The Food Price Threat

As in 2006-2007, it is again possible to predict a period of significant and long-lasting food price inflation, with food prices rising as much, or more than other consumer basics. At least two of the same reasons that made food prices rise so sharply three years ago are again in place.

These main drivers are sustained demand for imports of several key crop groups such as grains and oilseeds by China and India, high demand for palm oil imports by Europe and Japan, for uses including biodiesel fuel feedstock, and worldwide demand for sugar, in a context of continuing supply side pressure on world food suppliers and producers. World farmers and food producers face serious long-term infrastructure and natural resource shortages. To these we can also add the same factor which supports world oil prices - the weakening US dollar, used for the trade and supply of many leading food commodities.

The Nestlé company - one of the world's largest food companies - has again repeated in press statements and investor advice, that it believes the world food system is exposed to serious long-term supply/demand factors tending to force up prices. These rises, it warns, will be more than those simply due to currency changes and trading or speculative investor activity, which can easily shift prices quite rapidly up, and rapidly down in a short period.

To be sure, many leading sources of information and opinion on asset price and raw material commodity price trends, such as the IMF, World Bank and leading central banks like the US Fed and Europe's ECB, continue to claim we have as much risk of deflation, or falling prices, as inflation and rising prices. In addition, these 'classic minded' institutions like to think that both food and energy prices are set to remain relatively low, and not show appreciable price growth in the next six to nine months or perhaps longer. Their analysis is probably wrong, and the proof of their error is likely to be shown on agriculture and food commodity markets in the short-term future.

Backing the Nestlé company's outlook for certainly volatile agriculture and food prices, and an increasingly probable price rise in the five remaining months of 2010, the FAO Food Trade and Markets division adds depth to the analysis. In its June 2010 report, it indicates the increasingly uncertain outlook for world food production, stocks and prices in all categories, from the basic food and feed grains (mainly rice, wheat and maize) to oilseeds, meals, oilcakes, and sugar, meat, fish and dairy products. The FAO report underlines the shift in thinking on world food since late 2009. Until now, it was believed that a combination of circumstances, including the economic recession and lower oil prices, and potentially good or very good crop harvests in 2010, would tend to prevent any large rise in food prices.

This analysis and outlook is now changing. We can take the most important factors tending to drive up prices at this time and in the next six to nine months. These especially include the renewal and return of "the shrinking dollar", that is US dollar depreciation, rising oil prices, continued strong world demand for food in part simply due to growing population, very uncertain food production outlooks, weather changes including unprecedented fire damage in Russia, and equally uncertain food policy and food tariff changes by major food exporter and importer countries. Taking just one factor - weather changes - the present Russian heat wave and fire damage affecting the world's second-biggest wheat exporter was totally impossible to predict even one month ago. Previous forecasts of Russian grain exports may need to be revised down, and in this case major wheat importer countries will tend to buy more, to ensure they do not experience shortage.

Cumulatively, these factors all tend to indicate only two things: higher prices for world traded food, and the certainty that any trend to higher market prices will soon be exploited by traders, who will push up prices even further.

This trend is already reflected on world commodity markets, with the recent and relatively strong recovery of sugar prices, which in February 2010 had reached nearly 40 US cents a pound or close to $1000 a ton, before crashing to very low levels. It is also reflected by the new surge in wheat prices, with a very likely knock-on to rice, maize and soybean prices in coming weeks, if wheat prices are not "talked down" in the intervening period. In both cases, sugar and wheat, trader and analyst explanations of the price rise can stretch to near fantasies, such as ships being blocked in Brazilian harbours, Indian rains coming too soon, or biofuels producers turning to wheat feedstock in some countries - but the real causes of the price recovery are much more complex.

Concerning the "downstream foods" and notably the price of dairy products, meat and fish from acquaculture, all of which depend on upstream inputs of food grains, oils and proteins, the upstream price rises will take several weeks to start raising dairy product, meat and fish prices. This price knock-on will however happen, if there is no sudden decline and falling back of upstream basic food prices. We can therefore predict there will soon be volatile food prices, and a likely trend to higher price levels in the coming months.

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