Is this the end of cheap food?

2/9/2011 11:43 AM ET By Anthony Mirhaydari, MSN Money

Just as people have started to feel a little bit better about the economy, a new threat now looms. The specter of inflation can be seen most clearly in the rise of food prices to record highs — fueling, among other things, the political tumult that’s ripping across the Middle East.

The United Nations Food Price Index has moved to a record high and is up 62% from its recessionary low in 2009. Sugar prices are up 122% and dairy is up 92%. And just over the last eight months, the Dow Jones Grains Total Return Index, which is tied to things like corn, soybeans and wheat, is up a whopping 71%.

For many, this may seem like just another spin on the boom-and-bust cycle we’ve been suffering through. We saw a steep rise in food and fuel prices in 2008. Then a global recession that prompted fears of deflation — falling prices. Now, another fearful bout of inflation. ‘Round and ’round we go.

For most Americans, this will be yet another cost to crimp already strained budgets. Nearly 44 million Americans — more than 14% of the population — are using food stamp benefits that amount to $285 on average per month to fill their refrigerators.

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For the billions of people around the world who get by on much less, it’s a matter of life and death. Thus, the recent protests over rising food prices seen in places like Tunisia, Jordan, Mozambique, Algeria — and yes, Egypt.

But there is evidence that the current rise — driven in part by bizarre and destructive weather in important food-exporting countries including Australia, Argentina and Russia — will be more sustained than the 2008 event. Credit Suisse researchers led by Edward Morse note that while “the predominant short-term cause for most food price spikes in recent years has been supply disruption, it is possible that over time, increased demand from emerging markets could slow or even halt the long-term downward trend in food prices evident for at least the past 100 years.”

In fact, according to new research from the British government (.pdf file), we could be on the cusp of a historic change: The end of cheap food. According to their more-pessimistic projections, the price of some key foodstuffs, like corn, could double over the next 40 years.

Anthony Mirhaydari

And there’s reason to believe the situation could become critical much sooner — perhaps setting the stage for a repeat of the food price volatility of the 1970s, which resulted in a tripling of wheat and soybean prices and a 14-fold increase in the price of sugar.
That ’70s show

The similarities are striking, as outlined in another report (.pdf file) from the British government: Key antecedents were a weak U.S. dollar, increased demand for foodstuffs from a growing middle class in developing countries, and rising oil prices. The catalyst was a bad harvest due to poor weather. The accelerant was speculative hoarding. The result was a decade of stagflation as the economy stalled and inflation raged.

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All of these ingredients are in place now:

The dollar: American policymakers seem determined to devalue the dollar relative to its major trading partners, as witnessed by the Federal Reserve’s extreme money-printing, an out-of-control fiscal position and a fast-rising national debt that is now at levels not seen since just after World War II when compared to gross domestic product. President Richard Nixon dropped the dollar in 1971 by taking us off the gold standard. Freed from the shackles of gold and the so-called Bretton Woods currency standards, the Fed promptly increased the money supply and devalued the currency.

Oil: Back then, crude oil prices spiked in the wake of the Yom Kippur War as Arab allies punished the West for its support of Israel. Now, energy prices are rising on concerns of higher demand from emerging markets. There are supply concerns as well. One wonders what the outcome of the popular revolutions underway in Cairo and Tunis will be and whether the youthful unrest they represent will spread to the capitals of major oil exporters Iran and Saudi Arabia. A glance at the chart above shows the eerie similarities between the energy price spike of the ’70s and our current bout with $100 oil.

Consumer demand: The world is now girding for the pressure of newly empowered consumers in places like China, India and Brazil. In the 1970s, the pressure was from new consumers in places like Mexico, South Korea and Taiwan. As incomes rise, diets become less focused on starchy staples like rice and more calories are derived from fats, protein and sugar. That’s a problem, because protein from meat requires more resources in land, feed, water and energy to produce, taxing the global food-supply chain.

Americans lead the world with the highest proportion of grain-fed meat in their diet, and that puts a strain on crops. Americans’ meat habit translates to a per-capita requirement of grain four times that of a vegetarian diet. According to the work of the British Government Office for Science, the problem is about to get worse: The global cattle population is predicted to increase by around 70%, from 1.5 billion in 2000 to about 2.6 billion by 2050, while the goat and sheep population jumps nearly 69% from 1.7 billion to 2.7 billion.

