The Correlation Between Inflation & Farmland

Farmland has historically been correlated to inflation. But what does that mean? Why should you care? And how could it fit into your investing strategy? Let’s dig in.

Climbing Inflation & Economic Uncertainty

Since the 1980’s, the US economy, along with other developed economies, has been in an environment of decreasing inflation. But in 2021 that changed as supply chain disruption pushed inflation north of 3% and interest rates followed. This has challenged our views on expected inflation. According to the Federal Reserve, uncertainty around expected inflation in April 2023 was double the same time in 2019. Investors are increasingly looking for asset classes with a correlation to inflation to help manage this risk.

Past performance does not guarantee future results and there is no guarantee this trend will continue. Source: St. Louis Fed.

What is an inflation hedge?

Inflation hedges are assets or investments that have the potential to preserve or increase their value in times of rising inflation. Inflation erodes the purchasing power of currency over time, so investors look for assets that can outpace inflation and help protect their wealth.

Why is farmland considered an inflation hedge?

Farmland is often seen as a strong hedge against an inflationary environment. This is not only because of its longstanding correlation with inflation, but also because of the fundamentals that drive its value. A farm’s value can be distilled down to the value of the food, fuel and fiber commodities it produces. The price of commodities is an important piece of the Consumer Price Index (CPI), around 40% of the index. In fact, commodity crops such as corn are finding new uses and becoming further embedded in our lives. This has led to a strong correlation between corn prices and the cost of all goods. Below is a chart which shows that, over more recent time periods, the link between corn prices and inflation has become stronger.

Past performance does not guarantee future results and there is no guarantee this trend will continue. Source: USDA and Yale.

What is the correlation between farmland and inflation?

So what does the cost of corn have to do with anything? This correlation between the income received by a farmer for their crop and the prices of goods on store shelves is what drives farmland values to move in sync with inflation. Since the start of annual land value surveys in 1910, the appreciation of farmland has been positively correlated with movements in the CPI. In fact, farmland is 54% correlated with the CPI, compared to a -5% correlation seen by the stock market, as measured by the S&P 500.

Past performance does not guarantee future results and there is no guarantee this trend will continue. Source: USDA and Yale.

Why does farmland follow inflation more closely than the stock market?

The stock market is frequently buffeted by movements not associated with changes to CPI or to interest rates. This increases the volatility of values, with returns being 130% more volatile in the stock market than in farmland prices on an annual basis. Other assets such as real estate (30% more) and gold (50% more) also exhibit more volatility than farmland.

This volatility reduces the correlation between other assets and CPI. Farmland has a direct tie to commodity pricing and therefore a much tighter correlation. The more a farmer receives for their crop, the more they can pay in rent. This tie can be made more direct with the inclusion of a flex provision which allows an investor to further participate in a farmer’s upside.

Why choose farmland over other inflation hedges?

Other Inflation Hedges

Some other common inflation hedges include:

Real Estate: Physical properties like residential or commercial real estate tend to perform well during inflationary periods. Rental income from real estate has the potential to increase with inflation, and property values may rise in tandem.

Precious Metals: Gold, silver, platinum, and other precious metals are often considered safer assets during inflationary times. Their intrinsic value and limited supply make them attractive stores of wealth.

Long-Term Treasury Bonds: Long-term U.S. Treasury bonds can act as an inflation hedge to some extent. Their fixed interest payments may become more attractive during inflationary periods, if interest rates rise with inflation. However, their value can be eroded by inflation over time.

Certificates of Deposit (CDs): CDs are time deposits offered by banks with fixed interest rates and maturity dates. While they don't directly protect against inflation, they can be part of a broader strategy to manage inflation risk. By laddering CDs with staggered maturities, investors can periodically reinvest in new CDs with potentially higher interest rates if inflation rises.

Two Sources of Potential Returns

One aspect of farmland investing we haven’t touched on yet is the potential returns it provides. Farmland has the potential to provide a hedge against inflation while also providing both potential returns from annual rent and total land appreciation over time. Since 1991, farmland returns, as measured by NCREIF Farmland Index, have exceeded returns to other select investments that investors may consider during inflationary periods, as shown below. While CD’s provide annual return potential, and gold can appreciate, farmland has the potential to provide both of these sources of return. There are several key differences between farmland, gold, and CDs to keep in mind when examining this information as described in text below charts.

