Commodities – The Chokepoint?

Food and energy are important components of people’s budget and it is natural to be concerned with what people are concerned with. The story that we heard so far, is frightening as if it is about to crash through the floor, leaving the masses with no food to spare. Commodity prices across the spectrum have been on the rising since 2001 after two decades of underinvestment bought these to their inflexion point. From base metals, precious metals and energy, now price craze spreads to soft commodities including food.

Bad news is that if nominal prices are adjusted to real terms, the long term patterns of commodities suggest that we are some 75% of the way through this cycle, and probably have an average 2-4 years of higher prices ahead. Food demand still firm and as much of these demands are from outside the OECD countries, the prices will continue to rise into 2009-11. The CRB index has rebounded by 68% from its 2001 low but is still well below the 112% rebound from 1970 to 1982. The average rise of all commodities is 223% since 2001 but still again well below the 296% from 1970-1982 respectively.

The biggest single force for change is urbanization. In China, approximately 10 million people a year move into towns from rural areas and another 10 million live in areas whose designation is changed from rural to urban. Over the 2006-2010, forecasts made that China will see about 100 million people become urban and in the following decade, more than 200 million people should become urbanized. In the process, changing diet will drive the rapid growth in China’s food demand. The share of cereals falls while that of meat and fruit increases.

Good news is that higher prices will be the incentives to produce more. As the late Milton Friedman said `the cure for high prices is higher prices’ and this is already happening in mining with a close to a 55% increase in 2006-07 for non-ferrous exploration budgets. There appears to be plenty of land worldwide that could be bought into cultivation to meet the growing demand for food. The key suppliers of new land are likely to be Latin America – Brazil and Argentina and the former Soviet Union – Russia and Ukraine. Thus far, only 11.5% of the world’s surface is used for arable and permanent crops.

From 1961-99, more than 78% of output increase came from improving yields with another 7% coming from better crop intensity, leaving just 15% to come from land expansion. The FAO estimates that this may rise to a bit to 20% coming from new land over the next 30 years but still 70% should come from yield enhancement.

Trade pattern will see significant change in the next 10 years or more. Gone are the days when bulk cargoes dominated the food trade and the fastest growing category is processed food such as meat, beverages and chocolates. The conclusion of greater Free Trade Agreements (FTA) will also give greater comfort for many countries about the tightly guarded concern of about the need for a total food security. That in turn will create great opportunity for domestic producers to consolidate and in the process to build stronger brands. It would not be a surprise to see the growth of global multinational food companies comes from Asia. Food processors clearly have significant long term growth as currently only 30% of food processed and there is plenty of scope for growth considering that developed economies have around 80% of food processed.