MACQUARIE AGRICULTURAL FUNDS MANAGEMENT 1st Quarter, 2012
Food for thought IN THIS EDITION Farmland opportunities The role of agricultural beyond the U.S. investment in uncertain times Following an analysis of the emerging bubble in the U.S. farm land market in our last edition, we take a closer look at the investment opportunity outside the U.S., focusing on Brazil as an alternative. We observe that agricultural land in the U.S., comparable on a productivity basis, is priced a multiple of 3.4 times that of land in Brazil1. With similar yields and marginal differences in input and transportation costs, we conclude that the price differential is difficult to justify. An analysis of relative returns showing a healthy premium in Brazil supports our conclusion. Further, we identify potential upside in Brazil from improvements in transportation infrastructure and the downside risk in U.S. farm values from changes to farm subsidies and rising interest rates.
Global agriculture’s super trend: soybean exports to China
A strong long-term trend has emerged in global agriculture over the last 15 years: the rapid growth in protein consumption in emerging markets. The trend has been particularly evident in China where the appetite for pork and other meats has been growing strongly. The production of meat has become increasingly reliant on imported animal feed ingredients- the most important We investigate the diversifying properties of these is soybean. The pace of of agriculture and apply an equity beta this growth has meant that China analysis to farm land in Australia, the has gone from being self-sufficient in U.S. and Brazil. The conclusion is that soybean consumption to the world’s farm land has displayed low correlation largest importer, now accounting for to the broader equity market. In further half of all soybeans traded globally 2. analysis on Brazilian agricultural land We find that most of this growth has and hedge funds for a comparison, been met by a rapid rise in soybean we see the persistently low equity land area in Brazil and Argentina, where beta component of its total return. production has increased by more than 70 per cent during the last decade 3. Overtaking the U.S. recently, Brazil Continued page 9 is now the major supplier to China with 35 per cent market share 4. It has been an eventful few years for investors. For some, the diversification offered by traditional investments and even many alternative assets, has been less than expected or has been in decline. This has left a dwindling pool of asset categories available to portfolio managers seeking diversification from equity risk.
Continued page 4 Continued page 13
1 2 3 4
Univ. of Illinois; Global Farm Partners; USDA; Goagro; HighQuest Analysis USDA, FAS data set, March 2012 USDA Long-term Projections, February 2011 USDA Projections to 2021, February 2012
Food for thought
Macquarie Agricultural Funds Management
Agricultural experience, institutional investment discipline.
We invest in an inescapable fact. People need to eat and changing demographics are driving higher food prices. We take a unique approach to investing in food production, by bringing both investment management and farming expertise in-house and under one roof.
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Macquarie Agricultural Funds Management
Food for thought
Food for Thought is published by Macquarie Agricultural Funds Management Editor: Bradley Wheaton, Macquarie Agricultural Funds Management, Macquarie Private Wealth Corp. Authors: Daniel Hough, Macquarie Agricultural Funds Management James Freeman, Macquarie Global Investments Bradley Wheaton, Macquarie Agricultural Funds Management, Macquarie Private Wealth Corp. Contributors: Stephanie Burton, Macquarie Agricultural Funds Management, Macquarie Private Wealth Corp. Alan Hoppe, Macquarie Agricultural Funds Management
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Macquarie Agricultural Funds Management
Farmland opportunities beyond the U.S.
The agronomic output potential of the land is based on intrinsic factors such as soil, climate and topography; these factors can be used to evaluate the yield potential when the data is available. In the absence of this data, historical yields are an indication of productivity. Soybean yields in both the U.S. and Brazil have averaged 2.7 tons/ha since 1996. Brazilian yield growth of 3.63% p.a. is outperforming the U.S. of 2.64% p.a 1.
Soybean yields in the U.S., Brazil and Argentina
II) the cost to get products to market
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Put simply, there are four factors that can drive the investment return potential of a farm, wherever it is in the world:
tonnes/ha
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There are wide variations in price and numerous factors to consider when evaluating agricultural assets, so it is critical to focus on the specific variables that will contribute the most to underwriting long-term returns.
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Evaluating opportunities across borders
How much can you produce from the land?
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In our last edition, we looked at the U.S. farmland market and examined why some observers believe it is heading into bubble territory. In this piece, we take a closer look at the investment opportunity outside the U.S., focusing on Brazil as an alternative. We outline an approach for evaluating the productive capacity of farmland by looking at how transport and marketing costs determine the price for goods received at the farm gate and how these costs flow through to land price. We make a comparison of those costs in the U.S. and Brazil, which tells us a great deal about relative farm income and values.
