PORTFOLIO POINT: Inflation is generally the last thing on anyone’s mind as economies suffer from deleveraging and calls are made for monetary easing, but in the price of food and fuel it’s still a worry.
Visitors are often surprised that the year 2008 was remembered in Australia by a unique, three-letter acronym: the GFC.
Yet while the use may be distinctive to our shores – almost everywhere else it's just known as just "the recession" or "the financial crisis" – the acronym isn't. Indeed, in many other countries, from Haiti to Burma to Bangladesh to Yemen, the GFC of 2008 was ubiquitous. Ubiquitous as the Global Food Crisis.
Roughly correlating with the boom and bust of 2007-09, the Global Food Crisis sowed the seeds, as it were, not just of agricultural policies and trade over the forthcoming years – leading to an acceleration in land, fertiliser and farm machinery prices – but to the Arab Spring of 2010-11, which also roughly correlated with a second food price spike, which only just eased-off in the second half of last year.
There were many theories as to what propelled the crisis, ranging from the structural (population growth, increased soil salinity, global warming) to the cyclical (poor weather conditions, market distortions, higher oil prices) to the conspiratorial (financial speculation, the effects of quantitative easing, biofuel subsidies in the United States). Yet what made the crisis stand out from previous commodity spikes was that the confluence of factors was greater than ever before. And, I fear, there’s a confluence of factors building yet again.
Source: Also Sprach Analyst, National Bureau of Statistics
My favourite leading indicators for wider agricultural commodities are oil and wheat, both of which have resumed an upward trajectory, on geopolitical worries in the Middle East and an extremely cold European winter respectively. The trend for wheat prices looks especially interesting with the commodity’s 50-day moving average (the red line the above graph) turning the corner towards what could become a bullish crossover with the 200-day moving average (the pink line). That, to me, coupled with higher crude prices, would signal a new bull market in agricultural commodities and a likely repeat of the self-propelling events of 2007-08 and 2010-11, when oil and wheat foretold similar spikes. (For more on my outlook for oil, see Fuel for thought)
And with food price inflation in China already hitting 10.5% year-on-year in January, up from 9.1% yoy in December (see chart above), that looks especially ominous for Australia’s biggest trading partner, especially considering that overall inflation (4.5% in January) should be markedly lower considering a shock 15.3% yoy drop in imports for the month and a widespread fall in home prices.
If anything, China’s National Bureau of Statistics is probably understating food price inflation and overstating the contribution from other items. In February last year, China's statistics bureau increased the CPI weighting for real estate by 4.22% and reduced the weighting for food by 2.21%; a small adjustment, which could be read as a move to under play a crucial social issue in China. Either way it is symptomatic of the ever-changing nature of Chinese economic numbers. And if understatement is the case then that explains China’s very tepid response this weekend to calls to stimulate lending through a 50 basis point cut to the reserve requirement ratio. China can ill-afford yet more inflation considering the country’s political uncertainty this year (see Enter the dragon and China risks out of the shadows).
Oil and grain prices also feed into the wider agricultural mix due to their impact on fertiliser, capital and feed costs, not to mention market sentiment. Yet the concern for food price watchers isn’t just on the supply side, but on the demand side as well.
While Chinese imports look weak, based on latest numbers, agriculture analyst Brett Stuart estimates that US pork and beef exports may rise 2.7% and 10.8% respectively. Indeed, amid a relatively subdued year for soft commodities generally, Chinese pork imports rose 134% in 2011, the majority of it from the United States, which resumed exports to China after May 2010 following a lifting of restrictions associated with the A-H1N1 influenza. Moreover, in 2011 the average price of imports was up 65% in local currency terms. Even the outlook for lamb is bullish so to speak. Meat and Livestock Australia's mid-season update earlier this month projected exports to China to grow 11% this year despite record prices and exports in 2011, amid general growth in lamb production of 6.4%.
As Chinese food imports grow and food security declines this will in turn place pressure on other emerging markets that don’t enjoy the purchasing power or access to credit that China’s state-managed economy does, thus leading to the shortages and price spikes experienced in 2008 and 2010-11. This will also feed into an emerging investment thesis that investors go long basic essentials (food, petrol) and go short discretionary items (clothing, electronics), or go long things bought with cash and short things bought on credit. It also feeds into the growing recognition that inflation in emerging markets can long co-exist with deflation in developed markets – a phenomenon that has to date meant food inflation is off the radar of most investors in the Western world, despite an expected increase in US food CPI from 2.5% to 3.5% according to the US Department of Agriculture.
And although the World Bank last month forecast improved supply, it did admit this will vary from country to country and with increased protectionism likely in the coming year, increased supply may only end up getting siloed (see Free trade on the bloc).
Although this southern summer’s La NiÃ±a climate pattern was not as severe as last year’s – the phenomenon that led to Queensland’s devastating floods – and although a mild recession in Europe and a slowdown in China is causing hard commodity prices to fall (even Tim Treadgold agrees – click here), food demand is sticky and a change to diet can be afforded even if larger consumption or capital spending cannot. What’s more, while fixed-asset investment growth is almost certainly in or exiting blow-off phase, China's consumption growth is only just picking up (hence my view on Goodyear Tire in Ten-gallon stock tips). Consumption as a share of China's GDP has been perhaps underestimated by at least 3% over the past 10 years, according to Peking University's Yiping Huang, and boosting consumption further is a stated government policy.
What this all means is that add in the resumed unrest in the Middle East and continued disquiet among China’s rural population and it would appear we’re in for another bout of food inflation. I remain bearish on commodities in general and most equities markets with the notable exception of the United States, but I’m looking at ways to regain equities exposure to food. In the coming weeks I’ll be profiling some of Australia’s (limited) agribusiness stocks and other ways to trade this dynamic (for previous ideas see Food for thought, Phosphate’s promise and Under the Radar: Does money grow on trees?).
Asset prices might be getting squeezed, but I see food’s contribution to the cost of living rising in the year ahead. Unless you’re exposed to agriculture as an investment thematic this could prove to be a bitter harvest.