As the dollar, together with US equity and bond markets, continue an apparently inexorable slide downards, everyone’s been piling into safety – and especially into commodities. But as David Roche comments, “With global equity market capitalisation almost 10 times the notional value of commodity derivatives, the rush to commodities by investors has been like squeezing a quart into a pint pot.”
Opinion has been split on how much of the buoyancy in commodity prices is due to this short term price bubble; Martin Wolf, for instance, argued a couple of weeks ago that “Speculation seems not to be that important. If it were, inventories would be soaring. But they are not.” Still, that was then, and this is now – after the collapse of Bear Stearns, when the flight to safety looks more like a panic rush.
David Roche’s argument, though, is that the commodities bubble will prove short term because global recession will take the heat out of demand for commodities – for “contrary to received wisdom, economic decoupling [between the US and emerging economies] is unlikely.” Well, he may well be right about the decoupling, at any rate; Nouriel Roubini has also been saying so for a while, and he’s been pretty accurate so far.
So if the world does hit a serious downturn, and if commodity prices do take a tumble as a result, does that mean we can all relax about food prices? Not for long. Here’s why.
1) Even if China and India do hit a serious downturn, expect the effect on commodity prices to be more marked on metals than on food. Demand for base and precious metals is relatively elastic. It remains to be seen how ready the newly emerged middle classes will be to kick their new meat and dairy habits, on the other hand. It may be that other forms of consumer spending are reined in much sooner: for middle classes here and in China alike (and very much in contrast to the world’s poorest), food spending accounts for a small proportion of household expenditure. And even in a bad downturn, no-one’s predicting that China and India will fall back to their pre-2000 levels of income.
2) And remember that high income growth isn’t the whole story of food price rises. IFPRI reckon it’s about 50% of the reason, in fact – and that another 30% is down to biofuels. Now, since biofuels are profitable above $60 a barrel for oil for as long as current subsidies apply, that driver looks set to remain firmly in place; indeed, it will grow steadily if the US and EU stick to their dramatic plans for biofuel growth.
3) Global food inventories still look extremely depleted – and remember too that food supply is relatively inelastic (IFPRI reckon that for each 10 per cent increase in food prices, cultivation only goes up by 1 or 2 per cent a year), so there aren’t huge production increases in the pipeline arriving just as the world hits a downturn (unlike, say, commercial property).
3) Energy is likely to remain high – I’ve seen no predictions of it falling below $70 even in worst case downturn scenarios. And high energy costs mean high food costs: not only because of the arbitrage relationship implied by the food / fuel link, but also because of the price of inputs (fuel used in cultivation, harvesting, processing, refrigeration, shipping, distribution; energy used to make fertilisers and pesticides, and so on).
4) Over the longer term, remember the scarcity trends too – above all climate. True, the IPCC say that the net effect of temperature rise between 1 and 3 degrees C is likely to be positive for crop yields. But they also note that this is before extreme weather is taken into account – and that weather’s likely to be a bigger deal than temperature. Look at what recent droughts have done to wheat markets. Expect this driver to grow.
5) Finally, look at how many of the drivers for land competition remain in place too. Land for growing food is competing with land for feedstock; for fuel; for fibre, like timber and paper; for forest conversation; for carbon sequestration; for cities; and it’s also competing with soil erosion and encroaching deserts. FAO reckon that only another 12% of arable land is available – and that 16% of the arable land we use now is already degraded. And all this is before we recall that there are still another 3.5 billion of us arriving in the next 40 years or so.
So while we can expect to see some wild gyrations in food markets in the coming weeks, and maybe even a dip that’s sustained for a while, the balance of probabilities still points towards a longer term structural shift in food prices, and not just some short term cyclical fluctuations or bubbles inflating.
See also:
Food prices: where to get briefed
What do rising food prices mean for Africa?