Source: USDA, 2012
III) product prices IV) the cost of production Once we know these numbers, we can make a likefor-like comparison of land prices using the capital cost per unit of production as a common measure.
In addition, the dispersion of rainfall throughout the year in parts of Brazil, including areas in Mato Grosso and Goias, allows for rain-fed “double cropping,� meaning soybeans and another crop can be produced in the same year, which boosts productivity. In summary, soybean yields achieved in the U.S. and Brazil are similar. 4
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Macquarie Agricultural Funds Management
The cost to get products to market Marketing costs are a function of the transport, storage and handling infrastructure required to get products to market, as well as any tariffs or local taxes that are levied. Agricultural products are commodities, for the most part, freely traded around the world before they reach consumers. As such, prices are set with a reference to the major commodity exchanges. When farmers sell their products at the farm gate, the price they get is derived from these exchanges, adjusted for the cost to get the product to market and any local factors influencing price. This means the price a consumer of soybeans in Shanghai is prepared to pay is transferred along the supply chain to the farmer in Illinois or Mato Grosso.
Total transportation cost of shipping soybean from the U.S. and Brazil to Shanghai, China USD/Ton 250 200 150 100
The paving of the BR-163 A major infrastructure project underway in Brazil is the paving of the BR-163, which will connect the centre-west region with the Amazon port of Santarem. Along with reducing internal trucking costs for grains, the road is expected to make sea shipping costs to markets such as the European Union cheaper compared to ports in southern Brazil. The Brazilian Soybean Producers Association estimates that this will save at least $30 per ton in transport costs. FAS, USDA- March, 2012.
50 Minesota Shanghai Indiana - Shanghai 0
Domestic factors are also supporting prices in Brazil. In Western Bahia and Mato Grosso, animals are now fed using intensive feeding systems because of an abundant supply of grains, oilseeds, and cottonseed meal. Producers also want to avoid the high transportation costs to ports and meat processing facilities in the south. Producing closer to the source of feed and shipping high-value poultry and beef products to export or population centres is flowing through to higher grain prices 5. Meat exports grew from less than 2 million tons in 2000 to just over 6 million tons in 2011, and are conservatively forecast by the Brazilian Ministry of Agriculture to reach 8.5 million tons by 2020 6.
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2006
2007
2008
North Mato Grosso - Shanghai South Goias - Shanghai Q1 Q2 Q3 Q4 2009
Q1 Q2 Q3 Q4 Q1 Q2 2010
2011
Source: Transportation and Marketing Programs/Transportation Services Division www.ams.USDA.gov/GTR (October 2010)
Farm-to-port logistics are a part of the total marketing cost. While the U.S. has a well-developed rail, road and barge transportation network, Brazilian producers have ocean freight cost advantages when shipping to Asia, taking larger ships on routes that bypass the Panama canal and the associated access fees 2. Today’s bottlenecks in road transportation limit the efficiency of Brazil’s supply chain. However, infrastructure developments are underway that will mitigate these limitations. For instance, the Growth Acceleration Program (PAC), launched by President Lula in 2007, will invest BRL104.50 billion in transportation infrastructure in 2011-14 3. The publicly funded developments have been augmented with concessions enabling private sector investment in railway, improving the links between some of the interior grain-producing regions and ports 4.
An analysis of these costs from recent data collected by the USDA shows the average marketing costs for 2011 soybeans shipments to Shanghai, China. USD/Ton 600 500 400
Ocean Freight
300
Barge
200
Farm gate
Truck
100 0
Brazil, Mato Grosso
Brazil, Goias
U.S., Iowa
Source: Macquarie Analysis, USDA data, March 2012
In summary, freight costs to Shanghai from the farm gate in the U.S. are less than from Brazil, however, due to Brazil’s ocean freight advantage the difference is slight. 5
Food for thought
Macquarie Agricultural Funds Management
Product prices Farmers in countries with open trade such as Brazil and the U.S. are exposed to the same world markets for their agricultural products, like soybean, corn, wheat, sugar and canola. Farm gate prices are linked to those international markets, with the difference in marketing costs and trading tariffs reflected in the price farmers receive. Even for those products where there is limited international trade, local prices are still highly correlated to the world market because of the substitutability of agricultural products and the ability of farmers to switch production to more profitable products.
