Could agriculture be the solution that dissolves the trade war?
In context of the trade war, agriculture could well be the area that prompts both the U.S. and China to come to an agreement, says Mellon’s Robin Wehbe.
Technological progress is beneficial in all industries because a boost in productivity can never be a bad thing, right?
Not necessarily for farmers. The rollout of new seed technology for the purpose of better nitrogen uptake, pest resistance and fungus resistance led to a decline in corn prices in 20131 because it was so successful that supply began far outpacing demand.
Today, there are additional natural and political headwinds, which are creating a whole new level of worry among farmers and investors alike. However, despite a problematic outlook, Mellon portfolio manager and senior research analyst Robin Wehbe is running around a 20% allocation to agriculture, or twice the usual exposure of his historical allocation to the sector, in the BNY Mellon Natural Resources Fund, with the expectation there will be a reversal in the current situation.
The perfect storm
Recently, farmers had to weather the wettest 12-month period on record in continental U.S.2 This came on top of trade issues with China, which is one of the largest consumers of U.S. agricultural exports.
“Going into these two issues, farmers already had a heavy weight around their necks so it feels a bit like a perfect storm here,” Wehbe says. “They really just want to do their jobs. They want to get out there, they want to plant and they want to have free trade but these tariffs are like a headache for them.”
Headache or not, Wehbe says he and his team are making some big additions to the agriculture sector right now. This is because the team believes headwinds will subside in the near-term and wants to position itself to take advantage if the landscape starts to turn for the better.
You can’t predict the weather
Usually by the time June comes around, the largest corn producing states in the U.S. have 90% of the crop they intend to produce per year already in the ground3, but this year is different. These states only have about two-thirds of their normal acreage in the ground.4 This is partly due to flooding, which Wehbe believes has left farmers in limbo as they decide whether or not to take the risk of unsuccessful yields. Over the past two months5, heavy rains left fields drenched during the key time of year for planting corn, which is especially worrisome since corn happens to be the biggest produce crop in the U.S. by acreage.6
“When there is this impact from the floods and farmers can’t get to the fields, they don’t plant enough acreage and bottom line supply is impacted. They’re not going to come out of the harvest with as much supply as they normally do. In our opinion the result could be that they start pulling on inventories and prices start to move up,” Wehbe says.
As odd as it may sound, he believes this is actually a good thing for rebalancing supply and demand, or as Wehbe calls it, “painful medicine for the farm belt”. With prices moving up, farmer income should be a direct beneficiary as they clear out some of the loaded inventory from when supply was outstripping demand.
Some impetus for the U.S. to curtail negative trade implications on agriculture comes from the fact the farm belt is a key voter base for President Trump, which helped get him elected in 2016. He already committed a $16bn government aid package aimed at agriculture7 which could possibly help him retain support from farmers but Wehbe argues this is unlikely to be enough to offset losses from reduced trade.
Key decision makers in China, which has historically experienced famine problems, could also have a dark cloud hanging over their heads. They have a country that is developing and a growing middle class population that demands more animal protein like chicken, pork and beef, which all require higher grain intensity. All while their own agricultural supply is inadequate to meet that demand.8
“China could try and deploy more technology in its own farm belt but quite honestly, the U.S. has some of the most unique agricultural dynamics, which is hard to replicate. For this reason, you could say the U.S. makes up a portion of the bread basket for most of the planet,” Wehbe says.
Currently, Wehbe and his team have noticed that China has pivoted to Brazil to meet most of its agricultural needs9, particularly for soy beans. He believes this has created anxiety among the U.S. farming community in anticipation that they could lose major exporting partners.
In Wehbe’s view, it is possible that President Trump may realize he needs to reopen trade doors in order to appeal to farmers in time for the next presidential election. Wehbe also thinks China would gladly welcome exports from the U.S. and could have appetite for as much as $30bn in agricultural products.
“There are a hundred things that can happen between here and then, but in our view that seems to be the highest probable scenario from where we sit today,” Wehbe says. “When you put those political elements and dynamics on top of what we see as a fundamental situation turning the corner finally, we do think it sets the farmer (and investors in soft commodities) up more favorably for the end of this year into 2020.”
1 USA Today: Crop Values Drop 9.8% in 2013 as Prices Fall, 17 February 2014.
2 The Wall Street Journal: Farmers on Drenched Land Confront Tough Choice on Planting, 5 June 2019.
3 The Los Angeles Times: Soybean and corn farmers devastated by double punch: trade war and flooding, 30 May 2019.
4 The Los Angeles Times: Soybean and corn farmers devastated by double punch: trade war and flooding, 30 May 2019.
5 The Washington Post: After a biblical spring, this is the week that could break the Corn Belt, 4 June 2019.
6 AG America: Power of 10: Top 10 Produce Crops in the US, 10 March 2017.
7 NY Times: Trump Gives Farmers $16 Billion in Aid Amid Prolonged China Trade War, 23 May 2019.
8 Business Insider: China has alarming food problem – and there’s only one way to fix it, 10 June 2017.
9 Reuters: Brazil rides wave of soybean sales to China as US trade war rages, 17 May 2019.
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