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Friday, Nov. 28, 2014

The CommStock Report

Friday, January 4, 2013

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I read a simple fact in a farm magazine recently that I will go with: "Good times don't last forever."

Most of us with any grey hair in our beards remember the 1970s and 1980s. We couldn't see the end to the inflationary spiral in the 1970s that had us ordering new tractors because if we needed one the price would be much higher when it was delivered to the dealer. There were too few dollars, so we borrowed more, chasing too few goods relative to demand. It ended when then Fed Chairman Paul Volker made credit prohibitively expensive, shutting off the leverage. Those good times ended, if that is what you called them.

Then came the ag depression of the 1980s and the deflation that crushed farm economics. When U.S. consumers got over-leveraged in the recent housing crisis, at least the Fed didn't run interest rates up to 18 percent like they did in the early '80s, which precipitated the farm crisis. They dropped them, attempting to let overleveraged home owners off easy.

The U.S. dollar soared to such heights that U.S. ag products became prohibitively expensive to foreign buyers. Along about 1985 there were many farmers who sold out in order "to get a real job" as it got its blackest with the outlook as bleak and hopeless as it had ever been for farming. I was told at the time by a few wise men that it would get as good as it was bad then, but I could only half believe it, as things were so darn bad.

Life since has proven that bad times don't last forever. But as the farm article said, "Good times don't last" either. We have seen more wealth creation in the past few years than was seen in the previous 50. In terms of land prices it looks like it is never going to stop. Each new auction is bringing $500-$1,000 acre more than the last but we know that it will stop. I don't believe that we are seeing the leveraged bubble that we had in the 1970s, but it will rain someday and the drought will end, and we will bury end-users in corn and net farm incomes will plummet. The bull in farmland values will trip and slide to a stop. Or the U.S. economy will come up off its floor, interest rates will rise because there is demand for money again and the dollar will rise with them.

Low interest rates and a weak dollar are the cornerstones of a strong U.S. ag economy. High interest rates and a strong dollar kill us. These are good times in agriculture. Farmers made money. Crop insurance saved farm economics from the drought. Farmers invested in their operations. John Deere is doing so well even Warren Buffet bought Deere stock. They paid cash for a lot of it but not all of it as money is cheap. Cash rents, which lagged the initial farm revenue gains, have now caught up, enriching the landlords too. Land prices have gone up so fast so much that owner equity ratios have improved from less leverage instead of declined as in the 1980s as more debt than equity was added.

If it is a bubble it is a different kind of bubble. What collapsed farm land values in the 1980s was similar to is the housing bubble. When values fell, equity disappeared and the ability to service the debt with plunging farm incomes collapsed the house of cards, forcing land on the market in distressed sales worsening prices creating a downward spiral as the ag economy imploded. That is just not going to happen this time.

That doesn't mean that they can't pay too much for land. The underlying revenue still has to support it. There are some scenarios that suggest peak earnings for this cycle have been seen. Would there have been a housing crisis if all the buyers had started with 60 percent equity in their homes like most farms being purchased today?

There is the potential trouble that I see with the 2013 corn balance sheet. USDA now says that corn demand has been shrunk down to 11.167 billion bushels.

We will likely plant close to 100 million acres, so deduct from that to 92 million harvested acres and multiply times ISU Climatologist Elwynn Taylor's 147 bpa forecast yield and you get a 13.524 billion bushel crop. The trend-line yield is 160 bpa which would be a 14.72 billion bushel crop.

In other words, because of shrunken demand you can have a crop failure next year and still balloon the carryover and bury the price. Frankly, it is going to have to rain on my farms quite a lot until I have even 147 bpa yield potential. It would not be impossible for farmers to harvest 147 bpa, which here they would consider to be a crop failure and still only get $4 bushel for it because of huge planted acreage.

I think that may have been what that farm magazine was talking about when they wrote that "Good times don't last."

David Kruse is president of CommStock Investments, Inc. author and producer of The CommStock Report, an ag commentary and market analysis available daily by radio and by subscription on DTN/FarmDayta and the Internet. CommStock Investments is a registered CTA, as well as an introducing brokerage.



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