The Last Remaining Cheap Asset

Authored by Kevin Muir via The Macro Tourist blog,

There are two things that most men think they are experts at. Ask any man, and chances are, deep down, they believe they are the world’s greatest bbq’er and lover (probably in that order). Personally, I know not everyone can be the world’s greatest lover, so I hope I might be in the top quartile (I am giving myself a boost for all those too-good-looking guys who think they don’t even have to try), but god damn it! I know that I am in the top percentile when it comes to barbecuing!

My delusions about my mad bbq’ng skills are similar to everyone’s belief they are contrarians. Whether it is the NYSE specialist, the Chicago pit local, the Bay Street equity trader, the London credit specialist, or even the guy at home trading in his underwear, we are all consumed by these romantic narratives where we bravely battle the naive masses to nail the next great trade. But the reality is that we can’t all be contrarians. If we were, then it wouldn’t be contrarian…

Today we face expensive assets everywhere we look. Whether it is real estate, equities, fixed income - capital is chasing assets at a disturbing pace. Central Banks, with their massive quantitative easing programs and negative rates, have inflated anything with a CUSIP, and those private investors venturing out the risk curve have taken care of everything else.

So what’s an investor to do? Is there anything truly cheap anymore?

Well, rest assured, there is absolutely nothing easy left. Anything with a little bit of meat on the bone has been picked clean. You could try making some money taking the other side of this over valuation, but you need to realize who is on the other side of your trade. Although you might time the occasional squiggle lower, I would rather not fight Central Banks and their unlimited fire power.

No, I would rather go looking for something truly forgotten, hated, and cheap.

And nothing fits this bill better than grains.

I told you this wasn’t going to be easy, so when the idea of buying grains makes you throw up a little in your mouth, don’t immediately discount its investment merit. The grain charts look like death. No two ways about it. As the trader who sits beside me says, “going long grains is a hedge against profits.”

I realize these charts do not represent grain’s actual returns due to the problems rolling contracts and the embedded carry (positive/negative depending on the shape of the curve), but it gives you a sense of the spot market over the past five years. The selling has been relentless, and discouraging.

I like to follow agriculture twitter. It’s a nice break from all the finance guys bragging about their latest wins or posting pictures of the meat they are bbq’ng that evening. The ag people seem a little more humble, but I must admit, I get a kick out of them showing off their latest tractors or combines.

The reason I bring this up is to give you a sense of the sentiment within the agriculture trader community.

What’s that line legendary strategist Don Coxe likes to use? “The most exciting returns are to be had from an asset class where those who know it best, love it least because they have been burnt the worst?”

Well, there can be no doubt that grain longs have been burnt the worse. If we back up the timeframe on our charts, and then adjust for inflation, you will notice that grain prices are now all ticking all time lows.

Grains have been a vicious bear market in real terms.

Technology has caused grain prices to resemble the price decline of a 80386 microprocessor chip. Whether it be from improvements in fertilizer and pesticides, to the introduction of self driving farm equipment, the modern farmer has become dramatically more efficient over these past few decades.

Now maybe you believe these technological improvements will continue. Have a look at the increase in corn yields over the last 150 years:

Could this chart simply continue moving infinitely higher? Sure, never say never. Maybe Monsanto will come up with even better super grain seeds to create the fountain of perpetual food. Maybe we will figure out ways to automate the remaining last few jobs left on the farm to squeeze costs even lower. Then again, maybe Lindsay Lohan doesn’t have a drinking problem.

I just don’t buy that progress can continue at this pace. I have no doubt that farmers will continue improving, but I suspect the large gains are behind us. The moves from here will be incrementally smaller.

Over the past few years, the weather has been as close to perfect growing conditions as a farmer could ask. All of the droughts have been on the West side of the Rockies, with the grain growing conditions on the other side experiencing ideal weather. Although you should always be suspicious when a hedge fund trader starts predicting weather patterns, I wonder how long this can continue. This winter the West Coast experienced a record amount of precipitation, will the opposite now happen in the plains?

But you might not even need to get a drought to cause grain prices to rise.

This terrible bear market has not gone unnoticed by the speculators. Have a look at the net speculator position in the CBOT wheat contract.

Specs have never been this short! Everyone believes prices can only go one way - lower! After all, we are all top performing bbq’ers and lovers.

I must admit, I have been lugging around a long grain position for the past few years, so I am not sure anyone should listen to my analysis. Yet, while every is all beared up on grains, some smart guys are starting to talk about the investing merits of long positions. Great technicians like Peter Brandt are raising the possibility a long term bottom might be forming. And then, shrewd macro traders like Raoul Pal, are advocating long grain positions from a fundamental perspective.

But few are talking about the real reason that grains offer a compelling risk reward from the long side. If this Central Bank experiment goes off the rails, we could have a return of 1970’s style inflation. That happens to coincide with the last great bull market in grains.

Yeah, yeah, I know - inflation will never return. I know all the reasons why the absurd amount of Central Bank stimulus will never cause inflation. Trust me, I have been lectured by many a deflationist. Well, I will leave them to buy long term treasury bonds (after a forty year monster bull market), I am going to keep picking away at my long grain positions.

When you are busy dismissing the possibility of a 1970’s style bull market in grains, don’t forget - we all want to be contrarians, but it sure is hard. Don’t look now, but I think your steak is burning.