AGRI­CUL­TURE

Africa’s Agri­cul­tural Out­look

Africa Outlook - - Contents - Writ­ten by: Gary Vaughan-Smith, Chief In­vest­ment Of­fi­cer, Sil­verStreet Cap­i­tal LLP

Sil­verStreet Cap­i­tal shares its con­ti­nen­tal farm­ing fore­cast

Conditions in the first half of 2018 are set­ting up for very in­ter­est­ing in­vest­ment opportunities in the agri­cul­tural sec­tor and these opportunities look un­cor­re­lated to the world’s ma­jor eq­uity and bond in­dices.

At their lows

Agri­cul­tural com­modi­ties are gen­er­ally down around 40 per­cent from their 2012 peaks and have demon­strated their lack of cor­re­la­tion with eq­uity and bond mar­kets, both of which were in the throes of a bull mar­ket un­til Fe­bru­ary of this year.

Com­modi­ties in gen­eral are at the bot­tom end of their ranges as il­lus­trated in this chart which shows the cur­rent lev­els (the di­a­monds) com­pared to the long-term ranges for the key com­modi­ties. The chart il­lus­trates the ex­tremely low lev­els of agri­cul­tural com­modi­ties rel­a­tive to their his­to­ries.

These his­toric lev­els are im­por­tant be­cause pro­duc­ing food has a cost per tonne and if the price drops enough then more and more pro­duc­tion is taken off­line and hectares are planted into other crops. The price will not go to zero and ul­ti­mately reach a floor.

The ‘dou­ble La Nina’ anom­aly

An un­usual weather anom­aly com­bines to make this a piv­otal point in time for agri­cul­tural com­modi­ties. The anom­aly is that we have just fin­ished two back-to-back La Nina’s over the North­ern Hemi­sphere winter. This has only oc­curred 10 times in the past 100 years and the ev­i­dence sug­gests that the sec­ond La Nina is more in­tense than the first lead­ing to more ex­treme ver­sions of La Nina weather.

The key im­pact is in the US Mid­west where the US is a ma­jor pro­ducer of grains and soya. The Mid­west ex­pe­ri­ences dry weather in a La Nina and this is ex­ag­ger­ated in a dou­ble La Nina as we are now see­ing un­fold. Ma­jor mul­ti­year ral­lies in grains and soya prices seem to often orig­i­nate in a dou­ble-La Nina pe­riod or where a sin­gle La Nina is very strong: five of the past six strong ral­lies since 1970 seem to be re­lated to this weather fea­ture. Com­bine that with the cur­rent low com­mod­ity prices and the risk/re­ward looks very in­ter­est­ing.

Im­pli­ca­tions in Africa

West Africa typ­i­cally ex­pe­ri­ences low rain­fall in La Ni­nas and we are see­ing this re­flected in the pow­er­ful rally in co­coa prices, now up around 40 per­cent since the lows in Jan­uary.

South­ern Africa tends to re­ceive higher rain­fall in La Nina years which will be a wel­come change in many ar­eas. We have seen strong rains in South­ern Zam­bia and Botswana for ex­am­ple in the lat­est rainy sea­son. This leads to the in­ter­est­ing sit­u­a­tion where farm­ers in South­ern Africa can pro­duce ex­cel­lent crops of grains and soya in these La Nina years just when world short­ages emerge and prices rise. Given that much of the maize is grown by small­holder farm­ers we should hope­fully see im­proved prof­its on these farms where ad­di­tional in­come can have a ma­jor, pos­i­tive so­cial im­pact.

The lag­gards

There are crops that have fallen sub­stan­tially this year and these price anom­alies can also be ex­plained by La Nina. Any crops grown on scale in South­ern Asia tend to see higher har­vests in La Ni­nas be­cause of higher rain­fall. The key ones typ­i­cally im­pacted are sugar (down 30 per­cent in the past year) which is pro­duced to large scales in In­dia, and ro­busta cof­fee which ex­pe­ri­ences sim­i­lar pro­duc­tion lev­els in Viet­nam.

Sugar is worth a spe­cial men­tion be­cause its price is 11.5c/pound at the time of writ­ing ver­sus a long-term range of 10.5c to 36c.

Most sugar pro­duc­ers will strug­gle to make a profit un­der 15c/pound. In­dia has huge sur­pluses and has started to ex­port sugar, in­creas­ing in­ven­to­ries and putting pres­sure on the sugar price.The EU is ramp­ing up sugar pro­duc­tion fol­low­ing the lift­ing of quotas in Septem­ber last year.

Ethanol op­tions

Brazil is the largest pro­ducer of sugar and its re­finer­ies are set up to pro­duce ethanol from sugar as well as for nor­mal food pro­duc­tion. These re­finer­ies can tilt one way or an­other and have been in­creas­ingly switch­ing pro­duc­tion from sugar to ethanol this year. The ethanol price is linked di­rectly to the oil price which has been strong this year and is now around $75/bar­rel. The ethanol ‘equiv­a­lent’ price is around 17-18c/pound so there is a big gain for the re­finer­ies to switch as much pro­duc­tion to ethanol as is fea­si­ble. This should lead to a bot­tom­ing process for the sugar price over the next few months.

Sugar is pro­duced across Eastern and South­ern Africa and is a big em­ployer. In South Africa for ex­am­ple, some 250,000 peo­ple are said to be em­ployed di­rectlly or in­di­rectly be­cause of sugar pro­duc­tion. We are ex­pect­ing the South African Govern­ment to in­crease tar­iffs on sugar to help pro­tect the in­dus­try this year and next. A bot­tom­ing and rally in the sugar price over the next cou­ple of years would ben­e­fit prof­its and the em­ploy­ment of a large num­ber of peo­ple; and would be a wel­come bonus for the in­dus­try in Africa.

Con­clu­sions

In sum­mary, agri­cul­tural mar­kets rep­re­sent an in­ter­est­ing and im­me­di­ate in­vest­ment op­por­tu­nity and, an un­cor­re­lated al­ter­na­tive to the main as­set classes, now look­ing in­creas­ingly vul­ner­a­ble.

Agri­cul­tural com­mod­ity prices are close to their long-term lows and the ‘dou­ble La Nina’ weather anom­aly could lead to up­sides for crops grown in the US Mid­west such as grains, cot­ton and soya plus those grown in West Africa, like co­coa.

It is in­ter­est­ing to note that these crops are pro­duced largely by small­holder farm­ers in Africa and we should hope­fully see more money in the pock­ets of these farm­ers if this sce­nario pans out. With 60 per­cent of the pop­u­la­tion in sub-Sa­ha­ran Africa liv­ing on these small­holder farms, this will be a wel­come boost to the in­comes of this broad-based and low in­come group.

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