January 21, 2011

Time to Get Out of Ag?

Futures traders worry about peak prices amid food riots, extreme weather and a rise of petrodollars

Wall Street bulls finally saw the yellow caution lights flashing on Jan. 19. Not since before Thanksgiving had the S&P 500 declined by more than 1%.

Meanwhile, back at the ranch, another kind of bull has also slowed down, but just a little bit: Live cattle futures have stampeded to the highest mark since the CME opened these futures contracts in 1964.

According to a Drovers Cattle Network report, recently cited by the Global Macro Monitor blog, traders are bracing themselves for a repeat of 2008 when prices tumbled after a sharp upward surge. A flood of hot hedge funds and other speculators have been heavy buyers, with the ratio of long to short positions the largest since 2006.

Is now the time to get out of ag (or at least cattle futures)?

I’m not so sure. The markets often evince an apparent time gap between prices and fundamentals such as supply and demand. Alan Greenspan called this “irrational exuberance,” and “froth” is another commonly used nickname, but there is often a long-term “driver” that is hard to see amidst the froth.

The UN’s Food and Agricultural Organization just reported that its Food Price index reached a new high last month, surpassing the level reached in 2008, a year marked by food riots in many poor countries.

An FAO economist told the BBC that causes of food shortages in 2008 are not present today, underscoring the idea that it could be a while before it is known what is driving these agricultural trends. The FAO economist cited “unpredictable weather” as a possible concern, which doesn’t convince me. (Isn’t that why we have the Farmer’s Almanac?)

Global Macro Monitor cites an opinion by Daniel Dicker, author of a forthcoming book called Oil’s Endless Bid, that financial speculation run rampant is behind the commodities price spikesand that regulators have been unable to rein in large derivatives traders and their lobbyists, despite Dodd-Frank.

A story that caught my eye might offer a clue, if not exactly a global explanation, of the surge in agriculture and other commodities. Saudi Arabia has just announced plans to expand its grain storage capacity by 550,000 metric tons.

Seeing this, I realized that just as we have a Strategic Petroleum Reserve to protect us from a rise in prices of Middle Eastern oil, so too does Saudi Arabia maintain silos of wheat to hedge the risks of times such as this, when the prices of American grain products spike.

Americans grumble when the price at the pump rises and take food price rises with a shrug. But the Saudis know, and all of history tells us, that spikes in food prices bring down regimes.

There have been protests throughout North Africa and other areas recently, and regime change in Tunisia whose origin may have been anger over the cost and scarcity of food.

So while traders see statistics that look like a bubble bursting, it could be that we’re seeing one bubble fueling another: U.S. monetary and fiscal stimulus spurs a rise in oil that brings a wave of petrodollars that Saudis use to buy amber waves of grain, wreaking food chaos, riots and disorderly markets.

While speculators play markets, investors should maintain participation in a variety of markets, dividing their portfolio among non-correlating market segments.

If past is prologue, the boom in agriculture will certainly give way to a bust, but the timing is anybody’s guess.

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