throwing their money behind it… and I suspect many agricultural/foodstuff shares are enjoying fatter premiums than necessary.

I’m not talking energy, because the Earth yields as much fossil fuel as she may. Nor am I talking precious metals, which are also finite fruits of the Earth. I am talking agriculture & foodstuffs. For resources like wheat, what makes today unique? What makes this point in history the supply squeeze that the sell-side claims? Yes, farm land is finite. No, we have not groped its outer bound. Yes, there were fires in Russia, riots in the MENA states, and political chess in the Congo. No, these are not permanent features of the global outlook (at least not any more than they were before).

I don’t know an investment manager, an analyst or a journalist who doesn’t subscribe to the “Ag Boom.” Both the sell-side and the buy-side love a theme to latch onto, especially an accessible theme that clients understand. I smell smoke, and I’m looking for the fire.

In the end, the risk to my thesis is that the middle class monster in China continues to proliferate despite it all. The research is more complex than this, but take a look at a Chinese consumption growth rates (flat public & declining private) compared to strong inflation:

China- Public Consumption Growth Rate

China- Private Consumption Growth Rate

China- CPI Rate

Worst case, an outshift in demand for more farmland is eventually met by supply, for which I’d want to own fertilizer stocks. (Problem solved, I’ll buy a stake in Yara International (YAR-OS) if ever I decide to all-out short Ag. Look no further than the historical bull market in farmland & crops. It’s a golden age for farmers.)

Maybe it’s the economy or maybe it’s the recurring crises, but Ag equities like ADM & DE have pulled-back from rich valuations. The surprise to me is that physical Ag commodities have not pulled-back to the same degree. Capital markets are always late to discipline unruly bubbles. In another phrase, shorts are always too early to paradigm shift trades. The Ag lofty highs should persist for weeks to a month (at most). I may cut myself loose to consider some shorts on physical commodities, particularly the ones positioned with bearish long-term fractals. I’m evaluating an Agriculture ETF (DBA) as an eligible vehicle:

Coffee- descending

Corn

Cotton- completing a pullback to its base

Feeder Cattle- top of its range

Live Cattle- one more assault on the top

Rough Rice- not done rallying yet

Soybeans- starting the descent

–Romeo

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  1. Case and point:
    Analysts see food-related stocks as potential winners with China’s population of 1.3B increasing its appetitite for imported consumer food products. Crunching the numbers for the sector, TheStreet.com names 6 stocks as showing strong upside potential: DOLE, GMCR, FDP, THS, SBUX, CBOU.

    http://www.thestreet.com/story/11223088/3/6-food-stocks-that-could-rise.html

  2. […] where history may not be exactly redundant. I’m inclined to start with my contrarian mistrust of the multi-year Ag boom, which futures I’ve patiently tracked along with the Agricultural […]

  3. […] will pass from generation to generation. With the precious metals/commodities trades having corrected now (some more than others), I have the opportunity to purchase a business like FCX at an effective […]

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