Nicholas Nassim Taleb on Forecasts

"If you ever have to heed a forecast, keep in mind that its accuracy degrades rapidly as you extend it through time." Nassim Nicholas Taleb, 'The Black Swan'

Wednesday, January 9, 2013


We wish all readers a Very Happy and Prosperous New Year.

Our parent company, FoodWorks, has just launched a new (FREE) research study covering the broad parameters of investments in South-East Asia.

We are reminded that many of the world's major food and industrial crops originate in large volumes from this region. Rice is the main staple crop and Vietnam and Thailand are major exporters to the rest of the world. Oil palm (palm and palm kernel oil), sugar, rubber, cocoa as well as high value tropical fruits and vegetables and fish all come from this part of the world and production is increasing in line with prices.

Malaysian oil palm planting responds to rising prices
The study points out that demand is driven by an increasing middle class and by urbanisation. Agriculture will have to change dramatically in terms of its productivity and applied technology to cope with these demographic changes. And the region is far from the possible production boundary so there is ample opportunity to invest in areas the study highlights, like Mindanao in the Philippines and in Burma which is just joining the world trading community. Regional economic integration will also go a long way to foster growth.

To download the study directly, please click on this link:

Agriculture and Agribusiness Investment in South-east Asia

or for more information contact

Tuesday, October 9, 2012


The White Nile 
Late September the US Government announced an additional $450 million of aid to Egypt.  The USA already provides about $1 billion of total aid of which just under $400 million (2010) was economic assistance, making Egypt the 4th largest recipient of such aid. If you set aside the special cases of Af-Pak and Iraq, then Egypt tops the economic assistance chart. So the $450 million proposed to Congress was more than doubling the amount of economic assistance to be received. 

Clearly someone understands the critical importance Egypt has in the MENA region. Egypt is facing an acute budget crisis with a shortfall of $12 billion and an urgent need to line up an IMF loan of which the US assistance will form part of the overall assistance package.

Kay Graham (R- Texas) doesn’t agree with any of this saying, “I am not convinced of the urgent need for this assistance and I cannot support it at this time.”  She will apparently use her position on the House Appropriations Committee to block the assistance.

While we are always sceptical of foreign aid the case of Egypt needs looking at very carefully. Leave Syria, Israel-Iran and Af-Pak aside for a moment, these will be sideshows compared to an implosion of the Egyptian economy that for so long has depended on foreign assistance to maintain a social welfare net for its massive and youthful population.

Egypt’s population will have topped 84 million people by the end of this year and will double in 40 years at current growth rates.  It tops the next largest country in the region, Iran, by 10 million people but with a tiny cultivable land area in comparison.  The population is one of the world’s most densely concentrated with 1,500 people per square kilometer; 20% of these are below the  below the poverty line and there is a massive youth population of whom  25% are unemployed.

Whatever the Mubarak government did or did not do for human rights, it aggressively pursued economic reforms to attract foreign direct investment (FDI) and facilitate GDP growth.  But living conditions for the average Egyptian remained poor and contributed to public discontent and hence the events culminating in Mubarak’s ouster and a win for the Muslim Brotherhood.  Great for democracy, perhaps, but unfortunately not so great for the economy. Tourism, manufacturing, and construction are among the hardest hit sectors, and economic growth has dropped from around 5% to near 1% - not enough to even begin to create jobs. Public debt runs at 85% of GDP and inflation is over 13%.

Bottom line: Egypt is broke with no foreseeable way of changing that situation. Can it get worse? Read on Dear Reader, read on and be afraid, be very afraid.

A great article by Andrew Natsios (US News) says that Egypt faces four challenges (we always use the word “challenge” now instead of “mess” or “disaster” – part of the inexorable move towards unwillingness to face real problems, but that’s another rant).  These are: economic rapidly rising food prices and budget deficits, a precipitous economic slowdown driving high unemployment even higher, and a long-term crisis over the water resources of the Nile River.  

We want to look at what we consider as the most pressing and fundamental issues: water and food supply. As we showed in our last post, there is a close and not surprising connection between rising food prices and political unrest.  If Egypt cannot manage its food supply (and more than many places that depends on the waters of the Nile), then expect to see the world’s greatest political crisis unfold right in the world’s most explosive area and on the doorstep of Europe.

