Food, energy and raw materials inflation to deflate

April 2008:- Food and raw materials inflation will come to an abrupt halt within the coming twelve months. Despite gloomy inflation forecasts causing excessively high interest rates of central banks such as the European Central Bank and Bank of England, commodity deflation is likely.

To be sure, high energy, agricultural and general raw material price rises are squeezing businesses and consumers.  By raising costs and absorbing a rising proportion of disposable income during an economic downturn, higher commodity prices are ironically deflationary. The coming commodities deflation and potential general deflation may well appear to be a heretical prediction, but this maverick view is based on a simple basic fact.

A marked increase in speculation has played a major role in driving up prices of wheat by 162 per cent since 2006, corn by 130 per cent, Chicago traded rice by 119 per cent, soybeans by 111 per cent, Brent crude oil by 103 per cent, and cotton and copper by almost 80 per cent. There have also been hefty gains for sugar, coffee, cocoa and other metals, and the increases are still extensive even though prices have recently fallen from heady peaks. Only lumber, directly related to the US house building slump, has tumbled by 37 per cent.

Massive speculative positions

Hedge and managed future fund bull futures and options positions on commodity exchanges have multiplied, while open positions have reached new records. The Bank for International Settlements estimates that global turnover in exchange traded commodities jumped by 72 million contracts or 16 per cent in the fourth quarter of 2007 to 528 million contracts. On the OTC markets, the notional value (the total principal value of commodity contracts) surged from US$2.9 trillion in June 2005 to US$6.4 trillion in 2006 and US$7.6 trillion in June 2007, indicating that they now exceed US$8 trillion.

Shere stupidity of many pension fund and asset managers

Semantics cloud the extent of speculative activity. Pension funds, investment banks and brokers maintain that their commodity purchases are ‘alternative investments’ totalling $172 billion, according to Macquarie Bank. They have been buying metals, energy and agricultural commodities to ‘diversify’ their assets from income-earning stocks and bonds. Call it what they will, pension fund purchases of commodities are nothing less than speculation. Economic and financial historians will slam the stupidity and irresponsibility of pension managers who are now entering this dangerous market after extraordinary price rises. How on earth will they retreat when relatively illiquid commodity markets eventually head south?

CRB Commodity Index


Snakeoil spin of commodity sales people and fund managers

The claim that China, India, emerging nations and others are munching all the produce of Western farmers and are building new city after new city is snakeoil spin of commodity sales people and fund managers. The depletion of agricultural land and natural resources is Malthusian twaddle. Commodity super bulls maintain that the markets are in a ‘super cycle’ that will drive prices to exceptional peaks. Production will not be able to match demand and there are already shortfalls, bulls maintain.

Really? History has shown time and time again that if prices are attractive, productionl rises. In a recessionary economic environment, factories and other consumers won’t be in a hurry to purchase commodities from leveraged hedge fund speculators and pension fund managers who wish to offload their holdings.

Agricultural bulls hope is for El Nino natural disaster

If there is an ‘El Nino’ that causes hurricanes and drought, or a plague of locusts, agricultural bulls could well turn out to be right. Indeed, a natural catastrophe would in all probability generate an even greater speculative frenzy in agricultural markets and further misery for the poor and hungry. But on current crop and economic evidence, the skin of the commodity balloon has become microscopically thin; indeed, a tiny pin prick caused the sharp commodity price slide towards the end of March, although a swift patch job helped markets rally a bit.

A Red light-  Food company sells trading operation to hedge fund

Sometimes, an event takes place that sends a signal to the deluded crowd who are chasing prices higher and higher. A remarkable commodity deal could well be the breeze that blows the balloon towards sharp nails.

ConAgra Foods, a major US food company that has been in business since 1861, has just sold its commodity trading and merchandising operations to Ospraie, a hedge fund firm. The trading unit’s price, agreed in late March, was a mind boggling $2.1 billion. ConAgra CEO Gary Rodkin noted that it was ‘best to sell when times are good’ and that shareholders had become wary of the volatility and risk of the trading unit. In contrast, Ospraie, which manages $9 billion, believes that trading will remain buoyant. The volume of commodity demand from China and other emerging nations will not abate for some time, Ospraie executives contend.

David Threlkeld of Resolved Inc, a metals trader, believes that food and raw materials inflation would end swiftly if the exchanges forced speculators to place much higher margin, or deposits, to back their dealings. He may well be right; a speculative withdrawal would be accompanied by swift price declines.

This would be welcome relief for hard pressed pensioners, low and middle-income families.  Even farmers and raw materials producers would prefer lower volatility and more reasonable prices for their customers.  Miners, oil companies and others fear substitution.


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