Last June, I wrote that 'An imminent bursting of the investment bubble in industrial commodities from copper to oil will drag the agriculture complex in its wake' as indeed it did, but a year on, the fundamental long-term story remains compelling. For agriculture, as for energy, two decades of declining real prices have led to huge underinvestment that is now being revealed by relentless demand pressures. In 2008, the world's urban population equalled the rural for the first time in human history. China also became a net food importer for the first time ever. Overall, world food supply and demand remain precariously balanced. A variety of factors point to serious food shortages emerging over the next decade, with demand for food forecast to double over the next 25 years despire reduced availability of arable land and water. For the first time in history, urban demand for water is outpacing farm demand throughout the world and water tables are falling across key producing regions . Globally, we are losing about one per cent of productive land each year because of degradation and urban sprawl, notably in southern China. 

Arable land per capita has essentially halved from 0.42 hectares per person in 1961 to 0.22 hectares per person now. Optimists expect innovation to bridge the gap, and it's possible that developments like genetic engineering and smart irrigation may boost productivity, but as i nternational funding for agricultural research has been stagnant in real terms since the early 1970s , I wouldn't bet on it. While political factors that have seen productive land in areas like the Ukraine and Zimbabwe lie fallow may abate, the impact will be marginal overall. Up until the 1960s, increased food demand was met by increasing farmland under cultivation. Then, we began trying to meet demand by increasing yield via fertilizers, irrigation, and better, if more homogenous, seed varieties (one of the downsides of this has been a loss of resilience, as the same varieties are grown worldwide, and 80% of the global wheat planting area is vulnerable to the UG99 wheat fungus, now spreading rapidly in Africa). It worked to the extent that between 1975 and 1986 yields for wheat and rice rose 32% and 51% respectively, the so-called 'green revolution'. However, since then, these techniques have stopped producing increased yields due to adverse feedback effects: you can't spray fertilizer and irrigate fields beyond a certain point without damaging the land, thus  reducing yields. From 1970 to 1990, global average aggregate yield grew by 2.2% a year, but has since declined to only 1.1% a year.

Today, roughly half of the world’s cropland is devoted to growing cereals . If we combine their direct intake as bread etc with their indirect consumption, in the form of foods like meat and milk (about 40% of all grain is currently fed to livestock), then cereals account for approximately two-thirds of all human calorie intake. World production in 2009 is forecast by the FAO at 2.22 million tonnes, slightly down on last year's record 2.29 million tonnes, which should allow stocks to be replenished. However, fertilizer application is being reduced dramatically as a side-effect of the credit crisis, with estimates for North American potash application falling as much as 30% to 35%, phosphate by 20% to 25% and nitrogen by 5% to 10%. In the words of Bill Doyle, the CEO of Potash Corp. 'To put this in context, U.S. applications this fertilizer year are expected to be similar in total volume to the 1983 pick year while farmers now need to generate 90% more production than in 1983 and will plant 25 million additional acres of corn, the most fertilizer intensive crop in the U.S. Clearly, nutrient replenishment will suffer.' And with it, crop yields.

On the demand side, the Asian diet is becoming increasingly Westernised, with Chinese meat consumption up from 20 to 54kg since 1980, and the country is already importing a third of all traded supplies. In food as in many other areas, for Western consumers globalisation is now biting back as they compete for supplies from the rising middle classes of the developing world. Perhaps 500m consumers from Brazil to India are now reaching the critical income threshold at which discretionary spending accelerates ($3-4,000); consumption of meat and processed non-traditional foods will soar, along with the fridges and microwaves needed to store and cook them.

It is highly unlikely that even GM seed varieties will prove a wonder breakthrough that will solve the problem of raising world food production substantially in the foreseeable future, leaving ever increased application of nitrogen fertilizers on marginal new farmlands as the only viable option as demand and prices rise. The process of raising yields and agricultural advance is extremely complex; many of the developments that together will influence the world food outlook are fashioned by the wider environment, notably per-capita income growth in emerging markets and energy prices. Unfortunately, it isn't easy to get investment exposure to prime farmland, which is the ideal long-term exposure. I think core long exposure to corn, wheat, and soybeans via a managed futures fund, as well as the second derivative equity plays like Agrium (AGU), Potash (POT) and Monsanto (MON) on inevitable setbacks as we have seen recently should all prove rewarding over the next few years. The fallout from lower seed and fertilizer use this year should boost demand beyond 2010 as harvests suffer. A broad based alternative exposure is the DB Commodities Tracking Index Fund (DBC).