Taking the water supply first: without the Nile there is no Egypt, without its water and the fertile soil it brings with it on a yearly basis Egypt’s people, all 84 million of them – 168 million by the middle of this century - will live in a desert. Unlike countries where extra land can be brought into cultivation by irrigation, Egypt has pretty well exhausted its potential for extensive agriculture. By the time they reach the sea the waters of the Nile have been used to their maximum possible capacity. So there is no extra water or land to be gained. And Egypt is projected to have a per capita water availability by 2025 of just half what it had in 1990.

The Nile River Basin - the main population
center in Egypt (red) has no control
over the water sources (blue) 
The danger is that the water supply may be even  further reduced. The waters of the Nile originate in Ethiopia (the Blue Nile and the Atbara River) and in Uganda (the White Nile). The Blue Nile is vital. Though shorter than the White Nile, 59% of the water that reaches Egypt originates from the Blue Nile branch; when combined with the Atbara River which also has its source in Ethiopia the figure rises to 90% of the water in the later part of the year from June onwards and 96% of transported fertile soil. The White Nile has a more steady flow of water which keeps the Nile proper from running dry in April and May, supplying about eighty percent of the Nile's water during these months. Both of these water sources are threatened (Note 2).

The Ethiopian government is now building what may be the largest dam in Africa—the Grand Millennium or “Renaissance” Dam—which will produce more than 5,000 megawatts of power using the waters of the Blue Nile. The evaporation alone from the 65 million cubic meter lake created by the dam will reduce Nile River flows, as well future irrigation for Ethiopian agriculture (possibly – see Note 1 below this post). As for the White Nile, it originates in the uplands of Uganda and then crosses two countries that have been at war for the last 40 years, the recently independent South Sudan (Christian) and Sudan (Muslim).

The main issue here is water management within each of these countries both of which seek to attract major investments in agriculture. Sudan (before its separation from the south) was and remains a signatory to riparian agreements that allow Egypt its access to water. However South Sudan is not a signatory. Critical to its approach is the Jonglei Canal. Started in 1980, this canal (ironically then funded by USAID) is a hydro-construction project in Upper Nile Province of southern Sudan designed to alter the course of the White Nile as it passes through a swampy area in southern Sudan known as the Sudd. The purpose of the canal was to ensure the flow of water was equally distributed between Egypt and Sudan by draining the Sudd.  

But the Sudd provides one of the main water resources for cattle in the south. Resistance to this idea was one reason for the civil war and now the new Government of South Sudan has raised the issue again in the context of using more Nile water in South Sudan. With climate change changing the pattern of rainfall in a belt along the border between south and north, rising interest in investment in agriculture and a growing population (Juba in South Sudan may be one of the fastest growing cities in the world), this is not an issue that is likely to be favorable for the Egyptians, especially if economic pressures make the Muslim Brotherhood incline towards a more fundamentalist brand of Islam.

Let’s turn now to agriculture. Because of its water supply Egypt has historically been a bread basket for the Middle East, even Europe; the Roman Empire depended on grain shipments from Egypt and it was the threat of Antony’s alliance with Cleopatra and his stranglehold on grain exports that brought the army of Octavian, the Battle of Actium and the famous asp. 

Egypt - all cereals - total production and imports
Things have changed a bit. Egypt is now the largest per capita importer and consumer of wheat in the world and is thus particularly sensitive to world food prices. Imports were 11.5 million tons in the 2011/12 (July/June) marketing year, a level above the average of 10 million tons of wheat imported in the previous two years.

Egypt subsidies bread to maintain political stability, but those subsidies are now economically and fiscally unsustainable. Surveys in 2011 by the U.S. Embassy in Cairo showed at least 50 percent of the population felt economically insecure, a proxy for the fears of the poorest half of the country that they may not be able to feed themselves particularly if the bread subsidies end or are altered. Any reforms of the Egyptian food system—however badly needed—could destabilize a fragile political system in a precarious transition. And yet bread and energy subsidies are bankrupting the national treasury.

This year (2012-13) wheat imports are likely to be lower than even in the last price peak year of 2008 – 9 myn tons. FAO’s latest estimates indicate an above average production of 8.7 million tons of wheat, exceeding last year’s already high harvest by additional 4 percent. The increase in wheat production was attributed to availability of improved varieties, favorable weather conditions and increased government procurement prices. Similar production increases were posted for maize and rice, bringing the estimated aggregate cereal production in 2012 to over 23 million tons (rice in paddy terms), which compares to 22.2 million tons in 2011-12.

