Archive for the ‘Food’ Category

Why you have to change your idea of ‘investing’ in the coming years to come

Wednesday, February 16th, 2011

The global economy is in a diabolical dilemma right now. If the world economy is paralysed by deflation (which is Bernanke’s nightmare), prices of many things will fall. For example, as we wrote in How to buy and invest in physical gold and silver bullion,

In the second half of 2008, the world experienced unprecedented asset and commodity price deflation. As noted earlier, oil prices fell from a high of almost US$150 to just over $30 over the space of months. Base metals and agricultural commodities plunged along with a panic in the stock market. The US dollar and US Treasury bonds surged (at one point, short-term US Treasury bonds had a negative yield). Statistically (in terms of price volatility), the panic in 2008 was worse than the crashes of 1929 and 1987.

Despite the mainstream commentary screaming “Disaster,” we believe such extreme deflation wasn’t that evil in the bigger scheme of things.


If you believe that burning fossil fuels causes climate change? or that Peak Oil is one of the greatest threat to humanity, wouldn’t such extreme deflation give planet Earth an urgently needed respite? Wouldn’t the collapse of global demand for goods and services save planet Earth for the sake of the next generation? Since 2008, the world witnessed a ‘recovery’ (that was brought about by massive money printing).

But what do we get out of that ‘recovery’?

Surging price inflation that threatens the poor with starvation and pushed many from middle-class to poor.

For example, as Food prices at dangerous levels, says World Bank reported,

The World Bank says food prices are at “dangerous levels” and have pushed 44 million more people into poverty since last June.

This, our dear readers, is just the beginning of a more serious global food crisis. Australia’s CSIRO scientist, Julian Cribb wrote a very sobering book, The Coming Famine: The Global Food Crisis and What We Can Do to Avoid it. As this New York Times book review wrote,

Like many other experts, he argues that we have passed the peak of oil production, and it?s all downhill from now on. He then presents evidence that we have passed the peaks for water, fertilizer and land, and that we will all soon be made painfully aware that we have passed it for food, as wealthy nations experience shortages and rising prices, and poorer ones starve.

This is the price that the this and the next generation will have to pay if we keep up the current way of exploiting planet Earth for the sake of economic ‘growth.’ Hardly surprisingly, a recent Wikileaks revealed that Saudi Arabia cannot pump enough oil to keep a lid on prices.

Dear readers, don’t you see that this economic ‘recovery’ is an illusion?

The ultra-rich, on the other hand, have less to worry about starvation and more to worry about how to preserve the purchasing power of their existing surplus wealth. Some of them will rush to hoard agricultural land and commodities, which will exacerbate the plight of the poor.

The middle-class will see their standard of living being eroded by rising food and energy prices. As we wrote in April 2007, Smart money in alternative energy?Part 1: current energy quandary,

The most important ingredient that drives the efficiencies, comforts, automation and wonders of today?s modern way of life is energy. The trains, cars, ships and aeroplanes that transport massive quantities of people and goods over vast distances quickly require energy in the form of fuel. The heavy machines that do heavy physical work far beyond the scope of human labour require energy too. The powerful computers that process and store vast amount of data and information as well as automate mental labour requires energy in the form of electricity. The heating in winter and cooling in summer of our abode requires energy too. Take energy away and our modern way of life will very much grind to a halt and bring us back to the hard life of our ancestors. In fact, contemporary life rests on the premise of abundant and cheap energy. Therefore, whoever controls the supply and provision of energy controls power and wealth.

When energy prices go up, the prices of everything else will go up. When the prices of everything else go up, your standard of living will go down.

Some of the poor, who are already spending a large portion of their income on food, will have to starve. But before that will happen, we will witness increased incidence of revolutions, wars and conflicts. What we see in Tunisia and Egypt is just the beginning- there will be more.

Dear readers, after reading all these, wouldn’t you come to the realisation that this will have grave implications on the idea of ‘investing.’ Normally, investing is associated with ‘making’ money. But in the context of surging price inflation, ‘making’ money becomes meaningless as the value of money diminishes.

In the next article, we will talk more about this implication. In the meantime, have a think about it.

Who is to blame for surging food and oil prices?

