If you have been watching commodity prices over the last two months, you would think that the world’s consumers are in for another escalation in food prices last seen in the summer of 2008. Yet, short-term movements in agricultural prices do not necessarily translate into higher food bills in the long term.
Much of the recent escalation in “soft commodities” like wheat, rice, coffee, corn and so on can be blamed on the weather. Readers may recall my columns “Weather and the World’s Economies” and “What’s the Price Tag of a Perfect Storm.” In those articles I explained how weather can impact prices of all sorts of things but especially commodities. This year’s wheat crop is a good example of that.
This has been the hottest summer on record for us in the Northeast as well as other parts of the world. July was the hottest month in 150 years in Russia. By now, even if you live in Siberia, you are aware of the devastating drought within Russia, caused by that heat wave. The drought also sparked a series of fires that engulfed over 300,000 acres across seven regions. The weather and fires devastated that country’s wheat crop. As a result, the government imposed an embargo on any further wheat exports, which account for 13% of global wheat exports.
Although the Russian wheat short-fall occupied the headlines, grain production has also suffered this summer due to severe flooding in Pakistan, China and Canada, while Northwestern Europe has also suffered a drought. This has taken the wheat world by surprise. Wheat is a hardy grain resistant to all but the worst weather and producers grow it in overabundance. Huge wheat stocks have traditionally backstopped shortfalls in other soft commodities. As such, wheat is also the speculator’s favorite grain to “short” since price declines are expected in all but the worst years. However, this year the tables were turned on everyone setting off a short-covering panic and buying frenzy in wheat futures which have gained over 35% in a short time.
There is a domino effect when a commodity as important as wheat has a sudden and sharp decline in supply. Livestock producers, for example, who may have been feeding their herds on cheap wheat are shifting out of that high-priced grain to corn. Suddenly the price of corn begins to rise. Rice, often a substitute for wheat in human consumption, has also risen recently.
In the commodity trading pits, sentiment has rapidly changed because of these windfall profits. Speculators, looking to make a fast buck on the next commodity to move are buying up anything that goes snap, crackle or pop. Normally this kind of behavior only impacts prices in the short-term (similar to the price effect of an unexpected freeze in Florida’s orange juice production).
This time, however, because of wheat’s function as the grain of last resort, this impact on prices could stretch out into the first quarter of next year. Investors have bid up the stocks of fertilizer, farm equipment and other agricultural-related companies as farmers around the world plan to increase their own production in an effort to fill the “wheat gap.” Out in our own mid-west, farmers are optimistic that prices will be rising throughout the rest of this year and into next. But don’t start stocking up on Cheerios quite yet.
The U.S. Department of Agriculture is only expecting a 1.5% increase in prices this year, which is actually down from the prior two years when prices grew 1.8%/year. The real increases in food prices are still waiting in the wings until the world’s economies are on firmer footing. Once people can afford to spend again, prices are expected to move up quickly in commodities across the board.