HardAssetsInvestor

Mike Norman, Hard Assets Investor (Norman): Hey everybody, welcome to HardAssetsInvestor.com. I'm Mike Norman, your host. Today my guest is Shonda Warner, with Chess Ag Full Harvest Partners, making a return appearance here on this show. Nice to have you back.

Shonda Warner, managing director, Chess Ag Full Harvest Partners (Warner): Thank you for having me.

Norman: So let's get right into your overview about the ag markets right now. We had a conversation at the Index Universe conference that was held back in December, and I think you were a little bit bearish on at least some of the grain markets.

Warner: Yes. I think more so; I'm mixed right now.

Norman: Mixed?

Warner: Yes. The bearish side of that is that I think, by the end of 2012, there'll be lots of grain in the world if we don't have any major drought or sort of weather issues happen. There's going to be a lot of corn. We have plenty of supply, let's say.

Norman: OK.

Warner: If I were pushed to place chips someplace, I guess it would be still bullish dollar. The dollar is the best of a bad basket of currencies or countries that have problems. So I think we could continue to see the dollar rally in 2012.

Norman: So would that translate into …

Warner: That would translate into negative grain prices.

Norman: And negative commodity prices in general.

Warner: Yes. I think people who are insiders in this area, of course, live and breathe with the notion of the correlation with the dollar and hard assets. But maybe people new to the sector, who haven't invested in this area before, aren't so knowledgeable about that correlation. So I keep warning people; I keep talking about that.

Now, if the dollar rallies, and everything else is equal, we're going to sell off here. So that's sort of a bit concerning right now. I think overall, everybody is going to have to inflate. And how they do that is going to be the trillion/gazillion-dollar question.

Norman: Well, they're certainly not doing it through fiscal policy, which is austerity everywhere, right?

Warner: Right.

Norman: And the monetary policy side — QE1, QE2, QE3 — hasn't equated into any broad inflation at all. If anything, you can make an argument that it's deflationary. It removes a lot of interest income out of the economy.

Warner: I think that that's true, on one hand. And yet, on the other hand, just to have that discussion, I'm on my way back to Mississippi from 10 days in Europe. And everywhere I go, prices are higher for things that I want. A subway ticket in London is now 4 pounds for a single journey in the center of London. And just a couple of years ago, it was 2 pounds-20.

So I think we have this secret stealth-inflation thing going on as well in many, many places. Property prices have increased another 15 or 20 percent in the center of London, and yet there's sales in every store — 70 percent off. What's going on here?

Norman: Right. And you have wages going down.

Warner: Yes.

Norman: And property prices, at least here in the United States, still falling.

Warner: Still falling. And so, I think it's true that this money is sort of being sucked up away from the middle class, and certainly away from the poor, into the banking industry, just to save the banks or whatever. And the people are sort of aware of this, are afraid. And so, in London, my sense was that people were putting cash anywhere they could in hard physical assets. Now, that's sort of the other side of my little bearish thesis for grains, let's say, or farmland, for that matter, and we can get into the farmland side of that. That's the ultimate value play. If grains go up, land eventually follows.

Norman: Right.

Warner: If grains go down …

Norman: Is that happening now in farmland?

Warner: Farmland had an amazing year in 2011, scary amazing.

Norman: Pricewise?

Warner: Yes; up 20-30 percent or more in many places. And it was a wow. And it's sort of scary, in a way, because I think it's gotten a little bit ahead of itself. So, if you buy a farm, and you rent that farm out to a farmer, you typically might expect, I think, on average — personally, from all the work we've done — 5 percent, right?

Norman: Right.

Warner: Now that's gross. And you've got to pay taxes and insurance and repairs and maintenance and things out of that. But 5 percent is what you could expect.

Norman: Positive yield.

Warner: Positive yield, current yield. And that number, in some places, is down, now, around 2 or 3 percent, maybe 1 percent in some places.

Norman: Really?

Warner: Yes. And it's scary, because if there's any sort of shock to the system, let's say grains go down. There's plenty of corn. We don't have any weather issues. And everybody plants and goes crazy.

Norman: Well, that's when we go into a recession again.

Warner: That too; right. And grain prices come down. If oil doesn't come down with it, there's going to be some …

Norman: The profit margin goes negative.

Warner: Yes, there's going to be some problems on the farm. And guys are going to start bailing out of their $500-an-acre loan.

Norman: Now who is buying this stuff? Is it people in the farming industry or speculators?

