Africa’s Agricultural Outlook
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.
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.
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.
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.