Published:
March 5, 2008
"I think we need to tell the
American consumer that [prices] are
going up. We're seeing cost
increases that we've never seen in
our business."
That's direct from Larry Pope, chief
executive of Smithfield Foods (NYSE:
SFD), the largest U.S. pork
processor. And he's merely voicing
the beliefs of many in the
agriculture industry, who warn that
"real food inflation" is here to
stay.
Next time you visit the grocery
store, you'll see what I mean. Food
prices have seen a widespread
increase recently due to intense
demand and lower crop yields.
Follow the commodities industry like
my colleague at the
Xcelerated
Profits Report, Lee Lowell, and this
will be no surprise. Lee is a former NYMEX market maker — one of the
guys who actually used to set the
prices of major commodities like oil
and natural gas. To say he's a
commodities expert would be an
understatement.
Lee says there are three crucial
factors that drive commodities
prices:
Supply and demand
Inventory levels
Weather conditions
Forget The Chaff... Wheat Soars To
New Highs
That's certainly the case in the
wheat market. Sure, it doesn't get
much press compared to dominant
commodities like oil and gold, but
if you take a look at wheat price
action over the past year, you can
see that it's ballooned from lows
around $5 in May 2007 to a recent
high over $13.50. That's a bigger
percentage rise than oil and gold.
The reason for the move is a potent
twin combo of growing global demand
and a severe drought in
wheat-growing regions. That's a
recipe for a major bull market —
one that's set to continue,
according to both the U.S.
Department of Agriculture (USDA) and
Goldman Sachs (NYSE: GS).
As recently as January, the USDA
projected that U.S. wheat stocks
would total 292 million bushels by
the end of the 2007-08 marketing
year on May 31st. But it hasn't
taken them long to revise that
forecast.
It says recent shortages have
resulted in a sharp downward
revision to 272 million bushels.
This is the lowest level since
1947-48, according to Goldman Sachs'
weekly Commodities Watch report.
Fork Out For A Full Belly
In the past, I used to be able to
duck out of the grocery store,
having spent less than three figures
on food. Today, the bill regularly
tops $100.
As I trundle out of there
considerably lighter in the wallet,
all I can do is shake my head and
suck it up. Everything seems to have
risen in price. But it's like
gasoline prices. You can complain
about it all you like, but it's not
going to change the fact that you
still need these basic, everyday
commodities. There's little choice.
In 2007, consumer prices shot up by
+4.1% — the biggest rise in 17
years. Included within that was a
+4.9% jump in food prices — the
highest since 1990. It came on top
of a +29.6% spike in gasoline costs
and +17.4% rise in overall energy
prices.
Don't expect that trend to end any
time soon — at least in terms of
food costs...
An "Unforeseen And Unprecedented
Shift"
The above quote is how the United
Nations recently described the rapid
shortage in global food supplies.
According to U.N. Food and
Agriculture Organization (FAO)
records, wheat reserves sank -11% in
2007 to the lowest level since 1980,
while there are only eight weeks of
global corn reserves on tap. The
global shortage has resulted in a
food price spike across the world.
In fact, the FAO's food index soared
by +40% in 2007, compared with a +9%
rise in 2006.
At the recent USDA annual
Agricultural Outlook Forum, the
Advanced Economic Solutions group
chimed in and stated that higher raw
materials prices are also set to
maintain the bullish sentiment in
the agriculture sector.
The current forecast calls for food
price inflation of +3-4% this year,
as companies find it increasingly
difficult not to pass the higher
costs onto consumers.
And then there's corn. From
Cinderella to ugly duckling...
Corn Craze = Higher Costs
In response to America's "addiction
to oil" (the U.S. spends more than
$450 million every day on oil
imports and 97% of the
transportation system relies on oil)
and rapidly increasing prices, it
became imperative to beef up
alternative energy sources.
The U.S. Congress passed the Energy
Policy Act of 2005, which called for
an +87% jump in renewable fuel usage
by 2012, in order to reduce U.S. oil
imports -75% by 2025.
Ethanol, the fuel derived from corn,
immediately leapt to the front of
the line. With politicians falling
over themselves to offer incentives
and promote growth, the industry
kicked into high gear. New plants
popped up all over the place,
production surged, and ethanol
stocks took off.
Today, however, ethanol has
experienced a harsh fall from grace.
More folks have realized how much it
costs to produce ethanol — so
costly, in fact, that the industry
relies on a $0.51 per gallon federal
subsidy. In addition, because
ethanol yields one-third less energy
than gasoline, you can't travel as
far on a gallon of ethanol as you
can on a gallon of gasoline. So
you'd need to buy more. Basically,
ethanol needs to be cheaper than
gasoline to offset its weaker fuel
efficiency.
But for consumers, it's already too
late. The USDA says ethanol will
suck up 25% of the U.S. corn crop
this year. As farmers have set aside
vast areas of land to satisfy
ethanol demand, they've done so to
the detriment of other crops such as
wheat and soybeans, sending those
prices soaring due to lower supply.
Maybe a drink will ease the strain?
Actually, that's getting more
expensive, too...
More Bucks For Beer… And Two
Companies To Consider
Microbrewers are now feeling the
effects of rising grain costs. With
fields full of corn, wheat and
barley prices have soared. And after
years of oversupply, even hops
prices are now rising due to a -30%
loss in U.S. hops acreage between
1995 and 2006. Quoted in the
Associated Press, Terry Butler,
brewmaster of Washington-based
Snipes Mountain, says hops prices
have jumped more than +100% over
last year, while barley has risen
+10-15%.
Tack on higher fuel and glass costs
and you've got a recipe for higher
prices, as these brewers don't have
the same ability as their bigger
rivals to hedge against rising
costs.
So what can you do to combat these
rising food and alcohol prices?
You could consider companies like
Tyson Foods (NYSE: TSN, $14.92) and
British firm Diageo (NYSE: DEO,
$81.25). Tyson has little choice but
to pass on rising food costs to
consumers at the store, while Diageo
is the world's largest spirits firm,
boasting operations in 180
countries.
In addition, it's strongly
diversified among both beer and
spirits, and its many brands include
Smirnoff vodka, Johnnie Walker
whisky, Captain Morgan rum, Gordon's
and Tanqueray gin, Baileys Irish
Cream and the ever-popular Guinness.
This helps it offset higher costs in
some brewing areas, with the range
of both drinks and its global
presence resulting in some solid
results...
Over the first half of its fiscal
2008 year, sales rose almost +6%,
while earnings hit $2 billion.
Operating profits soared by +20%. In
troubled times, that's pretty
impressive.
Best regards,
Karim Rahemtulla
Investment Director, Smart Profits
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