Even with decreased import requirements, the increase in international grain prices is likely to add substantially to the cost of food imports. And the downturn in the overall economy means that Egypt simply will not be able to foot the bill. Somewhat optimistically FAO hopes that the high cost of imported wheat will not be felt directly on account of the country’s safety net program. But for how long can that be kept up?

Not long. Even if agricultural productivity can be increased and the water supply maintained, Egypt faces a population crunch. Tourism is unlikely to recover soon, and the world’s demand for Egyptian manufactures will continue to be hit by general slow growth. FDI will not increase with even the possibility of further civil unrest and perhaps a move towards more fundamentalist Islam. Compounding this are the longer term prospects for a diminished water supply.  In this situation, $450 million might seem like a small price to pay to help keep the lid on the pot. But we very much doubt whether ten times that amount will help.

We hope we are wrong.

Note1: The Grand Millenium Dam has not been started and may never start. Equally the Ethiopian Government has said that the water will not be used for irrigated agriculture in Ethiopia and claims that by holding back silt, the dam will actually prolong the lives of other critical dams such as Aswan. These are extremely complicated issues about which a book might be written; suffice to remember that nothing is simple in this part of the world.

Note 2: For more details on water usage in the Nile River Basin: and

Please comment to

Sunday, September 16, 2012

Surprise - Rising Food Prices Lead to Riots!

"Let them eat cake" famously  Marie Antoinette said of the starving French.  How did that work out?

Of course every politician knows that rising food prices can spell at the very least a lost election and sometimes a lot worse.  Even the Roman emperors knew that bread was at least an equal to circuses to keep their constituents quiet.  A little more recently FoodWorks was in Pakistan in 2008 when the price of "atta" (flour) rose sharply - people burned down shops in Lahore and Karachi.

So it hardly seems we needed an august academic group at the New England Complex Systems Institute to tell us that rising food prices are linked to civil disturbance.  Nevertheless they have produced this interesting chart. Here's what they say:

"......protests may react not only long-standing political failings of governments, but also the sudden desperate straits of vulnerable populations. If food prices remain high, there is
likely to be persistent and increasing global social disruption. Underlying the food price peaks we also and an ongoing trend of increasing prices. We extrapolate these trends and identify a crossing point to the domain of high impacts, even without price peaks, in 2012-2013. This implies that avoiding global food crises and associated social unrest requires rapid and concerted action
" (see reference below and click here to download the paper).

Oh, OK, so now we know.

In all seriousness, the Cambridge folk are right.  We've been arguing for years that rising food prices are a critical factor in instability and that with populations increasing exponentially in many developing countries where natural resources are depleted (take Yemen as an example) we are indeed facing a genuinely Malthusian crisis. We'll keep coming back to the issue... will anyone listen? 

Reference: The Food Crises and Political Instability in North Africa and the Middle East
Marco Lagi, Karla Z. Bertrand and Yaneer Bar-Yam
New England Complex Systems Institute, 238 Main St., Suite 319, Cambridge, MA 02142, USA, (July 19, 2011; revised August 10, 2011)

For more information or to make a comment, email

Friday, December 16, 2011 - JUST A GREAT ANALYTICAL TOOL

We were so enthusiastic about this tool that instead of just adding it to the sidebar (we've done that too) we wanted to highlight it for everyone to see.

Gapminder was founded in 2005 and is a non-profit organisation bringing FACTS to the discussions about development and economic growth - subjects near to our hearts. Click here for a quick link to their About page.

Agrimarkets is fascinated by charts and statistics that so often are able to cut through the chit-chat and help us understand what's really going on.  We've just added a page (see page bar above) where we collect and display whatever interesting chart data we come across.

Gapminder Agriculture is based on 700 UN FAO indicators that lets you create charts at will.  You can also access the raw data in tabular form.

Here's a chart that took less than a minute to create that answers one important question about agricultural productivity:

The chart shows cereal yields/ha. measured against incomes. It shows conclusively that the rich countries produce more cereals per hectare than the poorer ones.

Another chart gives a hint why:

It shows per capita incomes against the proportion of the labour force working in the agricultural sector.  The relatively richer nations have a LOWER proportion of their labour force employed in agriculture because they are able to use available capital (that gets invested in farm technology and agricultural knowledge) instead of unskilled labour (yes, they also subsidise agriculture while insisting that the developing world reduces subsidies - another story).

