Agriculture Commodities Sweet Future
Commodities / Agricultural Commodities Dec 04, 2009 - 04:30 PM GMTBy: Jennifer_Barry
In December 2008, I discussed the rebound in world food stocks. Excellent weather in the second half of the 2008 growing season led to near-record yields. The fall saw a bountiful harvest, especially in grains. At the same time, the global economic slump had crushed crude oil futures, dampening the associated biofuel demand. Most agricultural commodities, including the grains, fell sharply in price.
Nevertheless, I thought the sentiment was too bearish, and there was reason to predict a rebound in the agricultural sector in 2009. The ending stocks in corn were expected to be the tightest in three decades. Some experts deduced that old crop soybeans would be nearly gone by the time the fall harvest occurred, due to stockpiling by China and drought in the Southern Hemisphere. Wheat also was affected by poor weather and historically low supply.
My essay seemed prescient, as the grains formed a bottom just a few days after publication. The soybeans, corn, and wheat rallied vigorously into the new year.
However, these gains were not to last. The grains were dragged down by the sell-off of assets in generalized market anxiety in March 2009. After a spring recovery, growing conditions for the grains improved. A shockingly higher USDA forecast caused corn, wheat and soybeans to drop.
Unfortunately for global households, I doubt these low prices will last. India seems to be overly optimistic about its wheat stocks, and will probably need to import grain next year. China has a near-insatiable demand for US soybeans, buying in eleven weeks nearly as much as they purchased all 2008/9 crop year. Cocoa and sugar have already reached multi-decade highs this year, spurred by bad weather and disappointing yields. If these trends continue, a big harvest in the Southern Hemisphere will be required to keep prices from surging.
No Real Relief
While food production is currently meeting global needs, the fundamental problems in agriculture I’ve written about have not been fixed. Even though wheat yields increase 1% per year on average, this progress doesn’t keep up with demand which rises 1.5% annually. Recessions around the world are currently dampening per capita demand for more expensive foodstuffs, but the global population is exploding, expanding the need for food overall. The Earth will hold 7 billion humans in less than three years, and surpass 9 billion before 2050.
As the population soars, arable land is shrinking. National Geographic highlighted many of the difficulties in its June issue. Monoculture cropping has made formerly productive areas infertile. Intensive cultivation in dry areas causes steep drops in the water table and as well as salty soils. Fully 40% of global farmland is “seriously degraded,” and desertification in Africa is projected to make the continent 75% dependent on food imports by 2025 if this trend is not checked.
The population boom was made possible by the “green revolution,” as famines used to regularly kill millions in agrarian nations. This revolution was largely spearheaded by one man, Dr. Norman Borlaug, whose innovative breeding techniques developed high-yielding, disease-resistant wheat and rice varieties. Along with better seeds, Dr. Borlaug encouraged the adoption of modern agricultural methods such as the use of machinery, irrigation, fertilizers and pesticides. His revolution in farm output is calculated to have saved over a billion people from starvation, an amazing accomplishment and a feat for which he received the Nobel Peace Prize.
Unfortunately, this revolution wasn’t very “green” as it relied on cheap fossil fuels for inputs from fuel to chemicals. As petroleum becomes scarcer and more expensive, poor farmers in undeveloped nations will find it difficult to maintain production. The G8 has promised aid to African agriculture, but this won’t prevent over 1 billion people from suffering from malnutrition in 2009.
Mysterious microbes are an uncontrolled threat to food stocks as well, attacking pollinators which are necessary for 9.5% of total agricultural output. A new species of fungus was identified as the cause of white nose syndrome in bats, but no cure is in sight. Another fungus, Nosema ceranae, is suspected to contribute to Colony Collapse Disorder in honeybees, but the full cause is not known.
Although demand for ethanol and biodiesel have dropped due to lower energy prices and economic contraction in the West, government mandates will still cause food to be diverted to transportation needs. In the United States, the biofuel industries have strong advocates in Congress, insuring continued subsidies. Both the EU and India have committed to obtaining 10% of their vehicle fuel from biological sources. Malaysia plans to require all the nation’s diesel be blended with 5% palm oil-based fuel by 2010.
