Of Crops and Cash: A Primer on Agricultural Markets
Among the far-reaching effects of the ongoing Russo-Ukrainian War is a famine in Ethiopia, Kenya, and Somalia. Because Ukraine and Russia are both major exporters of grain–and the latter an exporter of fertilizer–the disruption of the war has decreased the world supply of grain, causing food prices to drastically increase. In rich countries, this production decrease has meant higher prices in an already inflationary economy; in less wealthy countries, the effects have been catastrophic. These famines are but one example of the critical role food has played and continues to play in the world economy. So how does it work, and how can you invest in it?
The official definition of agriculture is the practice of farming crops and livestock, as well as related steps like preparing soil and selling the products. It’s probably no surprise that agricultural concerns have been with us for a long time. The first economic revolution was based on agriculture; domesticating plants and animals led to enough increases in productivity for settled communities to form. European colonization in the fifteenth and sixteenth century was driven in large part by the demand for spices and sugar. Food production concerns were the center of Thomas Malthus’ concerns on excessive population growth. Advancements in agricultural technology helped humanity to break out of this Malthusian Trap, in which increases in the food supply prompt unsustainable population growth. Today, although the sector only accounts for 4.3% of global gross domestic product (GDP), agriculture still plays an important role in the world economy, as the crisis in Ukraine has so painfully proven.
Theoretically, agricultural markets function according to what economists call perfect competition. There is no product differentiation, for one; since agricultural goods are fungible–treated the same no matter which entity produces them–they fall under a category of goods known as commodities. Perfect competition also has many buyers and sellers and every purchase is at a collectively determined market price. No one person has the power to change the price, and anyone who wants to sell in the market can.
The world market for agricultural goods today looks somewhat different from perfect competition, with a few large companies dominating the scene. Still, no other markets quite embody the principles of supply and demand as purely as agricultural markets do. Prices of agricultural goods are often volatile; the price of corn, for example, fluctuated from $8.10 to $4.98 between August 2012 and August 2013. The reason for this is that agricultural markets, like other commodity markets, respond quickly to changes in supply and demand. A drought destroying this year’s crop, such as that which hit Midwestern corn producers in 2012, would decrease supply and quickly send prices spiraling upward. Consumer preferences are also fickle, and demand for an agricultural good can also shift rapidly.
Volatile corn prices
On the horizon, several long-term issues and opportunities confront the agriculture industry. With climate change in the national discourse and other social justice causes taking root, consumer demand is likely to continue playing a significant role, as demand for eco-friendliness and healthier food increases. This intersects with another issue in the agriculture industry, especially pronounced in wealthy countries: farm subsidies. In the United States, these subsidies primarily come through a farm bill renewed about every five years. They take a variety of forms such as crop insurance and subsidies for conservation and enjoy bipartisan support. Critics claim that most of this money is accrued by large, well-off farms, and that subsidies encourage environmental degradation and the production of unhealthy crops. As climate change and corporate social responsibility continue to loom larger over the industry, issues such as these will likely fall under ever greater scrutiny by producers and consumers alike. And of course, one cannot fail to ignore the increasing resource costs that climate change and more frequent severe weather events will inflict upon the industry.
There is, however, a significant growth opportunity for agriculture in the application of new technology. With increased connectivity through 5G, WiFi 6, and the Internet of Things (IoT), farmers can more effectively monitor the productivity of crops and livestock, apply fertilizers with more precision, and prevent disease outbreaks among herds and crops. Drone farming with machines like the Yamaha RMAX has been on the rise in the agriculture industry and has already provided benefits in more precise crop dusting and spraying, lower health risks for employees, and ultimately substantial cost savings. The integration of ever more new technologies into the industry will undoubtedly have similar effects.
The prospective investor in the agriculture industry is thus not short of choices. For one, you can invest in the stock of an agricultural company. Because of the many intermediate steps needed to produce a crop, you do not necessarily need to invest in a company that produces agricultural goods. For example, one could buy stocks in Deere and Company, which makes agricultural machinery, or agritech companies integrating new technologies into agriculture. Additionally, one can invest in agricultural goods themselves with options, a strategy which is especially useful in periods of high inflation; during these times, commodity prices tend to rise even more quickly. An optimistic investor might use a call option, giving themselves the right to buy a quantity of a good at a certain price, while a pessimistic investor would opt for a put option to sell a certain amount of the good at a set price.
As long as there are mouths to feed, agriculture will remain an essential part of the world economy, and as the war in Ukraine has shown, understanding the condition and workings of the industry are important to sustain it for future generations. Our food, brought to our plates by a complex web of economic interactions, should never be taken for granted.