"Food prices" where, and for whom? I tend to be frustrated when non-macro investors step in to make broad commodity calls because these systems are much more dynamic than any given cause-effect relationship. Many commodity prices — especially those most important to the average person — are driven in all kinds of crazy directions by government action, and they can stay that way indefinitely. With food prices in particular, I can't think of a single issue that's more instantly (and intensely) political. Why wouldn't world governments just step in to drive down prices? What levers would they use to do so if they felt they had to? How do these second- and third-order effects interact with the possibility of opportunities in this space?
The US once decided to prop up its local cotton growers with subsidies that negatively impacted competition in Brazil. The WTO declared those subsidies unlawful in 2004, the US appealed, and after years arguing in appeals, Brazil still prevailed. With appeals settling in the delicate aftermath of the GFC, rather than repeal the local subsidies, and unwilling to face retaliatory taxation from Brazil on US exports, the US decided it was easiest to just pay Brazilian cotton farmers $147 million/year. "Fuck it, write 'em a check."
The US is already seeing intense political pressure to "do something" about inflation, and of course more interventionist regimes like China's are already much more heavily involved with trying to manage commodity prices. What happens when this becomes something that gets broad fiscal firepower behind it?
In Diary Of A Very Bad Year, the anonymous hedge fund manager being interviewed remarks that his firm actively avoids taking a directional position on any of the major currency crosses because they tend to be mean reverting over time and they're ultimately driven by central banks and fiscal policy makers. He remembers going to an "idea pitch" dinner with other hedge fund managers, and everyone was very bullish on the euro, bearish on the dollar:
"Now, considering that everyone at the table being super-bearish on the dollar probably meant that they were already short the dollar and long the euro, I went back and basically looked at my portfolio and said: “Any position I have that’s euro-bullish and dollar-bearish, I’m going to reverse it, because if everybody already has said ‘I hate the dollar,’ they’ve already positioned for it, who’s left?” Who’s left to actually make this move happen? And who’s on the other side of that trade? On the other side of the trade is the official sector that has all sorts of other incentives, nonfinancial incentives, political incentives. They want to keep their currency weak to promote growth or exports or jobs. Or they have pegs, peg regimes, that they need to defend, and they don’t really care about maximizing profit on their reserves. They’re not a bank trying to maximize profits, they have broad policy objectives—and infinite firepower."
I wouldn't disagree that there's possible opportunity here, but I really want to hear the part where those opportunities are aligned with (and not facing off against) the counter-parties with infinite firepower and no profit incentive.
"Food prices" where, and for whom? - Usually the poorest countries and poorest segments of populations are hit the hardest by food inflation as the 2007-08 crisis evidenced.
Regarding dynamism of cause and effect, I specifically highlighted the complexities of agricultural commodities in the piece, which includes increased government actions by Russia, China etc.
As for where there is alignment, if I follow your argument correctly you're saying the biggest risk here is that governments step in and stimulate/incentivise (over)supply to bring down food/crop prices? It's possible, but given the complexities involved (unhedgeable political and weather risk) this won't necessarily lead to lower prices. Plus farmers etc would still need to procure energy, fertilisers etc that governments may not be able to adequately subsidise the cost of, as the underlying drivers of these are not under the influence of government policies (e.g. OPEC+ and energy prices, export restrictions, resource nationalism etc )
My real critique — to the extent that it is a critique, I'm mainly thinking out loud here — is just that I think you've correctly identified a "high tension" price situation here, but it's not clear to me how it resolves.
If the idea is that commodity prices for staple crops are primed to spike, I'm not sure I'd agree. Governments have all kinds of ways to suppress those prices through fiscal policy, and tremendous incentive to do so.
How does that happen? Governments could subsidize the input costs (your point), but they could also just pay farmers directly, eating a portion of the cost that would otherwise be passed on to consumers. That could be incredibly bullish for growers: unfettered demand but increased revenue from the government subsidies.
Or maybe they just rejigger existing subsidies, cutting back on bio-fuel subsidies to subsidize food crops. That could be bullish for energy companies (reduced alternatives) but could have all kinds of other effects, too.
Basically: where's the trade?
The direction of fiscal policy has many degrees of freedom here, I wouldn't want to make too many assumptions; on the other hand, certain pieces of the chain might be set to benefit almost no matter what.
My last note would be that something like oil production is much less elastic/dynamic than growing food, generally. It's a lot easier/less risky for agricultural production to quickly ramp up than oil production, and I can imagine all kinds of ways that growers might rise to the challenge.
Who benefits and where the trade is, is the subject of Part II, which I intend to publish next week.
With regard to your other points, governments were unable to alleviate the food crisis of 07-08 (the GFC eventually cooled food prices as oil and commodity demand declined) so I would question their ability to achieve otherwise this time around should a food crisis materialise. And again other market forces in a post-COVID world would likely be more effective this time in negating any incentive programmes etc, with countries such as Russia and China accounting for a large share of fertiliser inputs.
Thanks for reading and commenting. Impact depends on what type or food/staples business you are talking about. Companies in control of their own supply chains and selling essential produce should be resilient.
Have you explored how to play this? It would appear that futures prices need to increase in order to incentive farmers to plant more given their higher costs? Specifically, which future on which agri commodity and any idea if option prices are cheap or expensive?
I suppose I am trying to save myself the initial effort.
Great analysis. I have been accumulting shares of WEAT, SOYB, and CORN for some time. I think there is still upside left, and I don't think the risk it near as large.
"Food prices" where, and for whom? I tend to be frustrated when non-macro investors step in to make broad commodity calls because these systems are much more dynamic than any given cause-effect relationship. Many commodity prices — especially those most important to the average person — are driven in all kinds of crazy directions by government action, and they can stay that way indefinitely. With food prices in particular, I can't think of a single issue that's more instantly (and intensely) political. Why wouldn't world governments just step in to drive down prices? What levers would they use to do so if they felt they had to? How do these second- and third-order effects interact with the possibility of opportunities in this space?