Warner: I don't think it's speculators, per se, really. It's farmers themselves. They're still a major part of the market. And then there's all sorts of quite well-to-do people — I think it's actually beginning to happen on the coast, but certainly across the center of the United States — who look at their bank and say, "One percent — I can't take it anymore. Less than 1 percent, at least I get 1 or 2 percent if I go buy this farm." And they might not have experience doing that. And they might not realize there's hidden costs there. And they go out and pay a bundle for a farm. And it's happened all over the place.

Norman: But is that sustainable? It sounds like, from your description of the economics of it right now, it's sustainable to a point. Then it crashes right back down again.

Warner: Yes and no. I'm confused, so you're going to hear me talk both sides of this argument today.

Norman: I do that all the time.

Warner: I usually have really succinct opinions. And right now, I'm a bit torn. But this stuff is not levered. Don't forget that. So, if people are putting real dollars — not levering it off — into a house in London, or a farm in Iowa, they're not going to get squeezed out. They don't care if it drops 20 or 30 percent. They're holding on because they think something is going to happen in the next two to three to five years, which will sort of bring back their valuation. And they're happier there than with it in currency, perhaps.

Norman: Good point. I’m interested in when you described your own sort of confusion about prices. And you come from a background in the agricultural industry. And I find that often, people who come from the trade, they look at the fundamentals, and they look at the current price levels, and it does not compute. Is that what’s going on in your head?

Warner: Yes, that’s, to some extent, what I feel. And at the end of the day, if we talk specifics, whenever I go out to buy a farm to put into our fund, we do all the due diligence. And, assuming every hurdle gets jumped over, I say, “What if corn goes to $4? What if beans go back to $9.50? What if wheat’s at $4.50 or $5? Can I cash flow?” And, if I can say yes, I’ll probably stick my toe in the water. It might be dicey for a time. Things might back up. But I think I’m in the camp, ultimately, that something will happen. And I’d rather have the assets …

Norman: Right, to buy on the cheap. Now, recently, Congress took away the longtime subsidy for ethanol. What impact do you think, if any, that will have on corn prices?

Warner: I think that will almost have no impact on corn prices.

Norman: Really?

Warner: Yes. Because that subsidy went to big oil. And so, it was 42 cents a bushel, and it was a blender’s credit, to encourage big oil to blend ethanol into gasoline. And they have done it, and it makes them lots of money. And so, unless you were to see oil go down below $50, these guys are making too much money.

Norman: So the amount of subsidy is too small. There's still plenty of profit in there for them.

Warner: Plenty of profit.

Norman: So demand for corn, for ethanol, is going to be unfazed, basically.

Warner: I think demand for ethanol is going to be unfazed at the current price levels. I think that farmers really didn’t benefit from that subsidy, particularly, anyway. Big oil did. Did they need it? Well, different people …

Norman: Now, what about the removal of the tariffs on Brazilian ethanol?

Warner: Well, again, I personally don’t think it will have a huge impact. I can't remember the percentages. But a large amount of ethanol came in through U.S. protectorates, in the Caribbean, into the United States anyway. I don’t know whether it’s 25, 30 percent — somewhere in there — of all ethanol in the U.S. is from Brazil. And they need their ethanol in their country. They're further along with their technology, to run their vehicles.

Norman: What do you make of the explosion in ETFs? Now there's ETFs in everything. Every individual commodity: corn, soybeans, cotton, sugar. From your perspective, what has that done to the markets?

Warner: I have friends that run ETFs, so I have to be very diplomatic. I'm not a big fan of ETFs. I think that what’s true is that many investors don’t realize that their counterparty isn't a bank, or it isn't the physical assets itself, necessarily. It’s a company. And so, I don’t know when — one year, five years, 10 years — we’ll have this enormous explosion, and ETFs are going to have something to do with it.

I think it increases volatility in the marketplace, because as people are buying and selling ETFs, they are buying and selling the underlying. And that’s especially true in areas where there's a lot of 2X, 3X type of products.

Norman: Right.

Warner: I hate that: It makes it harder for real people to use those instruments to hedge, which is really what the futures were there for to begin with.

Norman: All right. So, your longer-term broad outlook: Put money into hard assets, X percentage of your portfolio, by some way, shape or form — these trends are going to continue. That’s what it sounds like.

Warner: Yes, I think these trends are going to continue. Be really careful. Try not to overpay. I guess think about what you're doing and what you're paying. If you back up, make sure you're happy. Do not lever to go there. But it’s probably a very good idea to have some portion of your portfolio in hard assets.

Norman: And wait for farmland to come down a little bit, right?

Warner: No, we’ll see. There's still deals out there. We’re still finding things we want to put in the portfolio.

Norman: All right, great. Shonda Warner, thank you very much. That’s it for now, folks. This is Mike Norman. We’ll see you here next time. Bye.