Is Ag Headed for a Soft Landing?

Is Ag Headed for a Soft Landing?

Despite margin compression, farmers appear set to weather economic storm

Farm booms always end. It's how they end that’s important.

That bit of wisdom comes from Brent Gloy, a Purdue Ag economist who recently returned to his family's farm operation in Nebraska.

It certainly appears this boom is ending, and it's not just due to lower commodity prices. We're still waiting to hear if the Renewable Fuels Standard will be upheld; even if it is, there's not much upside demand potential in biofuels right now. We also have a stubbornly sluggish world economy highlighted by fears of a real estate bubble crashing down on the newly minted middle class in China.

Source: Purdue University

What causes booms to end badly? A dramatic reduction in demand, such as the kind we had in the '80s, is one factor. Fortunately today, exports are steaming along, despite Russia's attempt to slap western wrists over sanctions. Interest rates won't zoom to the levels they did in 1984, even though we know they are going up.

Another way booms end badly is an over-response on the supply side. Millions of acres of crops have been planted worldwide as a response to higher prices. But, with any cycle, low prices cure low prices just as high prices cure high prices. Some of that land will switch to other uses.

In the short run two things could make things really ugly this winter: a transportation collapse and cash rents. Cash rents rarely adjust down when grain prices collapse. I recall talking to a Nebraska landowner at the 2014 Commodity Classic. Was he going to cut cash rent rates as grain prices were dropping? "That's not my problem," was his response.

Meanwhile farmers in some parts of the country with little on-farm storage lost millions due to railcar shortages last year. With a big crop coming that problem may get worse before it gets better. Make sure you have a home for your grain.

Avoiding a bubble

Over the past 12 years of steep land value increases, the major fundamental drivers were high commodity prices, low interest rates, and limited sales relative to demand. However, in 2014, key indicators are signaling that the long-term growth pattern needs to change, or risk the development of an asset bubble by extending the value/cost of land beyond its economic capacity to generate returns.

In a recent report, Rabobank concluded that land values, on average, have responded to fundamental drivers and are not currently the result of an asset bubble. However, with the prospects for increasing interest rates and falling commodity prices, an adjustment is needed beginning in 2014/15 to avoid the future development of an asset bubble.

Where does this all leave farmers? Most of them are well capitalized and could weather a rough landing if needed. But, you'd be wise to sharpen your risk management skills.

"Marketing is going to garner a greater degree of attention now with the prospects of $3.50 corn," says Jerry Lehnertz, vice president of lending at AgriBank, which provides financial resources for 17 of the nation’s Midwest Farm Credit Service associations.

Lehnertz, too, expects Ag to have a soft landing following the recent boom.

"Farmers are less idealistic today than they were in the late 70s, but also back then we had double digit inflation and double digit interest rates," he notes. "We anticipated that commodity prices were going to stay high, but it was just not sustainable.

"Today we see a moderation in land values and debt-to-asset ratios in the Midwest, but not a freefall," he adds. "In our district we just completed an update of benchmark farms and we're seeing modest declines, but there's still a lot of strength in farmer balance sheets."

In the late 70s farmers aggressively purchased land and equipment with debt capital using inflated assets as collateral. Today a lot of farmers are buying with cash.

Another positive is the new farm bill. For some farms payments could provide support at rates approaching $90 per acre, says Gloy.

It provides a robust crop insurance program that protects not only yield but also revenue, Lehnertz notes.

"That means the grain side should be pretty stable, and we now have strong profitability in livestock as well," he says. "Swine has some additional problems resulting from PEDv and beef has some hangover to work through but in all, these segments remain very strong. We are expecting an uptick in interest rates at some point, but not to the extent we saw in the '80s."

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