Thursday, May 22nd, 2008

Imagine you are standing in a typical petrol station in 1974 on a typical day (there was an oil shock in 1973). This is what you may see back then:

Cars queued for hours to get petrol in 1974

Now, imagine you get sucked into a time warp and time-travelled to today on 2008. This is what you may see:

A typical petrol station in 2008

So, let’s say a passer-by told you that petrol price had doubled more than 2 ½ times over the past 2 years, would you laugh at the passer-by? “Yeah right!” you may say. “Where’s the queue and rationing?”

Indeed, this is what has happened. As we said before in The Problem that can throw us back into the age of horse-drawn carriages, there are good reasons why the oil price rose over the past decade. In fact, this is true for commodities in general (e.g. base metals, food). As we explained before in Why are the poor suffering from food shortages? and Example of a secular trend- commodities and the upcoming rise of a potential superpower, there are good reasons for this. Already, we are hearing of food riots in the Middle East and Asia.

Yet, strangely, these upward price movements seem unreal. Where’s the queues and rationing? How do we explain this?

Two days ago, in the U.S. Senate Committee on Homeland Security and Governmental Affairs hearing, this question was put forth: Financial Speculation in Commodity Markets: Are Institutional Investors and Hedge Funds Contributing to Food and Energy Price Inflation? Here, we must give special thanks to one of our readers, Zoo for highlighting this piece of information at Picture of a fiat money.

Here, let us zoom into the testimony of Michael Masters, who is the Managing Member and Portfolio Manager, Masters Capital Management, LLC. As our reader Zoo said, “It seems it is the testimony of Michael Masters, a hedge fund manager, which made all the Senators sit up and take notice (sic).” This is Michael Masters’ introduction in his testimony:

Good morning and thank you, Mr. Chairman and Members of the Committee, for the invitation to speak to you today. This is a topic that I care deeply about, and I appreciate the chance to share what I have discovered.

I have been successfully managing a long-short equity hedge fund for over 12 years and I have extensive contacts on Wall Street and within the hedge fund community. It’s important that you know that I am not currently involved in trading the commodities futures markets. I am not representing any corporate, financial, or lobby organizations. I am speaking with you today as a concerned citizen whose professional background has given me insight into a situation that I believe is negatively affecting the U.S. economy. While some in my profession might be disappointed that I am presenting this testimony to Congress, I feel that it is the right thing to do.

You have asked the question ?Are Institutional Investors contributing to food and energy price inflation?? And my unequivocal answer is ?YES.?

That’s a strong categorical statement. Unlike many mainstream financial commentators, Michael Masters did not fluffed around with the “on-the-other-hand” and “having-said-that” types of answer. It is as clear as you can get, backed up by evidence, charts and numbers.

So, how do we explain such a spectacular rise in commodity prices without the queues and rationing? Michael Masters answered,

What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets

Just who is this “new category” of market participants? Is it China and India? No! The rising demand of these two giant nations had been gradually brewing and simmering over the past decade and will continue to the next decade and beyond. Their demand are hardly a shock. Michael Masters pointed the finger at:

Institutional Investors. Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors. Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant.

To give you a sense of scale of their share on the commodities futures contracts, Michael Masters gave an example:

According to the DOE, annual Chinese demand for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels, an increase of 920 million barrels. Over the same five-year period, Index Speculators’ [institutional investors’] demand for petroleum futures has increased by 848 million barrels. The increase in demand from Index Speculators is almost equal to the increase in demand from China!

There are a few more examples given by Michael Masters in his testimony. What happened was that these institutional investors hoarded commodities through the futures market, affecting futures price, which in turn affected the spot prices (i.e. the real world market price). The spot prices are the prices that we all face in our daily life.

In additional, these institutional investors (which Michael Masters called “Index Speculators” are a completely different breed from the traditional speculators. The latter were relatively small fries who (1) had limited supply of money, (2) specialised in certain commodities and (3) price conscious (i.e. they are careful with what price they pay for). The Index Speculators are poles apart. They have vast amount of money (fiat money in US dollars) to be distributed among “key commodities futures according to the popular indices” and are not conscious about the price they pay. They think in terms of portfolio asset allocation, which means that if they decide to allocate, say 2% of their assets into a specific commodity, they will “buy as many futures contracts as they need, at whatever price is necessary, until all of their money has been ‘put to work.’ ” Unlike the traditional speculators who buys and sells, Index Speculators never sell because they treat commodities as some kind of quasi-assets. You can expect such behaviour to have colossal impact on commodity prices.