Fertiliser makes up the largest proportion of total U.S. corn production costs Proportion of US Corn CofP
7 0% 6 0% 5 0% 4 0% 3 0% 2 0% 1 0%
Approximately 70 per cent 7 of the cost of production is from inputs, which have a high correlation to product prices. As product prices fluctuate, farmers are faced with correlated movements in their key input prices. Labour and fixed costs are influenced by locationspecific factors and are lower in Brazil than in the U.S.8 There is a relatively high correlation between grains and fertiliser, as demonstrated by the below chart.
F er ti liser a s % of C orn C os t s
2011
2010
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2005
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Cost of production
1998
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0%
C he m ic a ls as % o f C o rn C o sts
Source: USDA, Macquarie Research, September 2011
Fertiliser makes up approx. 30-40% of total production costs for corn & soybeans in Brazil 5 0%
Fertiliser as % of Brazilian Cost of Production
4 5% 4 0%
Grain Vs. Fert
C B O T C o rn & W h e at A ve . $ /T
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Source: Macquarie Research, September 2011
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F e rt il ise r P rice $ /T Lin ea r (Gr ain V s . Fe rt)
Source: Reuters, Macquarie Research, September 2011
In summary, while input costs in Brazil and the U.S. are similar, the break down differs; noncorrelated costs like wages, are lower in Brazil.
Fertiliser is one of the largest costs of producing grains in the U.S. In Brazil they represent a lower proportion of total production costs, so along with the actual grains price fertiliser costs will be a significant influencer on profitability.
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Macquarie Agricultural Funds Management
Comparing apples with apples- the price of farm land per unit of production
areas of Brazil such as Mato Grosso and Goias where a second crop of corn or cotton follows soybean each year returns are at the top of this range of 5.4 to 8.0 per cent.
USD per Metric Ton $4,500
Soybean farmland operating returns - 3-year cash margin per ton / Current land cost per ton
$4,000 $3,500 $3,000 $2,500
Operating return/MT
$2,000 $1,500 $1,000
Return Improved by double cropping
$500 $-
U.S., Illinois
Argentina, Sante Fe
Uruguay, Rio Negro
Brazil, M ato Grosso
Source: Univ. of Illinois; Global Farm Partners; USDA; Goagro; HighQuest Analysis
Operating returns – margins squeezed in U.S. farms at current values Because of the high underlying capital value of farm land in the U.S., operating returns continue to be squeezed. A proxy for operating returns is the price operators are prepared to pay in rent. The ratio of rent to value has been in decline in the U.S. for an extended period.
Cropland rent-to-value, 1967-2011
Source: Univ. of Illinois; Global Farm Partners; USDA; Goagro; HighQuest Analysis; MAFM research 2012.
There is also a contrast in the efficiency of the capitalization of returns. The chart below shows the trend for real estate values to be supported by cash flow in the U.S. We know from the operating returns and land prices in Brazil that the returns are not priced into land values to the same extent.
$ per acre
Current value of farm real estate versus maximum affordable value
As demonstrated in the chart located top right, an operating margin premium of approximately 1.5 to 4.4 per cent exists in Mato Grosso operations versus that of U.S. In the
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Sources: USDA-NASS Quickstats (http://quickstats.nass.usda.gov/) 2012 and USDA-ERS cash rent and Agricultural Land Values Survey data.
year Sources: USDA, ERS Farm Balance Sheet data, http://www.ers. usda.gov/Briefing/FarmIncome/Data/Constant-dollar-table.xls
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Macquarie Agricultural Funds Management
This trend is due to the U.S. being a more mature and efficiently priced market, with better access to capital. Debt levels have been between 10 and 15 per cent 9 since the 1990s, and there is a high participation of absentee owners, currently estimated to be 29 to 40 per cent of all farm land 10. Leverage on farmland in Brazil is lower, as credit is generally more difficult to obtain. There is a higher proportion of owner/operators and with the more recent development of arable land over the last 40 years it is a relatively less mature farm land maket. These factors culminate in a less efficient market and in a greater investment return opportunity11.
Estimation of World soybean production 90% 80% ROW
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U.S crop land investors at risk of overpaying Gavin Maguire- Reuters, 23 August 2011
Conclusion
100%
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“For those willing to stomach that risk and take into account the productivity potential evident in areas such as South America, their investment dollars will likely go further there than within the U.S.”
