Nothing in life – or the markets – is totally predictable. It was only a year ago that the world was totally side-swiped by a global pandemic. Did anyone see that coming before the first reported cases coming out of Wuhan? Hardly.
This is why I believe a big driver for wealth management is risk mitigation. Today, I believe we must prepare for the possibility that food prices rise significantly.
After toiling away for 40+ hours a week the last thing you want is for your hard earned money to be devalued. While most investors think about total returns, embedded within that expected return is a data point called inflation.
When you let someone else use your money (i.e. you invest), you expect to be compensated for the risk they won’t be able to pay you back, the general cost of money and the devaluation of that money when they do. Some investments have a greater risk premium than others. Some are simply linked to the price of an underlying commodity. These commodities – such as copper, iron, wheat – are the most raw form of prices in the economy.
Commodity futures markets are probably best explained by the Duke brothers in the 1980s comedy “Trading Places”, starring Eddie Murphy. (OK, there are probably better explanations, but when else am I going to get to include this clip in an article?)
Commodities are inputs into much of what the world produces and consumes. If the price of a commodity rises, the cost to produce items using that commodity also rises. Those prices are typically passed onto consumers.
If the price of wheat rises, the price of bread in the grocery store will eventually tend to rise.
Agricultural commodity prices are determined by current and anticipated supply and demand (plus any related costs of ownership, such as storage). Commodity prices are also affected by the amount of money that exists within the economy and the value of the US dollar (since most commodities are priced in US dollars). At the moment – and for the foreseeable future – it appears that many of these factors are converging to lead to higher agricultural commodity prices.
Indeed, general agricultural prices are already at a 7 year high. Perhaps most concerning, prices have risen about 50% since just the middle of 2020.
We’ve seen these kinds of price rises before, around 2008 and 2012. These historical price changes have led to dramatic social and economic upheaval. Many argue that the 2008 commodity price pressure (this goes beyond agricultural commodities) helped tip the global economy into recession, ultimately leading to the Global Financial Crisis. Leading into 2012, many suggest skyrocketing food prices led to the ‘Arab Spring’ uprisings across much of the Arab world. My point is these surges not only affect our pocket books. They can have serious knock-on affects for the economy and society in general.
Since around 2014, we’ve benefited from relative agricultural price stability. This stability was assisted by surplus production in the United States, referred to by some as the ‘global food reserve bank’.
Unfortunately, this period of stability might be over. As demand (and prices) picked up throughout 2020 US producers have offloaded stockpiles to a worrying degree. Lower surplus reserves could exacerbate future price increases.
The world is always just days away from total anarchy.
Don’t believe me? Go look in your fridge right now. You probably have enough food to last a week. I’m not predicting grocery store shelves will go bare, but I’m pointing out the extremes to which food shortages can go.
We are all dependent on ample food stockpiles, and any deficiency will QUICKLY be priced to bring supply and demand back into equilibrium. Without a buffer, a weak harvest – perhaps in Russia or India – could send global food prices soaring.
The base case is for an orderly rise in food prices, but anyone that cares about their wealth and health must consider scenarios where food prices lurch higher.
One doesn’t have to look to Russia or other foreign nations to see supply risk. There are serious problems in our own backyard.
Weather patterns in the US have become increasingly unfavorable over the years. Currently, a massive portion of the US is experiencing drought. Climate change is only making it more challenging to reliably grow food.
North American’s only spend about 5% of their income on food, so we take food stress for granted. Of course, that proportion is not the same for everyone as income inequality polarizes spending patterns. That 5% figure probably doesn’t show the true nature of food insecurity across North America. The rise in food prices will hurt many.
My point is simple: the risk of food price inflation is real. People need to consider ways to mitigate that risk. This includes better grocery shopping habits, stockpiling non-perishables and allocating a portion of investment portfolios to assets that might benefit from inflation.