The US once decided to prop up its local cotton growers with subsidies that negatively impacted competition in Brazil. The WTO declared those subsidies unlawful in 2004, the US appealed, and after years arguing in appeals, Brazil still prevailed. With appeals settling in the delicate aftermath of the GFC, rather than repeal the local subsidies, and unwilling to face retaliatory taxation from Brazil on US exports, the US decided it was easiest to just pay Brazilian cotton farmers $147 million/year. "Fuck it, write 'em a check."
The US is already seeing intense political pressure to "do something" about inflation, and of course more interventionist regimes like China's are already much more heavily involved with trying to manage commodity prices. What happens when this becomes something that gets broad fiscal firepower behind it?
In Diary Of A Very Bad Year, the anonymous hedge fund manager being interviewed remarks that his firm actively avoids taking a directional position on any of the major currency crosses because they tend to be mean reverting over time and they're ultimately driven by central banks and fiscal policy makers. He remembers going to an "idea pitch" dinner with other hedge fund managers, and everyone was very bullish on the euro, bearish on the dollar:
"Now, considering that everyone at the table being super-bearish on the dollar probably meant that they were already short the dollar and long the euro, I went back and basically looked at my portfolio and said: “Any position I have that’s euro-bullish and dollar-bearish, I’m going to reverse it, because if everybody already has said ‘I hate the dollar,’ they’ve already positioned for it, who’s left?” Who’s left to actually make this move happen? And who’s on the other side of that trade? On the other side of the trade is the official sector that has all sorts of other incentives, nonfinancial incentives, political incentives. They want to keep their currency weak to promote growth or exports or jobs. Or they have pegs, peg regimes, that they need to defend, and they don’t really care about maximizing profit on their reserves. They’re not a bank trying to maximize profits, they have broad policy objectives—and infinite firepower."
I wouldn't disagree that there's possible opportunity here, but I really want to hear the part where those opportunities are aligned with (and not facing off against) the counter-parties with infinite firepower and no profit incentive.
Thanks for reading and commenting.
"Food prices" where, and for whom? - Usually the poorest countries and poorest segments of populations are hit the hardest by food inflation as the 2007-08 crisis evidenced.
Regarding dynamism of cause and effect, I specifically highlighted the complexities of agricultural commodities in the piece, which includes increased government actions by Russia, China etc.
As for where there is alignment, if I follow your argument correctly you're saying the biggest risk here is that governments step in and stimulate/incentivise (over)supply to bring down food/crop prices? It's possible, but given the complexities involved (unhedgeable political and weather risk) this won't necessarily lead to lower prices. Plus farmers etc would still need to procure energy, fertilisers etc that governments may not be able to adequately subsidise the cost of, as the underlying drivers of these are not under the influence of government policies (e.g. OPEC+ and energy prices, export restrictions, resource nationalism etc )
My real critique — to the extent that it is a critique, I'm mainly thinking out loud here — is just that I think you've correctly identified a "high tension" price situation here, but it's not clear to me how it resolves.
If the idea is that commodity prices for staple crops are primed to spike, I'm not sure I'd agree. Governments have all kinds of ways to suppress those prices through fiscal policy, and tremendous incentive to do so.
How does that happen? Governments could subsidize the input costs (your point), but they could also just pay farmers directly, eating a portion of the cost that would otherwise be passed on to consumers. That could be incredibly bullish for growers: unfettered demand but increased revenue from the government subsidies.
Or maybe they just rejigger existing subsidies, cutting back on bio-fuel subsidies to subsidize food crops. That could be bullish for energy companies (reduced alternatives) but could have all kinds of other effects, too.
Basically: where's the trade?
The direction of fiscal policy has many degrees of freedom here, I wouldn't want to make too many assumptions; on the other hand, certain pieces of the chain might be set to benefit almost no matter what.
My last note would be that something like oil production is much less elastic/dynamic than growing food, generally. It's a lot easier/less risky for agricultural production to quickly ramp up than oil production, and I can imagine all kinds of ways that growers might rise to the challenge.
Who benefits and where the trade is, is the subject of Part II, which I intend to publish next week.
With regard to your other points, governments were unable to alleviate the food crisis of 07-08 (the GFC eventually cooled food prices as oil and commodity demand declined) so I would question their ability to achieve otherwise this time around should a food crisis materialise. And again other market forces in a post-COVID world would likely be more effective this time in negating any incentive programmes etc, with countries such as Russia and China accounting for a large share of fertiliser inputs.
great stuff, as always
Thanks for reading James
Thank you very much for your amazing substack.
How do you think this may impact in Food and Staples Retailing stocks?
Thanks for reading and commenting. Impact depends on what type or food/staples business you are talking about. Companies in control of their own supply chains and selling essential produce should be resilient.
There is value in the market out there. Look at lastminute.com, trading on 6x EBIT with net cash.
Thanks. Will take a look.
Very useful post, thanks. And for pointing out current backwardation in the strip prices. Perhaps this is where the opportunity is.
Thanks Oliver, glad you found it interesting.
Have you explored how to play this? It would appear that futures prices need to increase in order to incentive farmers to plant more given their higher costs? Specifically, which future on which agri commodity and any idea if option prices are cheap or expensive?
I suppose I am trying to save myself the initial effort.
I think BG is the way to play it, as outlined in Part II.
Great analysis. I have been accumulting shares of WEAT, SOYB, and CORN for some time. I think there is still upside left, and I don't think the risk it near as large.
Thanks for reading Shane.