How did all these Index Speculators came about? Michael Masters explained,

In the early part of this decade, some institutional investors who suffered as a result of the severe equity bear market of 2000-2002, began to look to the commodity futures market as a potential new ?asset class? suitable for institutional investment. While the commodities markets have always had some speculators, never before had major investment institutions seriously considered the commodities futures markets as viable for larger scale investment programs. Commodities looked attractive because they have historically been ?uncorrelated,? meaning they trade inversely to fixed income and equity portfolios. Mainline financial industry consultants, who advised large institutions on portfolio allocations, suggested for the first time that investors could ?buy and hold? commodities futures, just like investors previously had done with stocks and bonds.

The value of assets devoted to commodities by these Index Speculators grew from just US$13 billion in 2003 to US$260 billion as of March 2008. Over these 5 years, the prices of commodities grew by an average of 183%. In 2003, they were small fries in the commodities futures market. Today, they are the largest force in the market.

Why is it that no one seems to know about this phenomenon? Michael Masters believes that (emphasis in the original testimony):

The huge growth in their demand has gone virtually undetected by classically-trained economists who almost never analyze demand in futures markets.

To compound the effect of Index Speculators on commodity prices, it must be noted that the commodity futures markets are much smaller than the capital markets. For example, it is 240 times smaller than the global equity market. Thus, every dollar on commodity futures has a much greater impact on prices than the same dollar on equities. To compound the problem even further, it was observed that their demand increases prices, which in turn increases demand even more. That is, hoarding begets more hoarding.

So, let’s return to the petrol problem. Let’s say OPEC increases production in an attempt to help bring down the price of oil. Or the world decides to to embark on an oil fast. Will that work? You can see that these Index Speculators can easily pour more money into the oil futures sink hole.

Sad to say, through a loophole, the US Commodities Futures Trading Commission (CFTC) allows such speculators “unlimited access to the commodities futures markets.” As Michael Masters explained,

The really shocking thing about the Swaps Loophole is that Speculators of all stripes can use it to access the futures markets. So if a hedge fund wants a $500 million position in Wheat, which is way beyond position limits, they can enter into swap with a Wall Street bank and then the bank buys $500 million worth of Wheat futures.

In the CFTC?s classification scheme all Speculators accessing the futures markets through the Swaps Loophole are categorized as ?Commercial? rather than ?Non-Commercial.? The result is a gross distortion in data that effectively hides the full impact of Index Speculation.

So, whose fault is this? We can blame these Index Speculators. But as we said before in Connecting monetary inflation with speculation,

Thus, by further inflating the supply of money and credit in the financial system at such a time, there comes a situation whereby there are excess liquidity without adequate avenues for appropriate investments.

Is it surprising to see the arrival of the Index Speculators?

Why are the poor suffering from food shortages?

Tuesday, April 15th, 2008

Recently, there are a lot of news headlines about rising food prices and food-related riots and unrest. As this news article, Food inflation, riots stir concern reported,

Finance ministers meeting in the US to grapple with the global financial crisis have also struggled with a problem that has plagued the world periodically since before the time of the Pharaohs: food shortages.

Surging commodity prices have pushed global food prices up 83 per cent in the past three years, according to the World Bank – putting huge stress on some of the world’s poorest nations.

Is this a fairly recent phenomenon? In February and July last year, we touched on this looming food crisis in Corn as food or as fuel? and Prepare for more food price inflation respectively. Finally, in October last year, we had identified three macro-themes about this looming food crisis in Why are food prices rising?. So, you can see that this food problem has been in the makings for quite a long time already. It is only recently that it has received great attention in the media.

We have been thinking about this food problem for quite a long time, wondering whether there is a root reason for this slow-motioned tragedy. As we read the news media about this problem, the reasons seemed to be quite fragmented. Somehow, our intuition tells us that there must be an underlying force behind all these reasons. So today, we will attempt to come out with a theory to explain how it comes about, while hoping that we do not fall into the narrative fallacy that we talked about in Mental pitfall: Narrative Fallacy.

