Later this morning I am due to be interviewed by the WSJ about "scarcity" as an investment theme which I think means water and ag-related equities. As an amusing coincidence Robert Shiller is calling out farmland as the next bubble. Pragmatic Capitalist Cullen Roche has more detail on Shiller and he is sort of in agreement, he is focused more on commodities as a bubble in the making. The two are related but not precisely the same.
Farmland is not a bubble and I am quite certain it will not become a bubble.
Bubbles are all encompassing events that take many things down with them. For example the US housing market turned out to be a bubble taking down many world stock markets, many world fixed income markets and many world GDPs. As the bubble was inflating there were astounding statistics about equity extraction, a proliferation of mortgage products requiring no money down, an abundance of house flipping television shows and anecdotally a couple of people I know actually thought it was impossible to lose money in real estate.
Ditto the tech bubble. Since that was more of a stock market-centric event I would add that there were dozens of publicly traded, unprofitable internet stocks with little to no revenue with market capitalizations well north of $100 billion.
A few years ago I was on CNBC and asked whether solar stocks were a bubble. I think I was on to discuss this because of a couple of bearish of articles I wrote about solar for theStreet.com but either way it most certainly was not a bubble. At the time the total market cap of the Market Vectors Solar ETF (KWT) was less than $100 billion. Here I am talking about the sum of all the market caps of the stocks in the fund not the AUM in the fund. So the comparison was dozens of unprofitable companies each with market caps above $100 billion versus an entire industry worth less than $100 billion. The market cap of KWT now is only about $40 billion (I didn't realize it had dropped that much and stayed down until I just looked for this post).
The SPDR Gold Trust (GLD) which we own for clients is by far the largest exchange traded commodity product in the US at $55 billion and I am quite certain it is by far the largest exchange traded commodity product in the world. I am fairly certain (but did not look up every ETP) that iShares Silver is the second largest at $12 billion. PowerShares DB Commodity Index Tracking Fund (DBC) is a relatively big one at $6 billion. The The iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP) used to be a very popular one and it has $3 billion AUM.
I would be surprised if all of these added up to $100 billion but there is no way they all add up to $150 billion. As for related equities , the materials sector currently comprises 3.62% of the S&P 500 and 10.99% of the EAFE Index which are both a long way from the 20% level that becomes a flashing yellow light for reducing exposure.
As for farmland the numbers for the bubble case are a little more plausible. According to this from Thomas Hoenig, 1/6 of US jobs and US economic activity are farm related (these numbers surprise me) and the value of of all US farmland is up a lot to now $2 trillion dollars. In doing some Googling I found a couple of estimates for the total value of all US real estate to be $20 trillion but I have a low confidence in that number.
If farmland goes down a lot in value it would be for one of two reasons as best as I can tell; one would be that food prices would drop which would be a net positive for most of the economy or due to serious distortions with interest rates making the business of farming difficult/impossible/money losing but higher rates would be bad for the entire real estate market and the entire economy for that matter and very unlikely to originate in the farming industry--so farmland hurt by the economy not farmland hurting the economy.
I would also think that a decline in commodities would have several economic benefits and that it would not be a decline in commodity prices that would hurt economic activity, more like a downturn in economic activity hurting commodity prices.
This is not to say that both farmland and commodities are not manias that will see huge price declines because anything can drop a lot in price. Not everything that drops a lot in price is a bubble. Bubbles truly hurt many people and take many things down with them. The question of whether solar was a bubble a few years ago was a popular one at the time. The industry then went supernova (whether because of it own fundamentals or the bigger economic picture) and no one cared. When the real bubble surfaced, solar as a bubble was thoroughly disregarded.
This post is neither bullish or bearish so much as an exploration of a misused term. If you are worried about commodities and/or farmland imploding then make sure you don't own so much that a massive decline could do you in. If gold somehow went to $400 in the next week I promise you there would be tales of people being wiped out for being 100% in gold on margin.
There are obvious fundamental tailwinds for commodities and farm-related investments ranging from modernization to lack of supply but there are always fundamental tailwinds for these things. A large price decline is far less of a problem than being wildly over exposed when the bottom does fall out.
On an unrelated note some of you may recall I like to watch college lacrosse, among many other sports. This season one of the big advertisers for ESPNU's coverage is Select Sector SPDRs which is very funny as my wife tells me I am the only person watching.
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10 comments:
When Select Sector SPDRs begins to advertise for NFL games it will be time to sell.
Some additional thoughts on farmland. Most sales in the Midwest at least are cash events so that likely diminishes the chance of a crash a la residential R.E.
Rising interests rates could put a significant top on farm land prices and of course the new farm bill being debated now could also be a serious damper as well.
Most (if not all) farmland has been acquired by 1031 exchanges in recent years (last 10 or so) in my area by 1) farmers selling out near urban areas and moving to lower cost areas and 2) investors doing the same. Commodity prices are secondary factors in determining farmland values.
The majority of farmland is farmed under cash lease arrangements in my area.
What happens when 1031 provisions are repealed?
Like 7:16 says, chances of a crash may be dimished, but I think there is a chance of an extended period of negative real returns. Reversion to the mean if you will.
What happens if the IRS code 1031 is repealed? Most likely, the tax deferred will be due when the replacement property is sold. What may also happen is liquidity of real property like farmland will slowly seize to a trickle. Farmland will be sold by the owners beneficiaries. 1031 transactions once initiated for relocation, cash flow, diversification, consolidation, appreciation and depreciation will be not be as forthcoming.
The whole idea of farmland being in bubble was a bit odd to me. Sure I can see commodities but farmland? There's less of it more and more.
What I would like to see discussed is the bubble of US Debt.
It's a bit of a semantic question: What's a bubble, what's a mania, etc.
As with other discussions like this, the key thing is to get to the underlying economics of the situation, which hasn't happened on most sites talking about farmland (pro or con). The ultimate path of land prices will depend on that.
I think that the prices being paid are out of touch with the numbers currently, but that doesn't mean that land has to correct here and now.
Good comments from your readers. Many of the purchases have been cash events, which does lessen the probability of a calamity, but doesn't eliminate the possibility. And the 1031 exchanges (and possibilities going forward) are a factor to consider.
i think i address your question in the post. in my opinion the difference between bubble and mania is in the collateral damage caused
oh and the origination point of the event
Roger, I didn't mean that you weren't clear, I meant that everyone uses the terms differently. Most don't bother trying to define the terms as you did.
Roger, even at current ag. commodity prices, farmland production is not cash flowing at a reasonable rate to CURRENT farm land prices. Most farmland that is being financed is unfortunatly being financied not on traditional cash flow metrics, but on asset values. As long as the price of farmland increases all is well on paper, but like the price of residential real estate, once the underlying asset stops going up in value, due to the last sucker entering the casino, bad things happen. That in my opinion, will be the most likely scenario on the end of the farmland boom.
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