The coming surge in food prices

- "The surge in commodity prices in 2003-08 was the largest, longest and most broad-based of any commodity boom since 1900. The prices of energy and metals surged the most, but it was the agricultural market that saw the most fundamental change. It may not take much of a disruption in food supply to trigger another surge in prices given that the dynamics have become a whole lot more uncertain as a result of new and some increasingly powerful influences acting on both sides of the food supply-demand equation. Indeed, droughts this year in Russia and Kazakhstan and severe flooding in Pakistan and China have sent global wheat prices higher, while meat and sugar prices have hit 20-year highs, despite lacklustre growth in many of the advanced economies."
- "We expect another multi-year food price rise, partly because of burgeoning demand from the world’s rapidly developing – and most populated – economies, where diets are changing towards a higher calorie intake. We believe that most models significantly underestimate future food demand as they fail to take into account the wide income inequality in developing economies. The supply side of the food equation is being constrained by diminishing agricultural productivity gains and competing use of available land due to rising trends of urbanization and industrialization, while supply has also become more uncertain due to greater use of biofuels, global warming and increasing water scarcity. Feedback loops also seem to have become more powerful: the increasing dual causation between energy prices and food prices, and at least some evidence that the 2007-08 food price boom was exacerbated by trade protectionism and market speculation."
- "We assess how a steep secular rise in food prices can affect the macro economy and financial market prices, and we explain how the impact could be devastating for poor countries that import most of their food and spend a large share of personal incomes on food. Such countries may experience: a sharp decline in GDP growth, a surge in CPI inflation, worsening fiscal finances, higher interest rates, a depreciating currency and widening credit spreads. On the other hand, rich countries that are large net exporters of food could benefit."
- "We construct the Nomura Food Vulnerability Index (NFVI), providing a summary ranking of each of the world’s 80 largest economies, in terms of their exposure to another food price surge. NFVI identifies Bangladesh, Morocco, Algeria, Nigeria, Lebanon, Egypt and Sri Lanka as the most vulnerable to high food prices, while at the other extreme are New Zealand, Uruguay and Argentina. We use NFVI to quantify the impact of the 2007-08 food price surge, by comparing the 25 most vulnerable and 25 least vulnerable economies. We find that the most vulnerable group would indeed experience relatively weaker GDP growth, significantly higher CPI inflation, worsening fiscal positions, higher policy rates, widening credit spreads and widening government bond spreads to US Treasuries."
- "In terms of fixed-income strategy, we recommend using a combination of structured products – to buy a basket of agricultural commodities – and relative basket trades – in rates, FX and CDS spreads. We recommend paying 2y interest rate swaps of the 10 countries with the highest exposure to food in their CPI basket against receiving the 10 with the lowest. The impact on FX is more clouded, but we expect owning a basket of currencies selected from those with the lowest exposure to food in the CPI basket and most likely to experience an improvement in terms of trade against a basket of the opposite to be profitable. We use the NFVI in combination with a starting debt-to-GDP threshold to buy CDS protection on those sovereigns most likely to see fiscal deterioration against those least likely to. Trades in the inflation-linked space are limited, but we believe there is value in buying European inflation breakevens against US BEIs."
- "In the equity space, the total market capitalisation of the food sector is tiny compared to that of, for example, financials or property. However, while the investment universe may appear limited, investors ought also to consider companies involved in the shipping and storage of soft commodities, seed and fertilizer producers, and those that produce farm machinery, tractors and irrigation systems. Equally, we would suggest investors consider timber and other industrial soft commodities. We highlight four companies that we believe stand to benefit the most from rising food prices within the Asia ex-Japan region: China Agri-Industries (606HK Buy), China Yurun Food (1068 HK, Buy), United Phosphorous (UNTP IN, Buy) and Wilmar (WIL SP, Buy)."

Nomura Global Economics Strategy Sep2010

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