Source: International Food and Agribusiness Management Review Volume 12, Issue , 2009, “World Soybean Production: Area Harvested, Yield, and Long-Term Projections” (Tadayoshi Masudaa and Peter D. Goldsmith)
Land prices – farmland in the U.S. is three to four times more costly than in Brazil The critical question is whether with similar yields and marginal differences in input and transportation costs, the price multiple of 3.4 is justified. Further, an analysis of relative returns shows that in Mato Grosso, one of the most distant soybean production areas in Brazil, returns are more attractive than those generated in Illinois. Given the potential upside in Brazil from improvements in transport infrastructure and the downside in U.S. farm values from changes to farm subsidies and rising interest rates, the prospects for generating investment returns from Brazilian farmland are compelling.
The UN’s Food and Agriculture Organisation have projected strong growth in Brazilian soybean production, estimating that Brazil will produce 27 per cent of global production by 2020.
1 2 3 4 5 6 7 8 9 10 11
USDA, Foreign Agriculture Service, 2012 USDA, FAS March 2012. http://www.fas.usda.gov/info/iatr/030612_Brazil/default.asp Ministry of Finance, PAC 2 Report, June 2011. www.vale.com 2012. USDA, FAS January 2012. http://www.fas.usda.gov/info/IATR/012412_Brazil/012412_Brazil.pdf USDA, FAS, March 2012 USDA Soybean production cost data, 2011 USDA, FAS, March 2012 Brian Briggeman, Federal Reserve of Bank of Kansas City, 2011 USDA, ERS February 2012. http://www.ers.usda.gov/Publications/EIB92/EIB92.pdf Brian Briggeman, Federal Reserve of Bank of Kansas City, 2011USDA, ERS February 2012. http://www.ers.usda.gov/Publications/EIB92/EIB92.pdf
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Macquarie Agricultural Funds Management
The role of agricultural investment in uncertain times
One of the most revealing market movements of 2011 was the reaction to Standard & Poor’s downgrade of the United States’ sovereign credit rating. Instead of it becoming more expensive to insure against U.S. default, after the downgrade the cost of doing so actually fell. This reaction is not as perverse as it initially seems, when you consider what investors were seeking in times of uncertainty:
An increasingly limited toolbox
• Secure Income – setting aside the machinations of the current political environment, the ‘Full Faith and Credit’ in the U.S. Government is backed by the world’s richest economy, rule of law and ability to tax the population to meet its obligations.
Less effective diversification
• Liquidity – the status of the U.S. Dollar, as the global reserve currency, means it is the most deeply liquid and easily exchangeable. At times of stress, you know that you’ll have less trouble exchanging it than almost anything else.
• Looking deeper, we can see that the diversification of equity markets has eroded and has been doing so for some time. Chart 1 shows the diversification ratio for the Australian equity market.2 While volatile, this measure has been in decline over the past decade, a similar path to global equity markets. This illustrates a decline in the number of independent risk factors offered by a broad equity index.
This was just one moment in an eventful few years, which have posed new challenges to investors. While securing income and liquidity are important, they are insufficient to address one of the key risks facing investors today: equity market risk, which now dominates portfolios to a greater degree than many expected. To solve this problem, we refocus our search for diversifying investments, and we find agricultural investments to be amongst those worth considering.
Over the past decade the diversification offered by traditional investments, and even many alternative assets, has either declined, or been revealed as illusory. This has reduced the set of diversifiers available to portfolio managers.
The phrase ‘risk-on, risk-off’ provided useful shorthand for the volatile and undiversified behaviour of markets. In a sign that the concept has ‘made it’ in the investing world, a pair of risk-on / risk-off ETFs were launched in 20111.
• More broadly than equities, we see a rise in crosscorrelation amongst all asset classes (Chart 2).
Spurious diversification • Even amongst alternative asset classes, claims of diversification have turned out to be limited at best. Chart 3 looks at the performance of a broad hedge fund index in equity market crises, exhibiting more negative ‘crisis-alpha’ than many would have liked.
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Macquarie Agricultural Funds Management
These conditions make portfolio construction more challenging and the search for truly uncorrelated investments even more important. 3
2. Cross-Correlation is Up
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3. Crisis Correlation
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1. Index Diversification is Down
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100 Global Equities
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We calculated the Diversification Ratio for the Australian equity market index (S&P/ASX 200). This is a ratio of the weighted average volatility of index constituents (individual securities) divided by the volatility of the index.
