Could the Farmland Bubble be about to Burst? What Will this Mean for Corn Ethanol

There's another bubble blown up and ready to pop. Its farmland all across the U.S. priced off the chart.  For the alternative fuel future this is an extreme danger moment, the prime driver for alternative fuels for decades in the U.S. has come from corn based ethanol, thus what happens to corn based ethanol will have an impact on everything else.  The trailblazer market is in danger from the basics - land.

The world corn market is not abundant right now - the U.S crop came up short - although there is no danger of a shortage.  The price for a bushel has increased from under $3 to over $5 since mid summer.  Up more than 66% has sent good incomes to farmers, taken a huge load off taxpayers and attracted loads of greedy investors into farmland.

But, just as in the 1980s, farming is a business, not a lifestyle.  In the 1980s there was a horrible bust, wiping out lots of farmers.  This time more land is owned and mortgaged by non-farm investors.  The lifestyle idea isn't dead, this time its investors thinking land is a "can't lose" investment.  History has contradicted that repeatedly for centuries.

For corn, an acre average across the U.S is about 160 bushels earning at $5 - $800.  From that subtract property taxes, say $50, insurance about $35, seed near $70, potassium and phosphorus $70, nitrogen near $100, weed control perhaps $50 and the basic costs are $375.  Most farmers are going to be at about this cost.  But that doesn't include the equipment to use all the supplies, or the time value to get it all in the right place at the right time.  Some farmers will get the work done very cheaply, others will be much more expensive.  In a low middle of the range add another $100 for equipment, $15 for fuel and maintenance and $30 for labor.  Now there's $575 in each acre.

Somebody owns the land and needs a return, or pay the mortgage - lets suppose they need 7% on a $2,000 investment per acre.  Add another $140 for a total cost of $660 leaving a profit of $140.

Now suppose the investor has a mortgage and paid $4000 per acre.  Add another $140 and the farming made nothing.  Say corn goes down $1 per bushel - the bills can't all be paid.  Say the yield isn't 160 bushels, the weeds won, the bugs got fat and happy, it didn't rain enough or too much, next year is a big crop and price falls back 66% - this is a scary business.

In fact, farmers today are all pretty bright.  Some are taking advantage of the pied piper's work.  Sell the land for an astonishing price, rent it back, leaving the new investor holding the boom, which will bust.  Then buy the bust back for pennies on the dollar.  It's a kind of new take on real estate flipping - instead of a lender holding a distressed property the target is a greedy investor - times have changed.

FDIC Land Prices Over Time

The land boom isn't going unnoticed by some sound minds.  Many see the boom has become a bubble, the FDIC, those folks who guarantee you get your money back when a bank folds up are spooked and mentioned a warning last week. State governments have noticed and hope to collect some revenue from those vastly increased values; those costs noted above are going up nearly as fast as the land.

The pied piper has a mob following cheering all the way.

The blood bath will be not so large as the home market collapse of the current recession. But the hue and the cry will be deafening to politicians.  Taxpayers could be raped again.

Most people in free countries have a notion that markets are rational things.  Nothing could be further from the facts.  Markets are irrational beasts leading to the ancient saying that never seems to stay in the minds of the greedy "buy low and sell high."  Farmland as easily seen above is way past the extreme risk of $4000 per acre, even double and more in some areas.

Just like houses and oil, this will crash, too. The risks are not just to farmers, but also to the consumers of farm products. The food vs. fuel crowd is nowhere to be seen, which says a lot about their intelligence, government could wake up and limit banks exposure to something sensible, but people are going to do as they believe is best for them.

Meanwhile, the media is beginning to shower attention - a warning sign for sure.  Articles that promote the never-ending boom are getting space that only fills the bubble.  One example, rife with contradictions, warnings and great advice for sellers with lots of "motivational" hype for buyers comes from a land selling business talking itself up in Market Wire.

Imagine your $7000 acre would earn $140 in a good year or 2% and could in a few months or years be worth 30 cents on the dollar or less.  That CD in the bank looks really good again.

The last thing the free world, the economy, the alternative fuels market, researchers to consumers need is a land boom and bust on top of everything else.

The foundation for alternative fuels, the proof in the idea to expand and secure energy and fuel supplies is corn ethanol.  Blow it and much of the rest will be destroyed or set back years.  It would be a shame to have a growth market distorted by rich investors making dumb mistakes forcing a bad effect on everyone.

About the only worthwhile thing to do is let policy makers know, this time the lenders, stockholders and investors have to take the full loss without bailouts.  Made clear in time, those land prices could rationalize before a huge bust.  The business proposition is already a failure at $2000 to 3000 for an average corn-producing acre over time.  If the lending support stops at 80% per average acre, the country might just dodge another bust to the economy.

Investing in oil, gold, real estate, everyone is trying to make a fortune doing - no work.  The liars figure, but the figures never lie - farming is a business and a whole lot of work.

It is a great time to sell high, but be quick.  Buying now is for dreamers who love the sound of the flute.  Let the bust come sooner than later.

By. Brian Westenhaus

Source: Beware the Pied Piper