Today’s journey will begin in China. At the end of 2006, China’s rural population stood at around 737 million. From 1990 till today, we estimated around 230 million rural peasant Chinese migrated from the countryside to the cities (source: China’s rural population shrinks to 56% of total). Our guess is that the majority of the rural migrants are males. Over the past couple of decades, it is this mass migration that provided the vast quantity of labour to propel China’s rise as a major economic power. It is China’s economic power in manufacturing that enabled the debt-induced over-consumption and low inflation of the West, especially in the English-speaking nations (look at the US’s mighty trade deficits). Compared to Western standards, China’s peasant farming is not as efficient and productive per capita. Now, if around 230 million rural peasant Chinese (mostly males, and the males do most of the farming) migrated to the cities’ manufacturing related jobs, it is clear that Chinese farm output has to fall significantly. Also, China as a whole is getting wealthier than before and as a result, consumes more meat, which in turn consume grains for livestock, thus competing against the demand for human-consumed food. Therefore, to feed China’s vast population with significantly reduced farm output, food imports have to rise significantly, which puts upward pressure on the world’s food prices.

Next, China’s rise over the decades raises the consumption of commodities greatly, including energy. As we said before in The Problem that can throw us back into the age of horse-drawn carriages,

In summary, supplying environmentally sustainable energy indefinitely at a rate fast enough is a colossal global problem that must be solved. If not, the latter generations will not live better than the current generation.

With rising energy costs, the US embarked on a foolhardy ethanol program in the name of energy ‘independence’ (see Prepare for more food price inflation). This program resulted in even more diversion of more food production resources into fuel making, reducing the food supply even more.

In the more affluent Western nations, food production takes on a more capital-intensive form. These capitals requires energy. With rising energy costs, food prices have to rise because of the increasing cost of production and distribution.

To make matters even worse, food is tend to be much less income and price elastic, especially for the poor. That is, no matter what, people have to eat even if their income falls or if the price rises. This is unlike the more discretionary items like clothing whereby people can reduce demand in response to falling income or rising prices. As a result, any increase in the cost of producing food is easily passed on to the consumers in the form of higher prices.

When the effects of climate change and drought get thrown in, the situation becomes even more serious.

The more we look at it, the more we feel that the global economic growth of the past decade is not sustainable without serious environmental, food, energy and commodities repercussions. That is why we see that a severe global recession is a necessary evil. Otherwise, more sufferings and permanent damage will occur even for the future generations.

Why are food prices rising?

Wednesday, October 17th, 2007

Reading the financial press lately, you would have noticed that there are numerous reports of food price inflation over the past year. For example, the price of pork is rising in China and wheat prices are going up, along with the price of corn and other industrial commodities. Why is this so?

We have identified 3 broad global macro themes that will shed light to the answer to this question:

  1. Rise of bio-fuels (ethanol) production As we said before in Prepare for more food price inflation, producing bio-fuels divert agricultural resources away from food production and consumption, thus contributing to rising prices both directly and indirectly. Corn is the best example of this.
  2. Climate change This is the dominant reason for rising food prices. Many parts of the agricultural world are in prolonged drought, which resulted in reduced agricultural commodity output. Global warming has been blamed for it. It is unclear whether such climate change is permanent or not.
  3. Rise of China As China becomes wealthier, its people begin to consume more meat. More consumption of meat means more consumption of grains for livestock, which compete against the demand for human-consumed food.

Thus, as much as you believe that these 3 macro themes will remain, food price inflation looks set to continue.

Prepare for more food price inflation

Sunday, July 8th, 2007

In today’s globalized world, the adage that “everything is connected to everything else” has never been truer. So, today, we will look at this interesting question: what has the oil got to do with food price inflation?

As we all know, oil prices had been rising steadily over the years. Our view is that in the long run, despite the short-term fall of oil prices (see Analysing recent falls in oil prices?real vs investment demand) oil is going to be more expensive (see Is oil going to be more expensive?). The fact that there is a major push towards biofuels (e.g. ethanol) tells us that the security of the world’s oil supplies is not something that major countries are taking for granted any longer. Indeed, the list of oil worries includes: Peak Oil, Global Warming, rise of Chinese and Indian demand for oil, Middle-East geopolitical risks, etc.

Recently, we saw this news article: Biofuels ‘to push farm prices up’:

The rapidly growing biofuel market will keep farm commodity prices high over the next decade, a key study has said.

As we said before in Can ethanol replace oil?,

With these factors in mind, although ethanol will have its limited role to play in the world?s energy problems, we are not confident of it supplanting petrol in a mass-scale in the foreseeable future.

In fact, any major concerted effort towards this will have repercussions on the price of food. Indeed, the US efforts to produce ethanol from corn have caused corn prices to rise (see Corn as food or as fuel?).