January 24, 2011

When Food Prices Attack!

How central bankers will save us from rising food prices
Joel Bowman
Joel Bowman
Manning the trenches in Buenos Aires, Argentina...

En garde, Fellow Reckoner! We're under attack!

Jean-Claude Trichet, head of the European Central Bank, has sounded the alarm.

"All central banks, in periods like this where you have inflationary threats that are coming from commodities, have to...be very careful that there are no second-round effects" on domestic prices, Mr. Trichet told The Wall Street Journal from his office overlooking Frankfurt's financial district.

Can you believe it, Dear Comrade? If we are reading Mr. Trichet's comments correctly, it would seem that the world's food and energy communities are consciously rallying against us. Long thought to be soulless, mindless vegetables and minerals, commodities have apparently taken it upon themselves to "become" more expensive, to raise their own prices. We can almost hear the battle cries coming from the fields: Ears of corn unite!

Farmers are warned to sleep with one eye open lest an overzealous head of lettuce break ranks and attack under cover of darkness.

Mr. Trichet is busy marshalling the euro zone's 17 member countries ahead of this weekend's World Economic Forum in Davos, Switzerland. He's encouraging them to strengthen "surveillance" of each other's fiscal policies.

The fearless Frenchman noted that it is budget discipline that most benefits growth and job creation by "improving confidence of households, enterprises, investors and savers."

Amazing! What would we do without the world's central bankers, our frontline defense against self-inflating food prices? How would we know to save and invest if it were not for the battlefield cries of these intrepid, fiat fiddlers?

Waste...malinvestment...market distortions...worldwide food riots... There we go but for the grace of all-knowing central planners everywhere.

And yet, despite the best efforts of our monetarist saviors, food prices have been stubbornly rising across the planet. The Moscow News has the story:

Food prices shot up in the second half of the year following the summer's global drought, and a similar catastrophe in 2011 could send the world towards disaster.

The average basket of food products rose 10.6 per cent, exceeding inflation, which reached 8.8 per cent.

But global food inflation reached 25 per cent year-on-year at the end of 2010 - up from its low of 7.5 per cent in June before the drought hit.
What's going on here? How is it that an army of corn - up 94% since June, as Chris Mayer points out below - has outsmarted our finest academics?

Here's a thought: Perhaps, as Milton Friedman so eloquently explained, inflation really is "always and everywhere a monetary phenomenon."

True, in accepting this fringy position we'd also have to believe, as Friedman posited, that there's "no such thing as a free lunch." Crazy? Sure. But let's allow our imagination to wander for just a moment...

Let's say that, by inking trillions of dollars in new bills, central banks are actually causinginflation rather than raging against it.

What then?

Yes, yes... We know the "Bernankes" of the world are acting with our best interests at heart. We understand they know just which lever to pull and which knob to turn at precisely the right moment. But what if, somehow, they got it wrong? Would we see inflation leaking into the markets, pushing up prices at the pump and the grocery store?

What we need here is a recon mission. So tell us, Fellow Reckoner, what's going on in your neighborhood? Are you noticing a price creep in your monthly bills? Could it be that inflation is already here, that it has infiltrated our defenses and lurks in our very midst?

A story I've been warning about for years is making sensational headlines right now.

It's a story most people don't realize could make a huge impact on all of our portfolios in a number of ways.

"US Crop Stock Forecasts Deepen Fears of Food Crisis" read a recentFinancial Times headline. The US government cut its estimate for key crops. This came only a week after the UN warned the world faces "food price shock." Corn and soybean prices jumped and now sit at 30-month highs. Inventories are very tight. Corn is up 94% since June!

And the world worries about a repeat of 2008, when food riots erupted in poor countries around the world.

This has been in the works for a long time. It was there for all to see. The ratio of arable land to people has been falling for decades. Gains in crop yields have slowed. Population has expanded and income levels have grown. Diets have shifted. More people are eating more meat, which is much more grain-intensive to produce.

And the love affair with biofuels puts food production in direct competition with energy. Plus, there are water scarcity issues affecting food supply. My readers have made tremendous gains from this trend by owning shares of agricultural fertilizer producers Potash (POT) and Mosaic (MOS).

I should also make the point that this fits in with another topic I'm concerned about: inflation. Now, the man on the street uses the term "inflation" to mean when prices for everything seem to go up. Or put another way, inflation is when the dollars in his pocket buy less. In truth, this is the effect of inflation. The root cause is simply money printing. When you print more money, that money has less value than if you didn't print any new money at all.

So what we are seeing with rising commodity prices is not only the supply and demand story I led off with. It's also the effect of paper money losing its purchasing power in the real world of things. This, too, was easy enough to see. Finally, all that money printing - the "quantitative easing" baloney you've heard about - is coming home to roost.

Still, it's disconcerting to see it all playing out. For the sake of our world, I'd rather have gotten this one wrong. But we have to deal with the market we are in. So what might "Food Crisis II" mean from an investment point of view?

Food prices will have to rise: There is no way around this. We are all going to pay more for food. Wells Fargo predicts US retail food prices will rise about 4% this year. Some things will go up much more. Pork and beef could rise more than 10%.

This won't necessarily mean that meat producer stocks are good buys, because they may not get to raise prices to fully offset the rise in feed costs. Anecdotally, for instance, The Wall Street Journal cited a Minnesota 300-cow operation that reported feed costs had doubled. Plus, I've listened in to the conference calls of a number of food producers - Tyson, Hormel, and Sanderson Farms. They all talk about getting squeezed by rising feed costs.

I do think these companies will be good buys sometime this year, because people will adapt and farmers will respond. Producers won't produce meat at a loss for long. And farmers will bring every resource they have to bear. It's been slow getting the crops in the ground so far in many places. But ultimately, there is a lot of potential supply from Brazil and the US.

Still, weather is the big wild card here. If we have a drought in the US or in Brazil, this could really get ugly.

Emerging markets are vulnerable: This follows from the above. It doesn't really faze the typical American to have to pay 4% more at the grocery store. Food is still such a small part of the typical American's budget. I think Michael Pollan in The Omnivore's Dilemmapoints out that the US spends 9% of its income on food, which is among the lowest percentage of any people anywhere at any time in history.

The same is not true in India or China or many emerging markets. In China, people spend 50% of every incremental dollar on food. And in India, it's more like 70%. So the rising price of food is felt more keenly in these markets.

The price of food is rising faster in emerging markets, too. In India, food prices are up 18% and at their highest level in a year. China has the same problem. Prices rose 5% in November alone. All around the world, emerging markets have a big problem with rising food prices. Indonesia's president is trying to get people to grow their own chili peppers. And the South Korean government recently released emergency stores of cabbage, pork, mackerel, radish, and other staples. I could go on and on.

The point is that the emerging markets boom is not going to go far when it faces a food crisis. Already, the markets are starting to reflect this. India's Sensex was down three straight days and off 6% to start the year. Other markets also started badly. And if China and India and the rest slow down, it's going to have a huge impact on all those stocks and commodities most sensitive to emerging market growth.

I'm keeping a close eye on these developments. There will be opportunities in this crisis, as with all others. For instance, though rising grain prices are not good for meat producers or emerging markets right now, it's a boon for fertilizer stocks. As the old golf saying goes, "Every putt makes somebody happy."


Chris Mayer
for The Daily Reckoning

1 comment:

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