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Property (listed) Private Equity Equity Hedge Funds ABS return
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We took all major asset class indices, both traditional and alternative, and measured their correlation over rolling four-year periods, starting in the late ’90s. We summarised this extensive dataset by taking the average of all cross correlations.
4. Risk dominance of equities across portfolio allocations 6
15%
2007
EM Equity International Equity
Sep 97 Apr 98 Nov 98 Jun 99 Jan 00 Aug 00 Mar 01 Oct 01 May 02 Jul 03 Feb 04 Sep 04 Apr 05 Nov 05 Jun 07 Mar 08 Oct 08 May 09 Dec 09 Jul 10 Feb 11
2002
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We took a hedge fund index and compared its performance in equity crises (largest 10 draw-downs) to the hypothetical performance had the index sat out the crisis in cash (dotted line). The ‘crisis alpha’ was -5%pa.
Equity risk is at the heart of the problem The impact of recent market volatility on portfolio values surprised many investors. Even those employing advanced diversification discovered an uncomfortably high level of connectedness to the equity markets (Chart 4, portfolio C). This highlights a key problem facing many investors today: equity risk dominates their portfolio. By focussing on equity risk we can approach a solution. Looking at various asset classes through the lens of equity market beta is revealing. • Chart 5 shows 10 year returns of major asset classes in relation to equity market beta (S&P500). • Chart 6 expands on this analysis for hedge funds to reveal the evolving nature of equity beta (red). While the build-up of returns explained by equity markets over the early to mid 2000’s may have gone unnoticed, the financial crisis provided painful clarity on its pitfalls.
Equity 0%
A
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Macquarie Agricultural Funds Management
5.16% Long term returns vs. equity market beta 7
6. Beta De-composition: Fund of hedge funds 8
14%
HF Long-Shot
Dow Jones-UBS Commodity Index Equities (World)
1.50
Equity Market Beta
2012
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1.25
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1.00
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Period Ending
To reduce a portfolio’s exposure to equity beta, selecting assets with return sources independent from equity markets is recommended. One such asset is agriculture.
The diversifying properties of agriculture Applying the equity beta analysis to farmland in Australia, the U.S. and Brazil reveals an asset with little to do with the broader equity market (chart 7). Conducting deeper analysis on Brazilian agricultural land, as we did with hedge funds, shows the persistently low equity beta component of its total return (chart 8).
Why is this? Income: agricultural assets produce products with inelastic demand curves, an especially valuable characteristic in times of inflation. Therefore, the income produced has a low correlation to income from assets such as bonds and equities. Bhardwaj and Dunsby 9 have analysed commodity prices going back to the 1970s under a variety of market conditions, finding that grains are relatively insensitive to the state of the economy. This makes sense when you consider their role in delivering the most basic of human needs − food. Conversely, commodities at a different stage of the economic cycle, such as industrial metals, were found to be highly sensitive to the state of the economy, earning poor returns during recessions and good returns during expansions.
Land price appreciation: several long-term global trends have influenced the significant appreciation in agricultural land values. Some of these include: the declining stock of arable land; rising demand for agriculture commodities driven by factors like the growing emerging market middle class, largely moving to cities and demanding processed food and food higher in protein; and new sources of demand from biofuels and other industrial uses. Liquidity: the liquidity profile of an investment is an important consideration. Relatively illiquid assets have the benefit of being less volatile than liquid equivalents. Another perspective on liquidity is to look at how readily the asset’s output can be sold. Food and its inputs have a growing global market with relatively inelastic demand. Put simply, this is the last purchase people cut back on.