These charts are great!  For a final bit of fun look at these two:  the first chart shows the world (by the social measures of life expectancy and child birth) when the Editor of this blog was born in 1949.  The gap between the developed and less-developed countries was HUGE!

The second chart shows the same country data for 2010.  The difference is nothing less than astonishing.

Two points to note: the massive catch up by the Asian countries and the way Africa has been left trailing.  We still have work to do!

Please comment by writing directly to All will be answered.

Saturday, September 24, 2011

FOOD DEMAND ADJUSTMENTS ARE POSSIBLE - the question is how they impact agribusiness and the food industry

Today I threw away the end crusts of a loaf of bread because they were a little stale; if the price of bread rises by a lot my wife might take these end pieces and make rusks. In Pakistan during the mango season fruits litter the road;  even when the price of "ata" (flour) is through the roof South Asians still insist on eating their bread fresh and warm and throwing away the cold left-overs, and in the USA there are businesses built on taking restaurant waste and re-cycling for the homeless. Meanwhile in Somalia famine remains a concern of tens of thousands.

We mention these different elements of the food economy to illustrate that the way food raw materials are used is complicated and highly dependent not only on price, but on cultural habits and the mechanisms for processing and distributing food - the so-called "farm to fork" value chain.   The agriculture and food economy is not like making cars or refining crude petroleum oil or making computer chips but is instead hugely diverse and determined by interactions of the environment, climate and human psychology.  Many of the raw materials are used in conjunction with each other;  if the price of wheat rises because of adverse weather in North America, the production of cookies might fall reducing demand for sugar and cooking oil, even those these materials might be in reasonable supply.

In this case generalizing about the food industry, let alone making accurate forecasts is extremely difficult.  We try to avoid it, instead taking an approach that tries to explain why prices are where they are currently, that takes a longer term view than the very erratic short-term changes in specific futures contracts (though we report these too) and when things are going one way, we try and explain why they could go another.

Hence the subject of this post: how are high food prices affecting demand for agricultural raw materials and what might happen to take the steam out of the markets?

It may come as a surprise to some that food demand, even in developed, high income countries, can and does adjust down.  My anecdote about turning stale bread into rusks (for those that don't know, having never had the need, stale bread baked in a hot oven turns in delicious crunchy biscuits - try them!) is relevant -  Americans slashed their food expenses more during 2007 to 2009 recession, by an inflation adjusted 5 percent— the largest decrease in at least 25 years according to a report from USDA’s Economic Research Service. In 2006, before the recession began, total food spending by all US households peaked at $726 billion. By 2009 it dropped to $690 billion - $36 billion out of the food economy right there.

However there is more to the story:  the drop in consumption came from food bought in commercial establishments - restaurants, fast-food places - and the folk changing their consumption pattern were the middle-class; typically one expects that food is a relatively small part of middle class income earners overall household expenditure; indeed so it may be, but going out to dine is still considered by many as something of a treat.  People are not actually eating less, but they are paying less for the food by consuming it at home. This may not reduce the demand for raw materials, but it may e.g., drop the demand for industrial-sized packages of foodstuffs.

There is another lesson to be had from the data in the chart. The top line represents real total food expenditure from 1990.  Despite the (actually quite minor) adjustments down during recessionary periods, the overall trend is slightly upwards and this does reflect somewhat the overall long-run increase in prices; equally, apart from the change just discussed, overall the trend had been towards eating outside the home - more expensive and more highly processed foods.

Think about what constitutes restaurant food: food raw materials that have been grown commercially on a large-scale, processed by large commercial operators, packaged and shipped. In developed countries, of which this US data is representative, this trend suggests the growth of major industries,many not included in "agriculture", along the value chain to the dining table in that expensive restaurant.  Agriculture and even primary processing no longer hold the real keys to food demand in such countries but rather provide raw materials that have enormous value added to them before reaching the final consumer.  Changes in raw material supply and price certainly affect demand, but through the filter of this much more complex value chain.

Another feature is that the chart lines show little dramatic change or disturbance.  The headline writer at USDA makes much of the recent downwards adjustment - indeed we all have to write articles hung on a certain story.  But the real truth of food expenditure and demand in the developed world is that it is a remarkably stable demand whatever the circumstances. Your local high-end restaurant may see a fall off in custom and have to lay off some waiters, but the customers can still afford to cram down their 4,000 calories at home and still worry about obesity.

