U.S. corn futures have risen 75% this year. Much of that rise can be attributed to the “ethanol” hysteria sweeping the country. I still believe ethanol to be a fad…a trend whose long-term staying power may rival the impact of Pet Rocks in the 1970s.

Any energy source that yields roughly 10% more energy than was required to produce it won’t last all that long. And that’s assuming we divert 10% of the world’s landmass, or the equivalent of all the land currently under cultivation, to grow enough biomass to meet the world’s energy needs.

But that’s not to say I’m not a long-term believer in corn. Well, not so much corn as the growing need for massive amounts of food and water.

As the 5.5 billion people currently residing in emerging economies begin to rise among the ranks of the consuming class, the demand for these life-sustaining resources will only continue to grow.

By 2040, the transfer in global economic power will have completed this dramatic shift. The five largest economies by GDP will soon include India and Mexico:

Source: IMF, Goldman Sachs

Assuming population demographics remain constant, by 2040, China, India and Mexico alone will be responsible for feeding roughly 2.5 billion citizens.

Arable land and potable water will no longer be deemed a disposable resource.

But I’m still not quite sure of the best way to play it…still working on that one.

The Greatest Real Estate Market in the World

Another note worth mentioning this holiday season: Sun Hung Kai Properties, Hong Kong’s biggest developer, paid $231 million, $5,409 per square foot, for a residential site on the central island’s coveted peak.

The company plans to develop eight-10 residential houses on the site. Let’s assume it develops 10 houses. Even before the foundations are laid, the average price of the houses in question would run a cool $23.1 million just to cover the acquisition cost.

Now let’s assume the company expects a 20% internal rate of return. That would elevate the price of a single house to roughly $28 million. Let’s throw in $2 million for construction costs. Our rough estimate for the market price for one of these homes starts at $30 million.

As one individual in the office asked: Who can afford something like that? Well, when you consider CEOs from some of the top S&P 500 companies now earn up to $50 million a year… and considering compensation for leaders of the mightiest financial service firms has reached the $30-35 million range per annum, the market for potential buyers is certainly greater than one might think.

But America isn’t the only land of the rich. According to Forbes, China posts 15 billionaires…India can now claim 36. The entire Asia-Pacific region now boasts 115 members to this exclusive club.

And that group will receive a natural bump when their fortunes, based in foreign currencies like the yuan, eventually rise against the dollar…that can add a substantial gain on the Forbes U.S. dollar-based list.

But how does this relate to Hong Kong real estate?

Money will flow where it’s treated best. And I think you’d be hard-pressed to find any other place in the world that treats money better than Hong Kong.

The highest tax bracket comes in at 17%. Individuals are only assessed on annual employment income. And like the low personal tax rates, Hong Kong’s estate tax holds a maximum rate of 15% on assets exceeding US$1.35 million. So when Li Ka-Shing, the world’s 10th richest man, looks to pass on his $18.8 billion, he’ll do so under very favorable circumstances.

And here’s the kicker…

Hong Kong recently repealed its inheritance tax on property. Consequently, many Hong Kong property owners (U.S. citizens who own Hong Kong property are still taxed under U.S. inheritance laws) are now able to pass down real estate assets without any tax liability whatsoever.

Real estate is a great way to amass a fortune. Forty-six of the world’s billionaires, roughly 7%, made their money in real estate…and 28% of those live in Hong Kong, Japan or Singapore…and those markets are just getting started.

If you can’t buy the assets directly, property stocks in those regions should perform wonderfully for years to come.

Corporate Debt and the Magic of Private Equity

One final note to wrap up 2006…I also noticed that Moody’s downgraded Pfizer’s Aaa credit rating to Aa1. I find this interesting for a couple of reasons.

In 1979, there were 61 Aaa-rated American companies in the corporate landscape. By the early 1980s, that number had dropped to 32. Today, excluding financials like Berkshire Hathaway, only five remain: Exxon Mobil, General Electric, Johnson & Johnson, United Parcel Service and Automatic Data Processing. (Someone asked me about Microsoft…Companies with little or no debt, like Microsoft, generally don’t acquire credit ratings.)

Companies have been taking on more and more debt. They do so to fuel growth and satisfy shareholders. But in the wave of this private equity shopping spree, debt growth has really caught my attention.

The Financial Times reported that U.S. companies are now issuing debt levels on average 4.4 times their EBITDA. Thirty percent of the $122.7 billion in new debt issued in the U.S. in 2006 was rated B- or lower.

In 2000, the amount of high-yield debt issued in the U.S. was roughly $38 billion.

For some reason, we seem to believe debt doesn’t matter. Using the American government as a role model, one can see why.

But ask any business owner the one sign that frightens him about a business and he’ll most likely tell you too much debt.

Regardless of size, too much debt is the first red flag one should look for when evaluating a company. A debt-to-equity ratio greater than 1 almost always gets the proverbial ax when I search for investments.

Readers of The Daily Reckoning will note a good quote by Michael Lewis. “Private equity is not served up without piles of debt — the typical debt-to-equity ratio of a company after it has been bought by a private equity firm is 2-to-1 — so the actual purchasing power in the hands of private equity fund managers is something like three times as much as they have in their bank accounts. It’s as if a giant and especially successful new stock market has been created alongside the old one.”

I’m not sure how this global mountain of junk debt will eventually come to an end. I’ve got a pretty good guess, though.

Barton Biggs once said, “Discovery and success always kill the goose that lays the golden eggs.” In the 1990s, it was tech stocks…today, it’s hedge funds and private equity. Everybody wants to be part of the action. And they’ll pay whatever price it takes.

I certainly hope any of you aren’t planning to pay that price.

Have a wonderful holiday season.

Christopher Hancock
December 22, 2006

Investing in Agriculture was originally featured in the Penny Sleuth.