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Macquarie Agricultural Funds Management
7. 16% Long term returns vs. equity market beta 10
8. Beta De-composition: Brazil Agricultural Land 11 30%
14%
15%
Agricultural Land (US)
Property (US Listed)
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-5% -10% -15%
Equities (US) 0.00
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-20%
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2011
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5%
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Equities (Global Agri)
2007
Agricultural Land (Aust)
2006
10%
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4 year return (%pa)
10 year returns (%pa)
12%
Agricultural Land (Brazil)
Period Ending
To learn the lessons of recent times requires more than the further employment of traditional diversification techniques. A clear analysis of how much equity risk a portfolio actually carries can appropriately specify the problem. The identification of low-equity beta assets such as agriculture will help re-stock the tool-kit of portfolio construction. Armed with truly diversifying assets, investors have the opportunity to prepare their portfolios for times of further uncertainty. Author – James Freeman, CFA
1 2
“UBS Launches “Risk On” And “Risk Off” ETNs Covering Variety of Assets”, Dow Jones Newswires, 01/12/2011. Macquarie analysis, data source: ASX200 via Bloomberg. Diversification Ratio was developed by Choueifaty, “Methods and Systems for Providing an Anti-Benchmark Portfolio, May 2006, USPTO. Global analysis of the diversification ratio source: “The Most Diversified Portfolio”, TOBAM, All About Alpha, 27 March 2011. 3, 4 Analysis: Macquarie, March 2012. Data: Bloomberg, Feb 2012. 5 Analysis: Macquarie, March 2012. Data: Equity market (MSCI World), Fund of hedge funds (Barclay Fund of Funds Index). 6, 7 Analysis: Macquarie, March 2012. Data: Bloomberg, Feb 2012. 8 Analysis: Macquarie, March 2012. Data: Equity market (S&P500), Fund of hedge funds (Barclay Fund of Funds Index). 9 Geetesh Bhardwaj and Adam Dunsby, “How many commodity sectors are there, and how do they behave?”, SummerHaven Investment Management, 16/12/2011. 10 Analysis: Macquarie, March 2012. Brazilian agricultural land (AgraFNP), U.S.agricultural land (USDA Economic Research Service), Australian agricultural land (ABARES), Global equities (MSCI World Equity Index), U.S. Equities (S&P 500), U.S. listed property (FTSE NAREIT All REITS Index). 11 Analysis: Macquarie, March 2012. Data: Equity market (S&P500), Brazilian agricultural land (AgraFNP). 12
Food for thought
Macquarie Agricultural Funds Management
Global agriculture’s super trend: Soybean exports to China
While there is broad recognition that population growth has increased demand for agricultural products, one trend has been an aggressive agent for change in the global agricultural goods market: the rapid growth in protein consumption in emerging markets. Nowhere is this “super trend” more pronounced than in China. 1
The story of China’s rise has been well told; an urbanizing population that is enjoying higher incomes and a corresponding appetite for more nourishing, higher-protein food. However, a confluence of factors has sent this trend rippling all the way to the interior of Brazil. Here, we examine these contributors and look at why this trend represents a major secular shift in diets in China and beyond.
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Food for thought
Macquarie Agricultural Funds Management
The Strategic Pork Reserve Pork is the primary animal protein constituting over 70 per cent of meat consumption and price stability is a priority for Beijing. So when there’s a major disruption in the pork supply it hits the economy hard. In 2008 in response to the “blue-ear disease” outbreak, which cut supply and high feed prices that drove up costs, the Chinese government established a strategic pork reserve, to be ready during times of shortage and was the first of its type.
50% % Global Glob Gl ball C G Co on o nsumption nsum n s mpti ption ion 51.5 .5 M .5 Mi Mil Million Millio illi iill lli lio li io on nm met etric e etri et trric ic c tto tons ons on n 500 5 50 00 0 0M Mi Mil Millio illio il lllio lli lio io on np pig pi pigs ig gs g s
Foreign Policy, June 2011. Chinese Monthly Miniumum Wage by Region
Source: China Association, March 2011 Source: ceAnimal ChinaAgriculture Animal Ani Agriculture Association,
March 2011
From the factory floors of China to the fields of Brazil The twelfth Five-Year Plan of the Communist Party of China (2011-2015)2 carries important implications for agriculture around the world. Amongst the Plan’s key themes are “ameliorating social inequality”. This focus on addressing income equality in this and previous plans has far-reaching consequences for food demand 3. Firstly, the “rising tide” of income will stimulate demand from the bottom-third of wage earners for staples such as cereals and pork. At this end of the wage spectrum, demand elasticity for pork is 0.151, so as income increases there is strongly correlated demand for pork 4. Higher wage earners diversify their meat consumption and have spiked demand for poultry and beef at 4 per cent each year of the last decade 5.
Source: Compiled government data in APCO Worldwide, 2011.