This is NOT the case for the rest of the world, and it may help to get some handle on what I mean by this. World average per capita GDP is roughly $10,000 (IMF data). There are 81 countries (out of 183) where incomes are higher than that figure and we might use these as indicators of where there might be a significant middle class. This is a VERY rough way to look at things because a country like Pakistan has a large population, a large middle-class, but a per capita GDP of only $2,721.

The majority in the >$10,000 group are actually countries which have some kind of significant resource advantage such as Qatar which holds the Number 1 spot with a per capita GDP of over $88,000.  But don't expect Qatar to account for much by way of food demand! In fact we count only five countries in this top end group that have both large enough populations and a very significant middle class (USA and Canada - taken as one -  UK, France, Germany) to really impact food consumption.  So who does?

We might usefully look at a recent report on the emerging middle class by OECD.Note 1 A key finding is as follows, "Today’s rich countries accounted for 22 per cent of the world’s people in 1965, but only account for 15 per cent today, and their share is forecast to shrink to 13 per cent of the world total by 2034 (Ed. my bold). Overall, the world will add 1.6 billion people by 2034. But the population in today’s rich countries will grow by only an estimated 90 million. Ninety-five per cent of the population increase (excluding migration) will be in developing countries."

Similarly in 1965 the global centre of the world was Europe, with the USA and Japan being the two growth super-powers.  In the next 20 years this centre of gravity will have shifted to Asia, with India and China producing the largest number of middle-class. The report goes on:

"Globally, the size of the middle class could increase from 1.8 billion people to 3.2 billion
by 2020 and to 4.9 billion by 2030. Almost all of this growth (85 per cent) comes from Asia. The size of the middle class in North America is expected to remain roughly constant in absolute terms.......... Europe enjoys some early growth in the numbers of the middle class, but then sees a fall as populations decline in Russia and elsewhere.

So there you have it: right NOW, a fairly small proportion of the world's population actually accounts for the bulk of food industry demand - commercialized agribusiness and processed food; that population, concentrated mainly in the mature (stagnant?) developed countries, can change the kind of food it eats and where it eats it, but is unlikely to much reduce consumption overall - nor will it increase it - hey, 4,000 calories/day is an obscene amount of food!

By contrast most of the world's population is simply outside this market. Going forwards (if the OECD and other commentators are to be believed) while the proportion of middle-class falls, the total size of this market grows driven by newly rich folk in Asia.  These people will switch from rice and vegetables to meat and (probably farmed) fish.  These items require much greater supplies of feed and hence a higher push for staple commodities (corn, wheat, soybeans, barley, sorghum etc.).  

And of course in the future the issue of feeding the (larger) majority gets more critical.

This blog attempts to be action oriented, and future posts will look at  how these dynamics will affect investors in agribusiness and those interested in developing agriculture.

For the moment we can say this: the fact that demand can adjust very rapidly as knowledge circulates in the developed world certainly affects specific sectors and segments of the market. Witness the rapid growth in demand for "super fruit juices" and a slackening in demand for milk and sugar as the population ages and folk become (slightly) conscious of Metabolic Syndrome (or Type II diabetes) as they pass 40 years if age. In this case it is the composition of the food basket that is of real commercial interest.

Raw material costs affect processor margins, so while chicken farmers may benefit from a dietary preference for white meat, they lose from higher feed costs and chicken processors have work to maintain their margins as these costs get passed on. Simply because on-farm agriculture is seen to be doing well from higher prices does NOT mean that agribusiness is benefiting - and we'll be looking at the fortunes of the big publicly-owned food businesses in the next post.

For the majority non-middle-class world, caring little for what they eat or where they do so long as they DO eat (something), the issue is latent demand.  Most people on the planet simply do not begin to approach the dietary standards of the middle-class.  This demand is notional or "stored' in the sense that it cannot be calculated into the balance sheets of the commercial food industry.  However it can be considered by investors capable of tackling frontier economies and building a food supply that is cheap and available. Yet another story in the pipeline.

Note1: This is a highly academic report based on a specific model; treat it with some scepticism.  What is noted here is only part of the document which should be read in full to get the complete picture.

Saturday, August 13, 2011

Where to invest now? Agriculture or stocks?

The markets are in a turmoil, Wall Street is a roller-coaster, gold hits over $1,700/oz as Asians flee to a known safe haven, Europe (according to one Irish politician) is "run by a bunch of mad people in Brussels" and the Swiss are concerned because their currency is another safe place to be, so making their watches unaffordable. Where do we go next?

