High food prices, what could it mean?

Food and oil are usually the two commodities that the public find relevancy to their daily lives, and with good reason. Life becomes much more confounding when the two essential expenses; food and petrol, decide to double in price over the short term. Inflation, or to be more specific, stagflation now enters the foray, which starts factoring itself into all budget items, not just goods made from primary products, but also other items through increased wage and transportation costs. Without boring you with the usual economic dribble, out of control commodity prices are usually a big cooler on the economy, at least in the short term.

The SMH today debates several factors that seem to have been conspiring to lift raw food prices. They are:

- Weather patterns, namely the Australian Drought
- High oil prices, creating an opportunity for farmers to use food product as biofuel sources rather then human consumption
- Increasingly low inventories. “Research by the Commonwealth Bank says smaller wheat crops mean the “world is going to cut further into already dwindling inventories”. Inventories of wheat are likely to fall to about two months’ supply.”
- Increasing demand in Asia for more Western style foods.

Each is a fair point, but as most commodity traders would know, its only part of the picture. The fundamentals may create a bias, but its ultimatley the speculators who are driving the prices. This graph tells the story of the rise and rise of wheat:

Wheat is breaking out on the bull side, but fortunately, its doing so on less and less open interest (see the bottom bar). To read the chart properly, its important to understand what open interest is. Simplicity is easy in this case, as all open interest shows is how many futures contracts are trading the market. The lack of contracts is putting a temporary squeeze on prices, with momentum players (traders who ride big upward pushes) speculating further, driving the price high. Careful choices in langauge was used by fund manager, Dominic McCormick:

“McCormick says there will be huge corrections in prices along the way but the fundamentals are likely to remain to support higher prices over the long term. He says the main trend is the growth of Asian demand. Just as it is creating demand for resources, it is also the main driver of higher agricultural commodity prices.”

Translation: the fundamentals support the hypothesis of higher prices, but the short term value has gotten way out of hand. Food prices tend to fluxuate even more then oil/petrol prices. This is why the futures market was created in the first place; to leave consumers and producers out of the war zone. Higher prices may be a long term proposition, but a doubling of the long term mean would be highly unlikely.