Other principles and targets of the Five-Year Plan will shape this demand, including mandates like “increasing farm size and production efficiency in pig production and encouraging higher-efficiency poultry and dairy production” 6 – all of which flow through to increased demand for imported soybeans. Pork production driving demand for soybean meal Long before Chairman Mao embarked on the first FiveYear Plan, there was a culture of eating pork in China dating back 10,000 years. While other meat types such as poultry and beef are growing in both total and per capita consumption, pork still accounts for approximately 50 per cent of all meat eaten in China7. 14
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Macquarie Agricultural Funds Management
Demand for beef and chicken is driven by rising incomes at the middle and top third of the wage spectrum. During the next decade, annual consumption growth is expected to track 7.5 per cent and 5.2 per cent respectively 8. As Government policy and market-based factors impact the economics of farming in China, the adoption of intensive livestock production systems is driving demand for high-protein feed ingredients, which in turn creates a heavy dependence on imports of soy. Why has this trend been so pronounced in China? While not isolated to China, the super trend of a growing reliance on soybeans from the Americas has emerged because of a confluence of economic, cultural and agricultural factors: • Pork and chicken are traditional foods for the Chinese. Pigs were domesticated in China some 10,000 years ago, and for millennia, virtually every rural household in China raised at least one or two pigs each year. • Whereas grazing animals such as sheep, goats and cattle require large amounts of land, pigs and chickens are omnivores that eat feed with a concentration of nutrients. This makes it practical to raise them alongside high-density populations. • Income growth distribution has driven demand for pork as a protein staple. Government-enforced minimum wages have helped distribute the nation’s wealth. As the wages of more workers at the bottom end of the income spectrum have increased, so too has the demand for more nourishing foods like meat and dairy products. The tide of income amongst the working class is rising and it is lifting the demand for meat products with it.
Soybeans are the ideal feed for pigs and chickens The diets of pigs and chickens require mostly energy and protein. The energy component is met by a range of highly-substitutable grains such as rice, wheat or corn, depending on their respective price. The protein component is more reliant on the nutritional quality of the ingredients. Fish meal and meat and bone meal were once the preferred source of protein for these omnivorous animals. The supply of fish meal was tightly constrained and once several fisheries collapsed it became uneconomic. The ‘mad cow’ disease 9 outbreak in Europe precipitated restrictions on the use of meat and bone meal since 2000 in the E.U. and in other jurisdictions. The solution to the shortfall was to specially prepare soybeans to enable better digestion by these animals. With the oil removed, the remaining oilcake contains a combination of amino acids essential for growth in a more suitable combination than any other plantbased feedstock10. The emergence of industrially produced soybean meal resulted in a lower-cost protein source in the feed rations of pigs and chickens, enabling widespread low-cost production. The soybean supply dilemma for China Around the turn of the last century, China was hovering around self-sufficiency for soybean consumption and had import restrictions in place to protect local producers. In order to overcome domestic shortages, authorities enacted a series of measures to liberalize China’s soy trade, including those required by World Trade Organization (WTO) accession protocols, starting in the early 1990s.
Source: Why China Has a Top-Secret “Strategic Pork Reserve” Spencer, 2011.
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Macquarie Agricultural Funds Management
Soybean and soy meal imports and production - consumption has been fuelled by imports since the mid 1990’s
Million Metric Tons
80
USDA projects imports of 56 MMT for 2012
Soybean Domestic Consumption
70 60
Soy Meal Domestic Consumption
50
Soybean Imports
40
Soy Meal Imports
30
Global Soybean Exports from Brazil
Trade liberalisation pre-WTO accession paved the way for soybean import expansion
20 10
42 944 948 950 952 954 956 961 963 965 971 973 975 977 979 981 983 985 987 989 993 995 995 997 999 001 003 005 007 009 011 1 1 1 1 1 2 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2
19
Source: USDA FASUSDA, data set March Source: FAS data2012 set, March 2012.
Imports quickly overtook production, and today, China is the world’s leading soybean importer11. In 2011, more than 50 million metric tons of soybeans came into China, mostly from the United States, Argentina and Brazil. These imported beans accounted for 82 per cent of soy consumption in China in 201112, and were used exclusively in the production of soybean meal for livestock feed and soy oil for cooking.
Chinese meat demand and income growth projections15 Million Metric Tons 160
GDP Per Capita (USD’s based year = 2000 $ 5,000
Other Sheep and Goat Beef Poultry Pig
140 120 100
$ 4,500 $ 4,000 $ 3,500 $ 3,000
80
$ 2,500 $ 2,000
60
$ 1,500
40
$ 1,000
20
An interesting feature of China’s meat demand projections is that, under a range of economic development scenarios, demand for soybean feed ingredients is likely to remain strong. With poultry and beef gaining market share with higher income per capita, there is a diversified source of demand. As a consequence the demand for imported feed protein is robust. Based on projections, per capita pork consumption in 2015 is estimated to be 48.6kg (107 lbs), according to a study from Purdue University 13. Using a predicted population figure of 1.40 billion, projected total Chinese pork demand for the year 2015 is estimated to be 68 million metric tons. This is a large increase from 2003, when pork consumption was 45 million metric tons, and a 32 per cent increase from 2010 levels14.
