Saturday, May 10, 2008

The Food Train Wreck - Feed Me Please!



INVESTING SCENTS By S. DALI

In just two months, rice prices have risen 75% globally, while wheat prices are up 120% compared with a year ago.

Prices of oil and commodities are another thing. Food is food. Central banks in Brazil and India, seeking to tame inflation, recently took new steps to slow down lending and throttle back growth.

India raised the proportion of deposits that banks must hold in reserve, and Brazil boosted its key interest rate for the first time in three years.

Last Tuesday, Thailand's central bank said inflation this year could be twice what it was in 2007. Rising global food prices are contributing to high food inflation in many countries (Sri Lanka (34%), Costa Rica (21%), and Egypt (13.5%).

China and Vietnam are battling their highest price increases in a decade or more. India, Russia, South Africa and much of Latin America also face a growing threat from rising prices.

In a report released earlier this month, the Asian Development Bank said the risk of spiralling inflation in the region is “palpable,” and noted that official figures tend to underestimate the phenomenon.

Higher interest rates and government moves to put the brakes on economic growth tend to be bad for stock prices.

Inflation also hurts stock prices by increasing input costs for companies and putting pressure on profit margins. While I have been highly critical of developed countries central banks for being too liberal in pumping liquidity over the past 10 years, the emerging markets central banks have also been doing likewise albeit at a smaller scale in recent years as well.

The biggest problem, which many are still not aware, is that unlike the subprime crisis and the credit implosion, a food crisis cannot be solved or minimised by pumping liquidity or through more bailouts. And this – you can't plant more rice or coffee overnight.

Hence the headline: it's a train wreck waiting to happen. It will happen. There is nothing much we can do to stop it. How's that for being optimistic?

On the wisdom of hindsight, the move to boost production of biofuels now, seems pretty lame. This shift has increased demand for bio-fuel raw materials, such as wheat, soy, maize and palm oil, and triggered competition for cropland.

Almost all of the increase in global maize production from 2004 to 2007 (the period when grain prices rose sharply) was used for biofuels production in the US, while existing stocks were depleted by an increase in global consumption for other uses. The use of land to grow corn to feed the ethanol maw is reducing the acreage devoted to other crops.

Food processors who use crops such as peas and sweet corn have been forced to pay higher prices to keep their supplies secure and these higher costs have been passed on to consumers.

Similarly, with crude palm oil. The shift in turning edible oils and crops into fuel has resulted in a demand and supply shift. We are all seeing the consequences of that. In addition, it is not just an issue of absolute supply (of crops and edible oils).

The rise of biofuels also depletes the land available for genuine agriculture. Less land, more competition (for the land).

The rush in modern China to turn traditional farming areas into industrial zones or residential areas for expanding cities has decreased arable land to critical levels.

Climate change has hit certain important regions. Six long years of drought in Australia has reduced its rice crop by 98% contributing to a doubling of rice prices in the last three months. In several countries like Kazakhstan, China, Mongolia and Afghanistan, winter crops were devastated by extended periods of freezing temperatures. In Bolivia, severe floods have resulted in crop and livestock losses.

Not just 'An Inconvenient Truth': we will see rising frequency and intensity of floods and droughts due to global warming that will lead to a prolonged food crisis.

The food crisis is not an IF but WHEN.

Things we will hear more often for the rest of the year: levying export taxes and export bans to maintain domestic supplies; raising import tariffs; heavier monitoring of smuggling; further acceleration in price spiral; more riots and social unrest in particular from the poorer nations; heavy handed subsidies; and a lot more high powered talks and conferences on the food crisis that will not amount to much.

These high prices make it nearly impossible to cut the extensive subsidies maintained by many emerging economies.

With prices rising though these subsidies impose major fiscal costs. But removing them could cause greater political and social welfare costs. High oil prices are already making their way through the food production chain. Machinery, transportation and fertilizer costs will also rise.

With most commodities priced in dollars, a fall in the dollar usually implies a rise in prices. Any increase in commodity prices (in dollar terms) is particularly costly to those countries whose currencies track the dollar.

Even stocks in those supposedly good sectors with positive black swans (food manufacturers, plantations), their earnings jump will be regarded as an anomaly and would not get a long term hike in PER valuation.

What can the governments do? Put more funds into subsidy? Putting more into subsidy literally means putting more funds to chase after the limited fixed supply of goods – you can bet prices will rise as well as hoarding and panic. This is a case of people getting richer but clamouring for a reduced supply of goods. Prices get bid higher.

Unlike oil, which on a relative scale affects corporations a lot more, food prices leaves its imprint on a much larger and across the board segment.

We will have to live with much higher food prices, not to mention fuel prices.

Governments will have to pay higher salaries for civil servants. Countries like Malaysia will be net beneficiaries as we have oil royalties and plantations to help cushion the blows. Without a doubt, resource-poor nations will feel the heat. Developing economies with high poverty levels will be hit especially hard.

Even the aid in US dollar have depleted in value. In other words, it can now buy a lot less on the back of rising cost, which translates to less aid.

A looming food crisis equals spiralling inflation equals restrictive market policies equals higher interest rates to curb spending, which then translates to not-so-good news for equities.

A looming food crisis also means mounting government subsidy, controlled prices breaking loose that may lead to social unrest and riots which also translate to not-so-good news for equities. The greatest damage from this oncoming food train wreck is not the shaky outlook for equities but the unravelling of years of development aid to the poorest nations. Soaring global commodity prices will force the World Food Program to scale back food aid.

Food makes up 50 to 60% of household income, the rising prices is leading to social unrest in Haiti, Indonesia, Peru, Egypt, Cameroon, Ivory Coast, Senegal , Ethiopia and many more countries.

While the gap is still large between the poorer developing nations and developed countries, much ground has been made to close that gap over the last 20 years. Now in just one major looming food crisis, a lot of the “good” is threatening to go down the drain as the gap widens yet again.

p/s photo: Lee Ji Ah ... she is so my type, not over the top pretty but the demeanor is just right


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