In 2016, German chemicals giant Bayer announced its takeover of U.S. seeds and pesticides company Monsanto in a $66 billion deal. It was the largest all-cash merger of all time, promising innovations to help farmers respond to one of the world biggest challenges: rapid population growth.
Within the next 30 years, the global population is expected to increase from 7.6 billion to 10 billion, resulting in an estimated 50% increase of the amount of food crops required and a 70% increase in the amount of meat, owing to rising middle-class incomes in emerging economies such as China and India.
Technology and a new age of precision farming are likely to hold the answer to growing demand.
Over the last decade, there have been huge advances in the way crops are produced, in seed technology and disease and pest management. From the use of the global positioning system (GPS) to map crop yields and optimize use of fuel, seeds and sprays to the masses of data now available to better manage weather patterns, nutrient levels and pests, farmers have never had more control over the land and what they grow.
Among the latest developments, manufacturers including John Deere, CNH Industrial and AGCO are competing to corner the multibillion dollar market in driverless tractors and agricultural robotics, ushering in the era of automated farming. Meanwhile scientists are exploring new ways to boost yields by enhancing the natural process of photosynthesis.
Crop yields have risen dramatically as a result. Since 2000, yields of corn have surged by 35%; wheat is up 25% and soybeans have gained 23%.
“Investments in technology have enabled crops to withstand more intense periods of heat and moisture stress, so despite the growth in consumption, we’ve basically seen supply outstripping demand in recent years,” explained Tracey Allen, agricultural commodities strategist at J.P. Morgan.
Global crop yields indexed from 2000 - (2018 yields for each crop)
Source: USDA, J.P. Morgan Commodities Research
The knock-on effect on prices has been equally dramatic. With declining supply-side risks, agricultural prices have been at historically low levels for many years. In 2012, corn, the world’s most produced grain, cost $330 per metric ton; today, the price has more than halved to $160. Over the same period, the price of wheat, which covers more of the planet than any other crop, has dropped from a high of $350 per metric ton to $200 today.
More recently, there has been some relief, said Allen. Crop prices are now rising off the lows and further hikes are expected in the months ahead after heavy rains across key growing areas of the U.S. caused unprecedented planting delays for farmers. In May, U.S. corn futures rose to their highest levels in two years.
The J.P. Morgan Agriculture and Livestock Index
Escalating trade tensions between the U.S. and China, the two largest market players in agriculture, have until recently had an overwhelmingly bearish impact on agricultural markets. In May this year, Bloomberg’s index for grain futures slumped to its lowest level since 1977 after tweets by Donald Trump threatened to further intensify the conflict.
China is the world's biggest importer of soybeans, relying heavily on the crop for its poultry and pork trade while the U.S. is the world’s largest producer. In 2018 when the trade war began, China bought $9.3 billion in agricultural products from American farmers, down from $14 billion the year before.
"China has effectively stopped buying U.S. agricultural products, so that has put a lot of pressure on prices,” commented Allen. “U.S. soybean exports, the largest agricultural commodity by import volume to China, have been the worst affected, followed by tree nuts, pork products and ethanol.”
The U.S. Department of Agriculture has since intervened to provide farmers with $28 billion in compensation for the lower prices and lost sales stemming from the disputes. The immediate future, however, does not offer much hope for an end to tensions, nor a return to normal trade flows between the agricultural juggernauts. “There has been a gradual deterioration in confidence within the agricultural sector during the intensifying US-China trade war. A trade agreement would be material for U.S. agricultural demand, however in the absence of confidence and certainty, the market is trading the fundamentals at hand.”
Affluent countries have long been tempering their sugar consumption, and switching to alternate sweeteners. In emerging market regions, however, sugar consumption is still on the rise, chiefly due to population growth and because it is a cheap source of carbohydrates. Another significant food trend is being seen in countries like China and India where rising middle-class incomes are increasing the appetite for protein. That is also having implications for the demand for vegetable proteins such as soybean and rapeseed meals to feed the livestock and aquaculture industries.
Among the less widely reported factors affecting crop prices are the structural changes that have transformed how agricultural commodities are traded. The rise of algorithmic trading and price-following strategies have changed trading patterns across agricultural markets, at times reducing the relevance of fundamental supply and demand forces, according to Allen.
Probably the most significant change has been in the market participants. Today, there are four main categories of participants in the agricultural futures market: commercial types like farmers, grain traders and food producers; the swaps dealers from financial institutions who manage large commodity positions for clients; long-term investors who hold commodities as an index-type of investment; and speculative investors like hedge funds where the money flow is fast and the horizons typically short term.
One major player is absent from this mix. Seven years ago European pension funds still held large stakes in the agriculture sector. In 2013, they withdrew their investments because of concerns that they may have been inflating food prices.
“In my view, this has accentuated the impact of price-trend followers in the market,” argued Allen. “These days there are very few long-term investors holding positions based on a specific view on the commodities.”
“With many of the dollars once invested with a long-term view on agricultural markets getting reallocated to systematic funds, prices have been pushed lower, ignoring basic production economics.”
This dislocation has become even more pronounced in the last twelve months. “When you have incidents like the U.S.-China trade war, there’s no confidence from the major market participants and prices can go into large selling spirals. It has taken Mother Nature to drag agricultural markets out of their historic slump.”
Now that crop supplies are threatened by the wet weather, fundamentals are returning as a primary driver of prices and traditional market participants have returned to express their views.
More broadly, the implications of having lower prices for the long term are difficult to gauge. While lower food prices are good news for consumers and alone do little to imperil global food security, if prices fall back again more farmers are likely to question the financial viability of their operations.
Farming incomes are already at their lowest levels for years. In the U.S., net farm income has fallen by more than half since 2013, according to the Department of Agriculture. For every dollar that consumers spend on food, the farmer receives just 14.8 cents, it said.
For farmers’ incomes at least, more positive news could be on the horizon. For two main reasons, according to Allen.
The first is that while technology will enable farmers to answer the population-fueled growth in demand for food crops, the pace of productivity gains are set to slow – the yield gains from science and technology will ultimately reach a tipping point.
Probably the most important factor in the future of global food security, however, is climate change, as a recent J.P. Morgan research report highlighted. “The decade-long bear market on technology-driven gains in yields is not fully over, but over time it will be reversed by worsening water scarcity. Food security will still be fine, but there will be more climate-related shifts and they will become more noticeable,” commented Allen.
More extreme weather events like heatwaves, hurricanes or floods will create a supply-side shock, leading to crop shortfalls and putting upward pressure on food prices.
As the planet heats up, there is likely to be a geographical shift in the main centers of crop production with regions closer to the North and South Pole likely to see increased activity and improved agricultural yields. In the Northern hemisphere, countries and regions like Russia, Scandinavia, and Canada could benefit while in the South, Australia, New Zealand, Southern Chile, Argentina and South Africa all have great locations for crop production but remain vulnerable to droughts and flooding in low-lying areas.
Allen said that investors have not currently factored in the long-term impact of climate change on agricultural commodities.
“With agriculture prices already trading at the bottom of their 10-year range reduced arable land supplies and worsening water scarcity are probably not fully priced in.
“We fear that the world is making precious little effort to keep global warming below +3°C by 2100, and thus think it worthwhile adding some hedges against temperatures rising to over +4°C by 2100.
“For that reason, the advice for investors is to hold a broad long in agricultural commodities, and in particular wheat, the crop most vulnerable to water scarcity, as a hedge to the worsening impacts of climate change.”