I have an exact replica of my grandpa’s tractor, the Farmhall H, sitting on my desk. He never knew how much I learned from him and looked up to him and, if he were still around today, he wouldn’t believe his eyes: I’ve built a portfolio around what he couldn’t give away. And he sure as heck wouldn’t have believed he could have gotten $8 a bushel for corn last year!

With a deflationary spiral circling the globe, many investors would assume the poor ol’ farmers are in big, big trouble once again: The sun seems to have set on 2008’s historic collapse in commodity prices. But hold the collection plates and subsidies: According to my data, farmers are looking at their third best year in history - and that’s if prices don’t rebound a penny from here.

Corn's Collapse?

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All I did in the above chart was to subtract the artificially sweetened peak for corn futures. A different lens through which to view the last 8 years, isn’t it? Looks more like a secular bull market, in fact. I’m not a raging short-term corn bull; I just wanted to share the chart as a piece of overlooked evidence in the mystery of finding real demand underneath sky-high fear in all assets.

The spike, in this case, was fueled by a combination of an ethanol myth (I now find more plants in bankruptcy court than on design boards) and an estimated 2008 peak of $175 billion inside funds chasing commodities. Much of each are now gone, and yet corn is comfortably higher than it was before they started.

Why?

World Corn Usage, Stocks, and Stocks to Use Percentage

Click to enlarge

The multi-decade growing demand in yellow is less interesting to me than the falling blue line in the above chart. That is the percentage of corn left over in inventory “stock” compared to consumption at the end of each year. Across all grain markets around the world, we’re now sitting on inventory at least 25% below the average of the past 20 years. In other words, we have about 9 weeks of supply, which is historically tight - and that’s without any major weather shocks.

Over the past 2 months, while the fears of slowing economies (along with plenty of supply) took barrels of crude oil lower, some bushels from the farm were quietly going up at the exact same time.



That chart is of a commodity you hear far less about but will likely taste tonight - soymeal. It’s used as animal feed.

Unquestionably, economic disasters of any flavor can interrupt demand for agricultural commodities, and we’ll see that this year. And here’s an interesting fact that may surprise you, as it did me, about something we often think of as a discretionary item - coffee. It may be the only commodity whose demand holds up remarkably well during recessions. And even if demand does drop, this crop illustrates just how delicate the balance of supply is around the world on several farms.

Coffee beans grow on trees that need a lot more to go right than most crops to get to your kitchen. Perfectly warm and wet tropical regions and about 5 years are needed to just get a tree to produce “cherries,” which are then picked by hand, then dried and selected before being bagged. 132 pounds makes one bag, which is then shipped to roasters, where it takes about 4,000 beans to make 1 pound of your coffee. The average tree is good for a little more than 1 pound on your counter.

The 3 largest producing countries -- Brazil, Vietnam and Columbia -- may all see production fall significantly in 2009. I ‘ve seen estimates, for example, of a 20% year over year decline in Brazil and that’s if the weather is perfect from here. And we begin the year near all-time record lows of inventory.

And Yet...

At the end of 2008, judging by the spread between 10-year Treasuries and Treasury Inflation Protected Securities (TIPs), the rest of the world was betting on seeing considerably less than 1% annual inflation over the next decade.

A Big Question Mark

My work leads me to conclude there’s a multi-decade secular shift underway from paper assets to hard assets. Thanks to the credit crisis the capital markets have placed a question mark around hard assets, when in fact I believe it has added an exclamation point to the trade.

As for concerns about the “poor farmers,” and the devastating impact on equipment and supplies being predicted in those industries inside the stock market, the math has simply changed since my grandpa was lining the top shelf of his closet with hats from seed companies begging for an order.

The assumption is a farmer is getting crushed right now and cannot avoid deflation’s wrath. But to put things into perspective, using data from USDA and Citigroup, if I use year end 2008 crop prices, revenues would be down about $20 billion year over year. If we use year end fertilizer and fuel costs, those would be down about $20 billion.

Meanwhile farmland balance sheets continue to sparkle. While the rest of the world drowns under a sea of debt, according to USDA figures the average farm is now looking at a debt to asset ratio of around 9% now, after continuing to fall the past several years. I still say my favorite farmer’s best lesson for me was, “It aint’ whatchu make Ryan - it’s whatchu keep.”