Even agricultural commodities, historically more stable and rising for the last few years, have shown uncertainty and a drop off in investment values from the peak at the start of the year (Chart 1, a comparison of the S&P 500 with RJA-Agri, is discussed later in this piece).

Disclaimer: we economists are story-tellers, and we can tailor a story to suit your needs just like the augurs of old, looking at signs and portents and building the story to make folk feel happier.  Of course the real answer is,  nobody knows and we don't even know what we don't know.

But disclaimers and caveats aside here we go anyway following a tried and trusted method which is looking at the individual parts of the puzzle and seeing if we recognize a pattern - not so different from the ancient Chinese seers who shake the sticks or divine the I Ching from the patterns on a turtle shell.  We'll also ask, what can change things as we see them? Looking for the counter-argument or the absence of information is always helpful dealing with uncertainty.

First the fundamentals:  stocks of food commodities are tight, so tight that it will not take much to push prices up yet again. The weather in key North American production areas for corn and wheat has been record hot and the USDA has just adjusted its area estimates down. Rice crops are good, but for the international market a lot will depend on policy in Thailand (see our previous post on August 1st and this piece in Agrimoney).  So the supply side of the equation does seem to imply upward price pressure.

What can turn the pressure down?  Black Sea Grain reports that grain crops in the Ukraine will be larger and this is confirmed by USDA estimates.  This goes some way to compensating for any short-term decline in the USA. In the longer term, the supply side will react (our markets are at least free to do so) in a conventional way: more resources will be drawn into production and prices will react accordingly. Let's look at this in more detail.

There is huge interest in investment in agricultural land.  Every day emails come in to our FoodWorks office  bearing news of this scheme or that scheme, from wheat farms for sale in Australia to more exotic jatropha (bio-fuel) projects in Indonesia.  An excellent Bloomberg article describes the returns people have been expecting on agricultural land (16% annually!) to get an idea of how resources get pulled into production.

Two things: investors have to understand that unimproved land without the water supply, fertilizer, seeds, farm access roads, labour and machinery needed to grow crops is also unproductive land. Equally energy costs are pushing up inputs (fertilizer prices that have soared with the price of crude oil) and the wise investor should see if the gross margin he makes on the crop can really be achieved - it's NOT the farm-gate price that motivates the farmer, any more than it is the price at the check-out that bothers your grocer, it's the difference between production costs and the sales price that counts and that is not as clearly seen as the pure price level . We'll be looking at farm gross margins and profitability in a later post.

If investment does go into productive land, and we hope it will do via improved technology and market infrastructure, the supply may just turn around and go up, crashing prices.  Managing farm returns to make a long-term sustainable profit within the agricultural cycle is actually something that requires years of experience and we wonder if the hedge funds or their agents have it? We're not being patronising - after 30+ years in this business, we've probably LOST more money than we've made in risk-based agriculture (by which is meant agriculture in emerging countries).  So we understand just how difficult this industry can be.

The other side of the market equation is demand.  In this case we can point to consumption increases from China and India and other emerging economies where a middle class requires more sophisticated products and a wider mix of foods. In these countries the high rate of economic growth implies a rapid growth of the middle class and a consequent rise in demand (indeed this is implicit in GDP growth) for processed foods. As people get richer they substitute basic staples (cereals and starches) for dairy, meat and fish. As we shall see, the issue is not simply the absolute number of people on the planet needing to be fed, but the increase in the number of people who can pay, and pay well, for their food.

For fish the market situation is clear: world fish stocks are declining and farmed fishery (aquaculture) is struggling to keep up with demand (check out our page on Fishery for more detail). With regard to staples, livestock consume large amounts of animal feed to produce our desired dairy and meat products and the conversion rate from cereal grain to meat is pretty poor.  So there is considerable upward pressure on demand (and price) for the raw materials of animal feed as the rich world requires more milk, meat, cheese and eggs.

But that can go the other way just as rapidly.  As the world struggles with what seems to be an impending economic implosion (read new recession), inevitably consumers will restrict their demand for these expensive products or (where they can) revert to traditional diets. Here's news that Tyson Foods, the largest meat company in the US, has just reported third quarter profits down by 21%: Tysons warn of "sluggish demand for chicken, pork and beef as consumers face higher gasoline prices. The company has focused on streamlining operations as a weak economy dampens consumer demand and as feed costs continue to soar, forcing Tyson to also raise its prices." (quote from Market Watch)

Result: more corn and other feed ingredients left in inventory and a downward pressure on prices. Of course it isn't that simple. Newly urbanised populations in emerging markets have less opportunity to escape the mega-city cash economy and young people (the majority of the expanding population world-wide require energy foods based on carbohydrates and sugar, but the principle of saving on the food budget is there.

