Will high food prices topple markets?
Rising food prices, political unrest and soaring crude oil prices seem eerily reminiscent of the boom before the crash in 2008. Some are wondering whether high prices will come crashing down again in 2011.
In early March, the United Nations’ Food and Agriculture Organization (FAO) announced that its Food Price Index had hit an all-time high in February, with year-over-year world wheat prices up 75% and world corn prices 77% higher than a year ago. The increase was the eighth consecutive monthly rise. Earlier this year, the World Bank noted that escalating food prices have pushed 44 million more people in low- and middle-income countries into extreme poverty.
- Global rice prices have increased at a slower rate than other grains and the outlook remains stable, the World Bank notes.
- The world supply of high-protein wheat is exceedingly tight, and the U.S. and Russia don’t expect a bumper winter wheat crop.
- There is concern that as corn prices go up, the feeder industry will sell lighter animals, prompting even less meat to move into an already tight retail supply.
A Different Day. Despite these dire statistics, the world economy is not teetering on the verge of a Great Recession like it was in 2008. "Banks today are pretty well cleaned out of bad debt," says Peter Georgantones of Abbott Futures in Minneapolis. World economies for the most part are expanding, he says, not contracting.
Changes have also occurred in the world’s food supply, and while meat, corn and high-protein wheat are in short supply, another staple, rice, is plentiful.
Still, economists, crop producers, livestock producers and risk management consultants are on high alert today after having learned some tough lessons in 2008.
"People are more wary about this boom," says Michael Swanson, agricultural economist with Wells Fargo, in Minneapolis. "Everyone today is expecting a price decline. They just don’t know when it will happen."
For prices of agricultural commodities to plummet, a demand disruption would need to occur, Swanson says, and those are nearly impossible to predict. For instance, four months ago, the revolution that’s occurring in the Middle East wasn’t even on the radar. "Unrest in Egypt, Bahrain and Libya would have been given a microscopic possibility of occurring," Swanson says.
Mike Hogan, an analyst with Stewart-Peterson in West Bend, Wis., agrees a drop is coming. "Demand for food will be reduced, especially in the less-developed countries where food is a greater share of the take home dollar," he says. "A lot of the political unrest in the Middle East is tied to high food prices." He is not ruling out a steep crash similar to the one that occurred in 2008, and he says if it does hit, it will happen between May 1 and the end of January. A 50% retracement in the corn, soybean and wheat rallies that began June 30, 2010, can also not be ruled out, according to Hogan.
"The growth in global demand for food will likely slow due to high prices, but per capita consumption of food is unlikely to decline in economies like China and India where per capita incomes are rising," says Ron Trostle, an economist with USDA’s Economic Research Service in Washington. "Incomes are also increasing in many low- and middle-income countries, which generally translates into higher demand for food, feed and fiber."
China is also flush with cash right now. "It has very large foreign exchange reserves and it can buy whatever it wants by outbidding other importers, and it has been doing so to increase its domestic supplies in an attempt to fight growing inflation," Trostle says. Some low-income, food-importing countries are reducing import tariffs in an effort to reduce food costs to their citizens.
Short Crop, Long Tail. Wheat is considered a staple in many parts of the world. "People will switch to less expensive foodstuffs like rice when prices on wheat rise too high, but generally if a product is a staple, the alternatives are limited," says Scott Irwin, an agricultural economist at the University of Illinois. "The pass-through [cost] to retail bread prices in developing countries through the wheat and flour markets is faster than the pass-through in corn prices in most countries," Irwin says. It takes three to 18 months for higher farm prices to reach consumers in developed countries, and the retail price increase is about 30% of the rise in commodity wheat prices. Already, consumers in some countries have substituted lower-cost rice for wheat.
"There’s been an amazing sequence of production problems," Irwin says. "Wheat looks to me like a short crop with a long market tail." In this type of scenario, weather problems send prices up quickly to ration supply in the current marketing year; then, when supply bounces back due to increased world production, prices drop steeply and stay down for an extended period.
Demand-Driven Corn. A shortage of meat, extremely high hog prices, increasing cattle and milk prices and crude oil prices at or above the level needed to support ethanol production will prevent corn prices from collapsing. The U.S. needs an average 2011/12 yield above 158 bu. to avoid a continuation of the current situation, Irwin says. To return to a 15% stocks-to-use ratio would require an additional 10 million acres of corn this planting season, he says. He doubts the 2011/12 U.S. corn crop will produce a stocks-to-use ratio of more than 7.5%, though.
Because little corn is used in food processing, the main impact on consumers from increases in corn prices will be felt through rising meat, milk and egg prices. Not until livestock producers reduce their herds will the impact be felt at retail, and the pass-through can be lengthy, Irwin says: from three to six months for poultry, six to 12 months for hogs and up to two years for cattle and dairy.
Soybeans in Between. The market situation for soybeans falls somewhere between corn and wheat. World supplies of soybeans are not as tight as corn or high-quality wheat supplies, and the South American crop will add to world supplies.
From a demand standpoint, U.S. soybean exports hit a record high in the 2010–11 marketing year due to China’s voracious appetite, and early 2011 sales have been even better. While China is the biggest growth market for soybeans, growth is also occurring in the Middle East, North Africa and Southeast Asia.
"Ten years ago, we would have price rationed China out at $9 soybeans," Swanson says. "Now $15 soybeans don’t ration out the middle-income consumer in China, but the poor Chinese will be rationed out of the market. We really have two Chinas and two Indias."
- Spring 2011