Source: NCREIF, Yale, Federal Reserve.
Past performance does not guarantee future results and there is no guarantee this trend will continue. Note: This data covers periods 12/31/1990 - 12/31/2022. All returns are estimates of average annual returns and do not assume reinvestment of dividends. Index information is provided for illustrative purposes only and is not meant to represent the results of an actual investment. Returns do not include any management fees, transaction costs or expenses. The historical performance of each index cited is provided to illustrate historical market trends. Risk/reward profile for each asset class varies significantly. This should not be construed as a recommendation of any specific security. You cannot invest directly in an index.

Each type of investment vehicle has differences from others in terms of fee structure, liquidity, risk exposure, tax impacts, and objectives. For example, Bonds / Treasuries are subject to interest rate fluctuations, issuer credit and call risks. CDs are typically shorter-term investments, FDIC insured and are subject to interest rate risk. Commercial Real Estate is frequently subject to credit, liquidity, interest rate, and inflation risks. An investment in the S&P 500 is liquid, but subject to valuation and inflation risks. Gold can experience high price volatility.

Data source: NCREIF, Yale, NYU Stern and the Federal Reserve. "Farmland" = NCREIF Farmland Index. "Real Estate " = NCREIF Property Index. "Treasuries" = U.S. Treasury 10-Year Bond. "CD" = FRED 3-Month Rates and Yields: Certificates of Deposits. “Gold” = NYU Stern Gold Returns - Aswath Damodaran.

Higher Risk-Adjusted Returns

Another point to note is that farmland returns, as compared to other potential inflation hedges, have historically experienced stronger risk-adjusted returns. This means that farmland returns are larger relative to the volatility of those returns. In fact, the Sharpe ratio for CD’s since 1991 is negative, indicating that they have produced less than 3% annual returns, the risk-free rate assumed in this analysis. Meanwhile, farmland’s Sharpe ratio of 1.22 is almost double that of the general real estate market as measured by NCREIF’s National Property Index.

Past performance does not guarantee future results and there is no guarantee this trend will continue. Note: This data covers periods 12/31/1990 - 12/31/2022. All returns are estimates and do not assume reinvestment of dividends. Index information is provided for illustrative purposes only and is not meant to represent the results of an actual investment. Returns do not include any management fees, transaction costs or expenses. Volatility is measured as the standard deviation using the monthly total returns of each index or asset class. The historical performance of each index cited is provided to illustrate historical market trends. Risk/reward profile for each asset class varies significantly. This should not be construed as a recommendation of any specific security. You cannot invest directly in an index.

Each type of investment vehicle has differences from others in terms of fee structure, liquidity, risk exposure, tax impacts, and objectives. For example, Bonds / Treasuries are subject to interest rate fluctuations, issuer credit and call risks. CDs are typically shorter-term investments, FDIC insured and are subject to interest rate risk. Commercial Real Estate is frequently subject to credit, liquidity, interest rate, and inflation risks. An investment in the S&P 500 is liquid, but subject to valuation and inflation risks. Gold can experience high price volatility.
Data source: NCREIF, Yale, NYU Stern and the Federal Reserve. "Farmland" = NCREIF Farmland Index. "Real Estate " = NCREIF Property Index. "Treasuries" = U.S. Treasury 10-Year Bond. "CD" = FRED 3-Month Rates and Yields: Certificates of Deposit. “Gold” = NYU Stern Gold Returns - Aswath Damodaran. Stocks= S&P 500 Total Returns.

Conclusion

Farmland values are directly related to the commodities the farm economy produces, and therefore to inflation. Farmland values have historically moved with inflation, and total returns to the asset class over the past 30 years have exceeded other asset classes favored in inflationary environments.

So as you consider adding inflation hedges to your investing strategy, don’t overlook the benefits farmland could provide. Not sure how to get started with farmland investing? Take a look at our guide here.

The above content is not intended to be a comparison between products but is intended for general, educational, and informational purposes only. Any performance noted is historical and there is no guarantee any trends will continue. All investing involves risks, including the complete loss of principal. Diversification does not guarantee a profit or protect against loss in a declining market. It is important for each investor to review their investment objectives, risk tolerance, tax liability, and liquidity needs before investing. Investment vehicles have differences in fee structure, risk factors, and objectives. Investments are considered speculative, involve a high degree of risk, and therefore are not suitable for all investors.

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