------------------------------------------------------- Why food costs more John Greenwood, Financial Post Published: Saturday, May 19, 2007
After steamrolling through a laundry list of base metals, then oil and gas, the global commodity boom is finally hitting us in the gut: at the supermarket checkout counter.
Canadians paid 3.8% more for food in April compared with a year earlier, including an extra 12.9% for fresh vegetables. The experts have coined a new term to describe the phenomenon. They call it agflation, and they blame the hedge funds.
The examples are everywhere. Global milk prices are rising at the fastest rate ever. Powdered milk, a key benchmark, has jumped 60% in six months to US$1.58 at the beginning of May. Since 2000, beef prices have jumped nearly 30% on the Chicago Mercantile Exchange.
We've all heard how China and India are pushing up demand for food products, and how the biofuels sector is gobbling up corn supply. But many observers say hedge funds are the biggest culprits behind food inflation.
"This is a new game," said Don Coxe, global portfolio strategist at BMO Capital Markets. "These people have amounts of capital that are mind-boggling and if they decide they like something, they put in a lot of money and they are prepared to do it in a hurry."
Hedge funds are private investment partnerships that are permitted to use leverage, make bets on derivatives and commodities, take short positions and other strategies that are not generally available to other funds.
Over the past few years hedge funds have been among the first to take advantage of the explosive growth in China and India, most notably by playing the commodity markets, especially energy and base metals.
Owing to light disclosure among hedge funds, it is unclear how much capital they have invested in commodities with estimates ranging from US$30-billion to more than US$100-billion. Now they've moved into food.
But the difference this time is that agricultural markets were designed to allow industry players like farmers and down-stream food producers to protect themselves against the risk of price volatility. They were not designed for financial speculators with vast pools of capital who have likely never set foot in a barn.
"When you get all these hedge funds coming in, they just overwhelm the markets," said Bill Gary, president of research firm Commodity Information Systems in Oklahoma City, Okla. "The markets just can't handle it."
Since the rise in agriculture started gaining altitude last spring, hedge funds have been pouring money into commodity exchanges, driving up prices and transforming backwater grain bourses like the Kansas City Board of Trade and the Winnipeg Commodity Exchange into highstakes casinos. Since 2005, corn has nearly doubled. Wheat is up 50% in the same period, while canola, one of the biggest crops on the Canadian prairie, has climbed 34%.
But the biggest effect of all the new hedge fund cash sloshing through the system is a major increase in volatility. Prices are on the rise but the upward trend has been anything but smooth.
"We are unaccustomed to this," said Mr. Gary, who adds that he hasn't seen this level of volatility since the 1970s when a group of big speculators briefly "muscled the markets around." But what's happening now is different, far more treacherous for traditional players.
Like many experts, Mr. Gary believes the markets have become disconnected from the fundamentals as prices rocket through peaks and valleys that have little to do with supply and demand.
Many of the hedge funds are trend players, who make bets based on the technical details around the direction they think prices are heading, moving in and out of the market with lightening speed. For them, volatility is an opportunity to make money.
Part of the reason the hedge funds have gravitated to trading of agricultural commodities is that unlike other sectors, agribusiness is dominated by only a handful of major companies, many of them private. In Canada there are only two public grain handlers -- Agricore United of Winnipeg and Regina-based Saskatchewan Wheat Pool--and earlier this month they agreed to merge.
One of most influential agribusiness players is Minneapolis-based Cargill Inc., the world's secondbiggest private company. In other words, besides grain trading, there are not a lot of opportunities for investors looking to play the sector.
And the bad news for consumers is that although the hedge funds have helped drive food prices through the roof, the reality of stronger global demand could eventually push them even higher. China isn't going to go away, and its middle class -- the segment of the population that accounts for most of the increased consumption -- is swelling in size by about 40 million people annually.
And the emergence of the biofuels industry, the other main driver in the demand picture, is gaining steam as well. So far, most of the activity has taken place in the United States thanks to generous subsidies from Washington but with climate-change concerns becoming more of a political force globally, other countries, including Canada, are expected to unveil incentives of their own.
Meanwhile, on the supply side of the equation agricultural production has not kept pace. "For seven of the past eight years the world has not been able to produce enough food to meet demand, but you just can't keep on consuming more than you produce, " said Mr. Gary.
