23 Mar Agricultural Farmland – A Store of Value

By Ian Robinson

Let’s completely decouple the concept that the price of agricultural land is, or should be, correlated to the production capability of the asset and agricultural commodity prices.  If this was the case, then the underlying synopsis would have the defining parameter that the only person (or corporate) seeking to buy or acquire agricultural land was purely for agricultural purposes only.  There is no room in this equation for any other prospective buyer other than to sweat and till the soil from sunup to sundown.

The instant this defining parameter does not hold true, then the price of land becomes a function of other economic forces that are dislocated from its financial performance in relation to production capabilities.

Here enters the notion of Store of Value.

“A store of value is any commodity, currency or asset that would normally retain purchasing power into the future and is the function of the asset that can be saved, retrieved and exchanged at a later time and be predictably useful when retrieved” (Wikipedia)

Qualifiable attributes includes scarcity, aversion to deflationary impacts during times of inflation, satisfying the double coincidence of wants (usefulness or desirability to drive future demand) and liquidity.  If an asset maintains these qualifiable attributes, then it will attract capital on a domestic and global scale to protect future wealth.

Let us apply these attributes to agricultural land.

Productive agricultural land decisively increases in scarcity over time.  Soil degradation, urbanisation, regulatory intervention (and now potentially rising sea levels) all diminishes the supply of agricultural land which is a relatively finite resource on our planet.

Inflationary environments generally support the broad appreciation of agricultural commodities, which in turn, appreciate the fundamental primary assets producing these commodities – namely agricultural land.  This economic phenomenon ties back to our original synopsis.  Land prices may not be 100% correlated to productive capacity and commodity prices – but a certain percentage of correlation will most likely endure.

Enduring usefulness of the asset class by way of satisfying “the double coincidence of wants” ties back to land having the ability to produce food (and fibre) well into the future (under sustainable farming practices of course) which remains the primary hierarchy of needs for the human population.

So why is there a continual rolling global demand protect future wealth?  The simplest explanation is a strong desire to apply risk aversion investment strategies in attempt to mitigate against uncertainty.  You only need to read a copy of the Australian Financial Review to capture an appreciation of the depth of uncertainty on several levels that is playing out in the markets today.

Remember, investing under a mandate to achieve a “Store of Value” is not about investment outperformance.  It is about capital preservation.

The fundamental risk reward curve that we all learnt at school translates well in this instance.  The less risk an asset is deemed to behold, that is, its ability to be recognised as a superior Store of Value, the lower return it will yield.  It is an Economics 101 symphony at play.  As farmland becomes globally perceived as an efficient and perhaps undervalued store of value, price for farmland will continue to elevate with greater buying demand – and hence its cash flow yield will fall.

Conclusion

Now here comes the bell ringer.  There is no prescribed formula as to how high an asset can be priced when “Store of Value” becomes synonymous with the asset.  When the correlation between commodity prices and “Store of Value” gradually shifts in favour of capital protection and preservation over yield or return, prices will continue to defy gravity and perhaps economic rationality.