Hoarding: You don’t have to look very far to see signs of hoarding. Countries around the world have increased efforts to stockpile key food resources to keep prices down and placate angry citizens. Saudi Arabia said it will purchase a 12-month wheat reserve. Bangladesh has tripled its rice import target. A few weeks ago, Indonesia bought more than 900,000 tons of Thai rice. Russia has extended its wheat export ban.

Similar actions were seen back in the 1970s. The Soviet Union famously bought up much of the 1972 wheat crop in an effort to recover from a poor domestic harvest and improve its citizens’ diets. The grain was also used to build up livestock herds. Global food stocks were reduced, setting off a series of export-ban actions by Thailand, Burma and even the United States.
The similarities are clear and suggest that the recent bout of food price inflation could very well continue over the coming months and years, fueling the surge of inflation I recently warned about (see “Our next economic worry: inflation”).

But what of the long-term future? And can investors catch this trend and profit?
Running out of Earth?

In his 1798 work “An Essay on the Principles of Population,” British thinker Thomas Malthus wrote that the “increase of population is necessarily limited by the means of subsistence.” In other words, the Earth cannot support the unchecked growth of humanity. Increased demands for food will push people to cultivate less-productive land. And in the end, more-expensive food will result in the “premature death” of the less fortunate. Harsh, I know.

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To be sure, our demands on the planet are increasing. The global population is expected to grow from around 7 billion now to 9 billion by 2050. And there are simply fewer resources with which to feed those hungry mouths. Most of the world’s best farmland is already in production. Crop yields increased 115% between 1967 and 2007, while croplands increased by only 8% over the period. More-efficient agriculture closed the gap.

It will be difficult for these productivity gains to continue. According to the International Soil Reference and Information Centre, 24% of all the vegetated land on Earth has been damaged by humans, mainly through erosion. Fertilizers, which have been heavily used to boost crop yields, will become more expensive as energy prices increase the cost of production. Even fresh water is become increasingly scarce as ancient nonrenewable aquifers in places like Australia and Libya are depleted.

But this Malthusian future doesn’t give much credit to human resourcefulness. Societe Generale strategist Dylan Grice shrugs off suggestions that the only viable investment strategy in this environment is to invest in physical commodities and wait for supplies to run short, via futures or exchange traded securities like the iPath Cotton Total Return Exchange-Traded Note (BAL) or iPath Grains Total Return ETN (JJG).

Why? Because their expected long-run inflation-adjusted return is zero. I’ve illustrated this point in the chart above, which shows how real commodity prices have gone nowhere over the last 150 years while stocks and bonds have marched higher.

The better solution for investors, according to Grice, is to focus attention on low-cost commodity producers and the equipment providers that supply them. That’s because the march of technology and industrial power has steadily lowered the cost of production for all types of goods and resources. In his words, when you buy commodities for the long haul, you’re “selling human ingenuity.”

He continues: “Past performance is no guarantee of future results, obviously, but human ingenuity has a good track record of overcoming nature’s constraints so far. A commodity bull market is really just a bottleneck and as a species we’ve succeeded in bottleneck removal. Historically, most bull markets haven’t ended up where they started.”

You can see above how commodity prices go through boom-and-bust cycles as the process of technological development plays out. That suggests that while the current round of food price inflation will be painful for many, and deadly to some, the profit motive will encourage unique solutions to the problem.

And the idea of funding solutions might make investing based on these brutal trends a little more palatable.
Two ways to play for investors

The obvious play on food price inflation is Market Vectors Agribusiness (MOO, news), which invests in companies like tractor maker Deere (DE, news) and fertilizer producer Potash of Saskatchewan (POT, news). Admittedly, MOO has already posted some big gains and is up an impressive 61% from its July low.

But the venerable Don Coxe, the publisher of the Basic Points investment journal for BMO Capital Markets, believes there is still more upside to come for the sector — especially for Potash. The company recently fought back a hostile $39 billion takeover bid from BHP Billiton (BHP, news) and boasts 400 years’ worth of reserve potash assets in the ground. No other mining company can claim such reserves.

The other way to profit from food inflation is to take the bet that food and fuel inflation — so-called “noncore” sources of inflation — forces up the core rate of inflation that the Federal Reserve pays attention to. If so, precious metals should benefit, while bonds suffer.

At the time of publication, Anthony Mirhaydari did not own or control shares of any company or fund mentioned in this column.

Be sure to check out Anthony Mirhaydari’s advisory service, the Edge. A free trial has been extended to MSN Money readers. Log in with “freeuser” as the user name and “edge” as the password. Mirhaydari can be contacted at Click here to find Mirhaydari’s most recent articles.

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