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Are crop investors learning from the wrong crisis?

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Are investors drawing lessons from the wrong crisis?

They have taken a heavy toll on agricultural commodities since mid-February, when the start of Libya's turmoil crystallised concerns that the region's unrest could put global economic recovery on the skids, before Japan's earthquake compounded concerns.

Sugar and wheat have fallen some 20%, reaching the level which many analysts use for a sell-off to qualify as a correction. Rubber is down by more than 25%. The falls are reminiscent of the sell-off after the 2007-08 rally.

It is certainly rational to think that consumption will take a hit as higher oil prices bite. But there are good reasons to think a rerun of 2008, when prices of main grains halved in less than six months, is not on the cards.

Spring not sprung

One reason is in the timing. When investors ran scared from crop futures three years for fear of lower demand, northern hemisphere farmers had already got bumper harvests in the barn, and southern hemisphere producers got many of theirs' in the ground.

World wheat production jumped 12% in 2008-09, far faster than consumption, leading to a jump in stocks of more than one-third – and the depressant effect of ample supplies on prices.

This sell-off has happened before spring crops are sown in the likes of the US, Europe and Canada, or winter grains in Australia, giving farmers the option of pruning planting programmes plans rather than bringing less fertile or conservation land back into production.

Sure, the picture for sowing incentives in the US is clouded by insurance programmes.

But the message elsewhere is that with stocks of, especially, corn, soybeans and cotton at historically thin levels, markets need to persuade the farmer to get seeding big time - which they wouldn't by pricing in a 50% discount.

Inflation vs deflation

The second is the nature of the central shock which has got investors in such a stew.

An economic slowdown caused by higher oil prices would present the world with a different set of problems to those it faced in 2008, when a credit drought sent the globe into recession.

Inflation is one, as higher energy prices feed through the pricing chain, unlike the deflation threat posed by tight money which got central bankers worked up until lately.

The oil-induced inflation scenario, while hardly comforting, may not be such a setback to farm commodities as some other assets.

Shock resistance

Take the most famous hit by oil to the world economy, in 1973.

Chicago corn prices rose 73% that year, and a further 27% in 1974, while wheat prices more than doubled.

OK, failed Russian crops had a big impact that time, as they have in 2010-11 too. But in many other years when oil prices have spiked, such as 1979, 1991 and of course in 2007-08, crop prices have improved as well.

And correlations between grains and crude will only have been enhanced by greater use in making biofuels.

China factor

That's not to say investors can ignore Middle East instability.

For one thing, it would hit hard in China, such a huge importer of raw materials including cotton, rubber and soybeans. The country wasn't such an issue during previous oil shocks, before it became such an important global economic player.

But to think that we are about to witness 2008 again looks misguided too.

By Opinion, by Mike Verdin

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