Betting the Farm

CHINA’S LAST EMPEROR, PU YI, LOVED HIS SOYBEANS. They were a staple of the Manchurian diet in Northern China. In the 1930s, a forward-thinking Brazilian friend asked Pu Yi if he could take some soybeans back to Brazil. Pu Yi, only a nominal regent by this point, complied. The beans eventually made their way to bustling Rio de Janeiro.

Of course, neither Pu Yi nor his friend could foretell the momentous role soybeans would play in Brazil’s future. Nor could he predict that investors one day would pine to own acreage in the sun-filled green lands of South America.

Up until that time, soybeans were unknown to Brazil. But in Brazil’s fertile soils, soybeans found a welcome new home. Over the ensuing decades, they would become one of Brazil’s most important crops. Today, soybeans are Brazil’s largest export.

Vignettes such as this, little odds and ends, make up so much of history’s important turning points. (I picked up the Pu Yi story from Robyn Meredith’s interesting new book, The Elephant and the Dragon: The Rise of India and China and What It Means for All of Us.) It’s always fascinating to me how one person’s decision, sometimes even on just a whim, can have such enormous impact over the years. Perhaps soybeans would have eventually made it to Brazil anyway. But the world would surely look different depending on when and how.

So there are historical roots for the boom in trade between China and South America. Trade between the countries has really surged in recent years. Argentina sells nearly 10% of its exports to China. Chile supplies nearly one-fifth of China’s imported copper. And China gets about one-third of its food supply from South America — with a good chunk of that from Brazil’s vast farmlands.

It’s a natural, too. Not just for China, but for the world. In Brazil and Argentina, you have one of the few places left in the world where you can acquire large tracts of land in temperate climates with plenty of rainfall to support large-scale agriculture. Already, the two countries produce about one-third of the world’s agricultural commodities. As China is the world’s workshop and India its back office, so has South America become its breadbasket.

Brazil is already the world’s largest producer of coffee, sugar cane, ethanol and fruit juice. It is also near the top in soybeans, beef, poultry and tobacco. Brazil’s agricultural sector alone has grown at a 5%-plus clip since 1999. That’s pretty good for such a big sector. Agriculture represents about 8% of the economy, employs one-quarter of its work force and supports some eight million enterprises.

Likewise, Argentina is also a leader in beef and grains — it is the largest consumer of beef on a per capita basis in the world. In beef production, Argentina is behind only Brazil and Australia. Argentina is big on soybeans, wheat, sorghum, rice and barley. Argentina also produces an abundance of fruits — lemons, apples, peaches, pears and more.

But — as hard as this may be to fathom — there is the potential for so much more. The rise in the living standards of hundreds of millions of people in China and India, the resulting shift in dietary habits and the global push for alternative fuels derived from agricultural products put South America in the catbird seat.

The agricultural markets are abuzz these days. The prices of corn, barley, soybeans, coffee and cocoa are all well above their averages over the past five years. Meat and poultry prices are also on the upswing. You can see it, too, in the behavior of the companies involved. Dannon recently announced it would boost prices for its dairy products. That follows on the heels of similar announcements by Nestlé, Unilever and Cadbury Schweppes, Kellogg’s, General Mills and others.

As an investor, I think I’d like to own companies that make the stuff that everybody else wants to pay more for. So it’s not hard to see why I should gaze at those lush farmlands in South America.

Historically, the productive capacity of this region is underdeveloped — despite its chart-topping production. Some 90% of Brazil’s fertile and productive land has not yet been cultivated. Similarly, the United Nations’ Food and Agriculture Organization estimates that farmers have cultivated only 3% of Argentina’s fertile land. So there is lots of land to accumulate and turn into a top-notch farming operation.

Only in the last decade or so have producers in these countries applied cutting-edge technologies in managing their farms. The result has been a great expansion in crop yields. In today’s markets, farmers in Argentina and Brazil are highly competitive in the global market for corn, wheat, soybean, sugar and other products. In fact, some of the success in Argentina and Brazil has come at the expense of American farmers — especially in the area of soybeans, for example.

Brazil and Argentina have something else of great value: water. Take a look at the chart, which shows that South America has about 26% of the world’s water supply. Asia, by contrast, has many more people to support with its water supply. Then again, this chart makes things look better than they are. Most of China’s water supply is in the south, while most of its people live in the north:

In any case, Brazil alone holds 14% of the world’s supply of fresh water. I remember, too, visiting a ranch in Argentina and having the owner proudly show me how water generously bubbles out of the ground from underground streams and then waters acres of crops. Quite a natural advantage.

Perhaps it goes without saying that the biggest risk down here is the populist and interventionist policies of governments. That is a risk one takes everywhere these days — even in America, and even in Canada (remember the income trust fiasco?). Political risk seems to be on the rise the globe over, something we should expect after a long period of fat years. People get complacent and take economic growth for granted.

While the political risks of South America bear watching, I believe the investment merits of owning farmland down here outweigh the risks.

Sincerely,
Chris Mayer

November 21, 2007