Agricultural Black Swans
Since December, new threats to food security have emerged. The El Niño-Southern Oscillation (ENSO) developed during the Southern Hemisphere winter, and strengthened in October. ENSO conditions occur every 3-8 years, and usually last 9-12 months. This weather pattern involves warmer water in the Eastern and Central Pacific Ocean, and the decrease or reversal of prevailing easterly winds. This phenomenon predictably causes droughts in Australia, India, Southeast Asia and southern Africa.
As billions of farmers depend on rain for crop production because they don’t have access to irrigation, global food production is likely to drop noticeably. Palm oil has already risen on the expectation of lower yields in Malaysia next year. This summer’s disappointing monsoon in India could indicate a severe ENSO like the one that occurred in 1997-98. At that time, the Australian wheat crop withered, vegetable prices in California spiked, and huge forest fires raged in Indonesia which produces 30% of the world’s vegetable oil. Shockingly, even the Panama Canal had to close as it lacked enough water to operate the locks! Drought-stricken countries may not be able to afford imported food if crops fail - especially as global credit is still tight - throwing them on the mercy of food aid.
A potential for a “black swan” event in agriculture was discovered in Uganda in 1999, but it received very little attention until this year. A new variety of stem rust fungus named Ug99 can devastate wheat crops. It’s resistant to both fungicides and Sr24 and Sr36, the genes that protect most of North American wheat from rust. Approximately 80% of this staple is globally vulnerable, yet little research has been conducted for decades as the disease seemed to be vanquished in the 1960s. Scientists’ alarms about Ug99 were ignored, so Dr. Borlaug was forced to come out of retirement in 2005 at the age of 91 in order to galvanize effort around the rust threat. Fortunately, this research will continue although he passed away in September.
Ug99 is no longer confined to Africa, as it’s recently moved past the Red Sea barrier into Iran. As this fungus is wind borne, it’s expected to enter the prolific wheat growing regions of India and Pakistan soon. Professor Jim Peterson of Oregon State University termed Ug99 “a time bomb." Stem rust is a serious threat, as past outbreaks in the US have destroyed 20-40% of wheat crops. Genetic modification to produce high yielding resistant varieties that are acceptable to industry takes 9-12 years, and scientists have expended just three years of serious effort to date. In addition, only two labs on the planet to have agreed to study this dangerous pathogen, and then only in the depths of winter, further thwarting progress. With ten years time to interact with wheat crops, the fungus has already mutated once, making it even more virulent.
Sweet Future
I am still bullish about the future of agricultural commodities. This sector did not experience a true bubble, with the vast majority of the public never participating in the gains.
Grain futures are currently very cheap on an inflation adjusted basis, and higher oil prices and government mandates could spur demand for grain-based biofuels. Although sugar appreciated substantially in 2009, the sweetener is only at 34% of its nominal 1974 high. Cattle prices fell sharply in 2009 due to the flooding of the market with culled dairy cows, but it looks like a bottom has formed. Pork supply was sharply reduced as millions of pigs were destroyed worldwide due to fears of the H1N1 epidemic, and demand is picking up. The US cotton output is the smallest in 24 years, as many former producers have switched to a more profitable crop - soybeans. These commodities are priced in US dollars, so debasement of the currency can only push prices up in the long term.
Agriculture has lagged the broad commodities index as represented by the Reuters CRB. In contrast, base metals have surged in 2009, with lead jumping more than 47%, and copper up 157% from last Christmas’ lows. Crude oil has more than doubled since February. Even the precious metals are soaring after a volatile summer. This indicates that food will be the next impressive commodity move, as speculators swap their depreciating US dollars for anything tangible.
by Jennifer Barry
Global Asset Strategist
http://www.globalassetstrategist.com
Copyright 2009 Jennifer Barry
Hello, I'm Jennifer Barry and I want to help you not only preserve your wealth, but add to your nest egg. How can I do this? I investigate the financial universe for undervalued assets you can invest in. Then I write about them in my monthly newsletter, Global Asset Strategist.
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