Feeding inflation – The enduring soft commodities boom

Spiralling household costs in the form of energy and food are here to stay. The devastating floods which have battered the crops of Mid West America are the latest in a series of supply side shocks to drive the price of food skywards. To say the world is in the midst of a food crisis is no overstatement. A rapidly expanding global population, increasing affluence in the developing world and the rise of biofuels, are all feeding a growing soft commodities bull market.

Our bullish stance on commodities, in particular on gold and oil, is well known. And this position extends to soft commodities too, albeit for different reasons.

The fate of the US dollar continues to look perilous. As the US Federal Reserve gloves up for a fight against recession, it is appears increasingly powerless to stop inflation racing ahead. And the resulting weaker dollar will in our opinion only serve as rocket fuel for commodities prices.

Earlier this year we spoke of the damage being done by the flood of US dollars in circulation within the global economy. Well, now it is floods of a literal kind in America’s heartland which are doing the damage.

While more and more of the arable land in the US finds itself underwater by the day, the Chinese and India juggernaut continues in the fast lane. Over in the East, rampant growth is being supported by both global AND domestic demand. And these prospering economies are working up quite an appetite.

Indeed, with current levels of demand for food showing little sign of abating, production levels in some crops are not managing to keep pace. In our view, this supply/demand chasm will only widen.

Accounting for approximately 70 percent of global exports for corn and approximately 40 percent for soybeans, the US is the world’s biggest producer of the two commodities which are on a tear at the moment.

Recent events have seen some US farmers lose their entire corn crop, with estimates of more than 400,000 hectares being abandoned. The impact on price has not gone unnoticed.

Importantly, over the long term the price of corn has jumped over 71 percent this year. Indeed, this would be the fourth consecutive annual gain and, according to the US Department of Agriculture (USDA), global corn inventories as of August 31 will drop to the lowest in 24 years.

For soybeans also, the clear upward trend in price cannot be ignored. Prices have gained 28 percent this year and reached a record $15.865 per bushel during March.

Production of wheat, has also fallen victim of the weather. CBOT Wheat Prices jumped 7 percent in a week and in our opinion, such price moves will be sustained over the long term.

Whether or not global warming is to blame the fact is that the planet’s climate is becoming increasingly volatile and acute. Droughts, severe winds and floods are hitting the headlines on a more frequent basis. These events, more so than for other goods and services, can have a significant influence on supply.

Indeed, the “100-year” floods that are currently erasing the Midwest grain crops are precisely the kind of natural disaster that, under many climate forecasts, will become routine a few decades from now.

And whilst supply is being choked, the planet has never been hungrier.

The principal force behind the soft commodities freight train is the growth of the world population. It is anticipated there will be 9 billion mouths to feed on the globe by 2050. And no matter the economic climate, the population has to eat.

Not only is population soaring, but many of the newcomers are wealthy enough to eat meat. Given that it takes an average of eight pounds of grain to make a pound of meat, the dietary requirements of the world’s burgeoning middle class is resource intensive.

It is not only food consumption which is underpinning demand. A greater proportion of agricultural production is set to go toward producing fuel, rather than feeding people.

With the United States keen to reduce their dependence on oil, plans to increase the use of biofuels will raise competition between food for fuel or for eating.

We are far from conviced that ethanol is the answer to soaring energy costs. Doubts have arisen about its ability to lower net CO2 emissions (processing is energy intensive), and the diversion of crops to biofuels has contributed significantly to higher food prices.

In fact, in the US, 20 percent of corn now goes into highly subsidised ethanol production. Yet despite these widely apparent inefficiencies, ending subsidies will require overcoming significant political hurdles.

For now at least, the alternative energy industry is playing its part.

The strain on supply is clear for all to see and disappearing farmlands and global water shortages elsewhere are exacerbating the problem.

Food production is highly water intensive. And according to the UN, agriculture is the number one consumer of freshwater.

Looking ahead we believe the problem is only going to get worse as water becomes costlier. In the same manner in which high corn prices have propelled all meat to ‘sirloin’ prices, a jump in the price of water will further propel the price of food.

In addition, farmland is increasingly scarce. Most of the readily arable land is already under cultivation and much of what remains is in forest. More and more land is being used for producing corn for fuel, leaving less space for food production. Also, as the level of housing and business development increase it is farmlands that are making way.

Add to the mix the prospect of declining subsidies in countries where production is uneconomic, and the case for falling supply is even more than compelling.

In our view, an aging western population will divert government spending away from agriculture. This in turn will lead to an increase in agricultural prices, reflecting the real (economic) cost of production.

All factors considered, the current climate of constrained supply in the face of insatiable demand looks set to continue. The supply side is in desperate need of assistance. High petroleum prices as well as underinvestment in agriculture technology add to inefficiencies of production which will force the price of agricultural commodities to increase over the long term.

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