Food Prices Will Rise for Years

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Illustrating how tight the global grain markets are becoming, and the concern of governments over higher grain prices, yesterday Russian Prime Minister Vladimir Putin said he had signed two governmental resolutions to start supplying grain from the state intervention fund to Russian regions affected by this year's abnormal heat and drought. "We will separately send the necessary volume of feed grain to the regions, which need to support their cattle breeding while food grain will be sent to Moscow, St. Petersburg, the Moscow and Leningrad regions. The work will start in the nearest future. The documents have been signed and will be released today," Putin noted.

The Ukraine, also hit by drought last summer, extended its grain export quota, due to end on December 31st, until the end of March 2011. The draft resolution proposed additional quotas for the exports of 500,000 tonnes of wheat and 1million tons of corn.

The U.S. Grains Council this week released a study that indicates China may boost corn imports to a record next year as the U.S. Corn purchases may grow fivefold from 1.5 million metric tons this year “to upward of” 7.4 million tons in the 2011 calendar year, Thomas Dorr, president of the industry group, said in an interview. China, as the world’s biggest grain user, may overtake Japan as the largest corn importer within five years buying as much as 25 million tons by 2015. This would drive prices higher as rising incomes fuel demand for pork and chicken, Rabobank Groep NV said last week.

China “sends the appropriate market signal to the world that there is new demand for corn,” Dorr said yesterday. “Whether the Chinese ultimately take 5 or 7 million or 10 million tons of corn, whether they take from us or they take it from Argentina, we don’t know,” he said. Corn has jumped 42 percent this year, climbing to a 27- month high of $6.175 a bushel on Nov. 9 after the U.S. government forecast smaller-than-expected supply. The contract for March delivery traded at $5.8650 a bushel in Chicago this week.

Even the International Energy Agency (IEA), an energy watchdog for the developed economies, noted last week that rising food prices in China were above the 4.4% inflation level in official Chinese statistics. An estimated 60% rise in vegetable costs and some other commodities, "could herald rising domestic tensions if left unchecked," the IEA said. "The government has reacted by announcing a series of price controls targeting several commodities, and has vowed to fight 'speculators'." Like Russia, China may import or distribute grain or food to areas impacted by higher prices and disappointing supply.

Currently reports indicate drought conditions are seen affecting 17% of China’s winter wheat growing area, with the dry weather forecast to extend until spring next year.

In the U.S., the tax bill passed last night extends the Volumetric Ethanol Excise Tax Credit (VEETC) through 2011 at the current rate of 45 cents per gallon, as well as the associated tariff on imported ethanol at the existing 54 cent level. The bill also extends through 2011 the 10 cent per gallon producer tax credit for small ethanol producers producing no more 60 million gallon of ethanol a year. The tax credit is applicable to just the first 15 million gallons of production for eligible producers. With 37% of the U.S. corn crop used this year for ethanol production, the extension of the tax credit assures robust demand for corn for this market next year.

The Financial Times published a column by Gavyn Davis earlier this week on why commodities, including agriculture and energy sectors, will be an attractive area to invest in next year:

Since the rally in risk assets started in August, commodity spot prices have risen by about 20 per cent and there is a case for worrying that this may be a crowded trade in the near term. But current investor holdings of commodities represent less than 0.5 per cent of global financial wealth, whereas portfolio optimisation techniques suggest that the “correct” share of wealth that should be allocated to commodities is in the order of 15-25 per cent. So there is an enormous distance to go before investing institutions are likely to be satiated with commodities.

Furthermore, this is the phase of the global economic cycle when commodity prices tend to rise most rapidly. The early stages of the rebound in world output had relatively little effect on commodity returns, largely because the responsiveness of supply proved greater than had been expected. Producers had substantially increased their capacity during the price boom of 2005-07, and this capacity was brought on stream as demand began to pick up. But the cushion of spare capacity has now largely been used up, so price pressures could be much greater if global commodity demand continues to expand rapidly. . . .

The growth rate of global industrial production has dropped during 2010 from an annualized rate of about 11 per cent in Q1 to about 3 per cent in Q4, largely because of a fall in the contribution from inventories in both China and the US. But the inventory adjustment is now virtually completed, and industrial production may bounce back to about 6 per cent growth by mid 2011, bringing with it a further strengthening in commodity demand.

Unlike in the past 18 months, supply may not be able to cope with this, so much higher prices could ensue. This is especially true in cyclical commodities such as oil and industrial metals. And a further boost to returns will come from the fact that the futures curves in many important commodity markets have recently shifted from “contango” to “backwardation”, meaning commodities for immediate delivery now command a premium.

. . Equally importantly, the correlation between commodity and equity returns has been negative for most of that time, establishing a clear benefit for commodity holdings portfolios. But the exact opposite has been the case in the past few years. In fact, since 2007, commodities have shown a positive correlation with global equities averaging as high as 0.8 or 0.9, which seems to negate their diversification benefits. These high positive correlations are most unlikely to prove permanent. . .

What type of shock seems most likely in 2011/12? Provided that Chinese growth survives the current tightening in monetary policy, as it probably will, both China and the US will soon be growing simultaneously at close to their trend rates. During 2008, when this last occurred, the combined growth of the world’s two biggest economies finally proved too much for the supply capacity of commodity producers, and spot commodity prices trebled in a very short period. . . .We may discover in the next few years that a healthy US recovery is not compatible with rapid emerging market growth without some strong upward price pressure on commodities. . . .

Even the United Nations warned last week that the U.S., the world’s largest wheat shipper, may not have the logistical capacity to meet rising global demand after rains cut the quality of the harvest in Canada and Australia. As much as 8 million metric tons of Australia’s wheat harvest may be downgraded because of excessive rains and Canada’s output suffered from wet weather, pushing importers to seek alternative suppliers according to the UN Food & Agriculture Organization, citing government estimates.

A UN spokesman noted “right now, the only country that would have such supply to compensate for the downgrade of Australia and also Canada would be the U.S. The problem is that the capacity in the U.S. for terminals to absorb enough milling wheat for shipment, it’s just not there.”

Last, as the Great Lakes shipping season comes to an end the port of Duluth reports this was one of the busiest seasons in many years with overall traffic up 25 percent. Activity was up mainly due to grain shipments which were up 60 percent over last year. With no Russian grain on the market due to the export ban the world has turned to the U.S. to fill the need. The Russian export ban has been extended to next July and may be extended depending on the results of the Russian spring wheat crop. The port is the largest on the U.S. side of the Great Lakes.

The port's main grain is hard red spring wheat; North Dakota is by the far the nation's largest producer of it, and Minnesota usually ranks second or third. This year, U.S. hard red spring wheat production was up 6 percent over last year. Grain moved out of Duluth to countries the port hadn't shipped to in years, Egypt and Turkey -- nations primarily served by Russia, said Ron Johnson, trade development director at the Seaway Port Authority of Duluth, a public agency. We examined several investment opportunities based on this theme (higher activity in grain and ore shipping in the U.S.) but found no attractive investment candidates.

Bottom line is that the demand and supply balance in global grain markets should remain favorable for the agricultural sector for a number of years, and with higher prices additional capital should be allocated to the sector.

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About Joseph Dancy