2030
2029
2028
2027
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
3004
2003
2002
2001
$-
2000
Super trend or major secular shift
$ 500
0
Source: FAOSTAT, World Bank WDI, and estimation by Tadayoshi Masuda and Peter D. Goldsmith (2010).
Most of this growth has been met by a rapid rise in soybean acres in Brazil and Argentina, where production has increased by more than 70 per cent during the last decade16.
“While China is limited to 140 million hectares of agricultural cultivation, Brazil is using 80 million hectares now, has another 200 million hectares of pasture for cattle, and can insert another 140 million hectares into production without encroaching on ecologically protected areas.” Charles Tang, President of the Brazil-China Chamber of Commerce, 2011
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Global Soybean Exports
Global Soybean Imports Million Meter Tons
Million Meter Tons 140
140
Other Brazil
120 100 80
Argentina Other South America
60
United States
N. Africa & Middle East Latin America 1/
80
East Asia
60 40
20
20 1995
Other
100
40 0 1990
China
120
2000
2005
2010
2015
2020
EU 2/
0 1990
1995
1/ Includes Mexico.
2000
2005
2010
2015
2020
2/ Excludes intra-EU trade
Source: USDA Projections to 2021, February 2012
Increased reliance on corn
Conclusion
The combination of strong growth in consumption, reduced stock levels and production problems forced China to import significant quantities of corn in the 2009/10 crop year — the first time since 1996. To meet immediate needs, the shift to higher imports has continued, forecast this year to top 13 million tons 17. The inability for yields to rise in pace with consumption is expected to put continued strain on corn reserves as well as production in coming years. Similar to the significant growth in soybean imports that started more than a decade ago, a trend is emerging as China moves from a net corn exporter to an importer in the years ahead.
With the greatest scope for both land area expansion and yield growth amongst the top three producers, Brazil is well placed to increase its share of soybean exports to China. With a record 19.8 million metric tons in 201118, which is forecast to increase further, there is a growing reliance in China on Brazilian soybeans.
Other 10% Brazil 35%
Argentina 21%
12
11
Source: USDA, FAS March 2012. (2012 Forecast from INTL FCStone Inc)
20
10
20
09
20
08
20
20
07
06
20
05
20
20
04
03
20
20
02
01
20
00
USA 34% 20
19
99
Million Metric Tons
20
14 12 10 8 6 4 2
Chinese Soybean import market share 2011
Source: USDA Foreign Agricultural Service, March 2012
1 USDA, Foreign Agriculture Service, January and March 2012 and Economic Research Service, March 2012. MMT is Million Metric Tonnes. 2, 3 APCO Worldwide, December 2010: China’s 12th Five-Year Plan 4, 8 FAOSTAT, World Bank WDI, and estimation by Tadayoshi Masuda and Peter D. Goldsmith, 2010. 5, 7 USDA, Foreign Agricultural Service (FAS) 2011. 6 China Animal Agriculture Association, March 2011. 9 Or Bovine spongiform encephalopathy (BSE). 10 OIT Agriculture Plant/Crop-Based Renewable Resources 2020 11 USDA Long-term Projections, February 2011-2012 12 USDA, FAS 2011 13 Purdue, 2009. http://www.ces.purdue.edu/extmedia/EC/EC-758.pdf 14 www.meatpoultry.com 15 Forecasts from 2009 16 Source: USDA, Major Foreign Soybean Exporters and Importers, March 31, 2011 “http://www.ers.usda.gov/Briefing/Soybeansoilcrops/trade.htm#foreign?” 17 INTL FCStone Inc 18 China Daily – Asia Pacific, March 2012
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Macquarie Agricultural Funds Management (MAFM) recently launched a website, designed to be a single source of information that offers material on the agricultural thematic as well as the business itself. The website contains a number of features including: • End of day agricultural commodity prices • Links to relevant news articles • White papers • Insights from the MAFM management team and agricultural specialists • The MAFM Food for Thought newsletter To find out more, or to download a copy of previous editions of food for thought visit macquarie.com/mafm
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