“Food, Glorious Food…”
Actually, that should probably read: “Food, Expensive Food…”"I think we need to tell the American consumer that [prices] are going up. We’re seeing cost increases that we’ve never seen in our business.”
That’s direct from Larry Pope, chief executive of Smithfield Foods, the largest U.S. pork processor. And he’s merely voicing the beliefs of many in the agriculture industry, who warn that “real food inflation” is here to stay.
Next time you visit your local frocery store, you’ll see what I mean. Food prices have seen a widespread increase over the past year or so, due to intense demand and lower crop yields.
Follow the commodities industry like my colleague Lee Lowell and this will be no surprise. Lee is a former market maker on the NYMEX - one of the guys who actually used to set the prices of major commodities like oil and natural gas. To say he’s a commodities expert would be an understatement.
Lee tells me that there are three crucial factors that drive commodities prices:
- Supply and demand
- Inventory levels
- Weather conditions
Forget The Chaff… Wheat Soars To New Highs
That’s certainly the case in the wheat market. Sure, it doesn’t get much press, compared to dominant commodities like oil and gold, but if you take a look at wheat price action over the past year, you can see that it’s ballooned from lows around $5 in May 2007 to a recent high of $11.50. That’s a bigger price rise than oil and gold.
And Lee tells me that in dollar terms (on a futures options contract basis), it equates to a move of $32,500.
The reason for the move is a potent twin combo of growing global demand and a severe drought in wheat-growing regions.
What’s more, the trend is set to continue, according to both the U.S. Department of Agriculture (USDA) and Goldman Sachs.
As recently as January, the USDA projected that U.S. wheat stocks would total 292 million bushels by the end of the 2007/08 marketing year on May 31. But it hasn’t taken them long to revise that forecast.
It says recent shortages have resulted in a sharp downward revision to 272 bushels. This is the lowest level since 1947/48, according to Goldman Sachs’ weekly Commodities Watch report.
In light of this supply shrinkage, Goldman itself has raised its price forecast for wheat futures to $13.50.
Fork Out For A Full Belly
As the Federal Reserve tries to stave off an economic recession amid a stock market slump, ugly real estate market and diving dollar, it’s in the midst of a wholesale interest rate cutting policy.
But as it chops the base rate down to 3%, inflation is headed higher. Consumer prices shot up by 4.1% in 2007 - the biggest jump in 17 years. Included in that was a 4.9% jump in food prices - the highest since 1990. It came on top of a 29.6% spike in gasoline costs and 17.4% rise in overall energy prices.
Don’t expect that trend to end any time soon - at least in terms of food costs.
At the recent USDA annual Agricultural Outlook Forum, the Advanced Economic Solutions group added to the already bullish sentiment within the agriculture sector by stating that higher raw materials prices are also set to maintain the status quo. This includes products like vegetable oil.
The current forecast calls for food price inflation of 3-4% this year, as companies find it increasingly difficult not to pass the higher costs onto consumers.
So what can investors do about this situation? My colleague Marc Lichtenfeld has some tips on managing your portfolio here.
Monday, February 25, 2008 — by Martin Denholm, Managing Editor, Mt. Vernon Research
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