Farms, Housing And Investing

November 15, 2011

It appears that something good is finally developing out of the housing crisis.

When housing prices were high, it made sense for farmers to sell their land to real estate developers—such profits outpaced the money they could expect to earn from farming.

Now, however, the tables have turned. Land prices have fallen nearly 70 percent since mid-2006, while U.S. cropland values have risen almost 20 percent, according to a Wall Street Journal article this week that cited the Lincoln Institute of Land Policy and the U.S. Department of Agriculture.

If farmers themselves aren’t buying back the land, they’re being hired by real estate developers to work the land.

So what does this mean for your portfolio? A couple of things.

For one, the influx of new crops will eventually drive prices down until it is no longer profitable for newcomers to enter the market.

That said, it’ll be a long time before supply catches up to demand, but it’s unlikely that such an imbalance will go unexploited forever.

Noted commodities trader Jim Rogers has been singing this song for years—in July, he predicted that farming salaries will eventually outpace the salaries of financial professionals, and exhorted financial analysts to take up farming.

I’m personally not about to switch careers, but I can see his point—as long as the need for food continues growing, so too will the need for crops.

Rising demand results in higher prices, which will spur supply increases. The world population is growing quickly, implying that demand will continue to rise, but at some point—and especially if finance majors start switching over to agriculture—supply will catch up.

What Goes Up . . .

Currently, 31 agriculture ETFs are on the market that investors can use to profit from what remains of the more than decade-long boom in commodities. To hear Rogers talk about it, this boom is likely to last longer than he originally foresaw, particularly as it relates to agricultural commodities.

ETFs such as the PowerShares DB Agriculture Fund (NYSEArca: DBA) or the United States Commodities ETF (NYSEArca: USCI) are two future-based, multicommodity funds that are designed to manage the forces of contango and backwardation.

To review, contango is when the next-to-expire futures contract is cheaper than contracts that expire in later months. That means that fund managers lose money when they roll into the newer contracts to maintain exposure.

Backwardation is the opposite of contango, when front-month contracts are more expensive than later-month contracts. When a commodity is in backwardation, the fund manager will make money when he sells the front-month contract at expiration and buys the next-to-near-month contract.

When commodity spot prices start their next downward trend, that could make it cheaper to roll contracts over, and could even result in a positive roll yield—backwardation—which could help cover the fall in spot prices.




. . . Must Come Down

As I said, there will come a day when crop supply finally catches up to demand.

While you could short USCI or DBA when that day comes, there are also two inverse agriculture ETFs on the market designed to profit when crop prices fall.

Those are the PowerShares DB Agriculture Short ETN (NYSEArca: ADZ) and its double-inverse cousin, the PowerShares DB Agriculture Double Short ETN (NYSEArca: AGA).

For now, though, the bull market in commodities is intact, even it seems like global capitalism is unraveling one European country at a time.

More Farms Mean More Jobs

Another important product of increased investment in farmland is a healthier economy. As more farms spring up, more farmers will be needed to tend to crops, which should bring down the unemployment rate.

Converting unused land into farmland should also increase U.S. GDP, as we increase production levels, and decrease the trade deficit as well.

All the factors that are already coursing through the economy are making U.S. equities very attractive.

In particular, the PowerShares Dynamic Food & Beverage Portfolio (NYSEArca: PBJ) is poised to benefit from cheaper agricultural prices.

Companies focused on consumer cyclicals are also likely to do well, which will keep ETFs such as the Vanguard Consumer Discretionary ETF (NYSEArca: VCR) rising in value as our economy recovers.

It’s inviting to see some good come out of the economic malaise we’re in, but it remains to be seen how many farmers will take advantage of cheap land and pricey commodities.

But, like the piece in the Wall Street Journal made clear, the incentives seem to be there.


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