We've made the point before: the world's food markets are currently finely balanced and which way this goes is not at all certain. 

Let's consider a couple of other frequently discussed elements: Demand for bio-fuel is consistently cited as a reason for high food prices.  We think it's more complicated than that.  Sugar cane and palm oil are both major sources of bio-fuel.  Neither is grown on land that is primarily suited for food crops.  Oil palm plantations in particular are grown on former forest areas in tropical countries. In the case of Malaysia, many of these plantations have been in place for probably 60 years; in Indonesia there is much new planting and to the extent that it depletes rainforest that is environmentally of concern, but does not immediately impact food crops, although here is an impact (so far unquantified) via climate change.

Climate change may indeed affect e.g., Sub-Saharan Africa, reducing food supplies, but this sector of demand is not what drives the current high market prices. As our recent post on Somalia indicates, population growth is occurring in those countries which are (a) very low incomes - so they cannot afford to buy on the international market - to use economist's jargon, this segment represents "notional" demand based e.g., on FAO or WFP benchmarks for what people should eat rather than what they can afford and do eat (or not in the case of Somalia) - "effective" demand, and (b) in many cases the poorer countries are largely agricultural and grow their own foodstuffs; China, India and Indonesia are by-and-large self-sufficient in rice.

So the driver for commercialised agricultural produce is NOT the 3 billion people at or below the poverty line (it is estimated that 3.4 billion persons live on less than $2.5/day), but as we have said the new middle class in countries like China and India that might just withdraw their demand for commercialised agribusiness products if another recession hits. One more point to remember: currency changes impact the food markets; a weaker US dollar makes US-produced food attractive to international buyers (especially given the rapid drop against the Chinese RMB) but it makes input costs (especially energy) higher reducing farm margins.

To return to bio-fuels argument for a moment.  In the USA, the expansion of the corn area has been driven by the ethanol subsidy. But to the extent that corn is grown with wheat and soyabeans as a rotation crop, we suggest that by adding to farmers' overall revenues it has actually enabled food production e.g., through the acquisition of new machinery. In general we believe that a search for renewable energy is the right (only) way to go and that the impact on the food security situation needs considering and analysing unemotionally and in depth. Overall, so long a bio-fuel competes with crude oil we think this will support agricultural investment.

So much for the fundamentals of supply and demand.  The truly shocking fact is that with the world's population hitting 7 billion, only a relatively small proportion can actually afford marketed food, i.e., the agriculture and food-based industries reflected e.g., in the exchange traded funds.  But this proportion is growing rapidly at a rate exceeding population growth and, recessions aside, can be expected to continue to grow - The World Bank estimates that the global middle class is likely to grow from 430 million in 2000 to 1.15 billion in 2030!

In this case, investing in industries that feed those with money to buy food seems like a safe enough bet. Of course what happens to the rest of the world, the majority who are poor, is critically important but a subject for another day. Let's now turn investment and the actuality of how the markets have behaved.

Take a look at the chart at the head of this article (Chart 1).  It compares the Rogers International Commodity Index for Agriculture (22 ag commodities) with the S&P 500 index of stocks (the black line is the RJA, the red line the S&P 500) since 2008 (as the peak ag prices started to decline).  Without getting too technical (and we are not technical specialists) it is clear that agricultural investments have done better than stocks.  The peaks are higher and the valleys less deep, the recovery more intense.

It is however true that since January the RJA has been going down or sideways but  it is also true that as the current decline has set in, agricultural investment has held up better than stocks (see Chart 2). So not only is there less long run volatility in agricultural investment, but the data shows the returns are indeed also better.

Another interesting point from the data  is the volume of contracts trade in the market. Look at the red and green bar chart. Note the greatly increased volume of trades since January, creeping up since the previous September. Volume is an indicator of where people are putting their money and the build up of interest in agriculture is significant.

What's do we conclude? From our perspective agriculture is a long-term safer bet than stocks because despite it's dependence on biology and the environment and the obvious fact that it has large cycles, the fundamentals are more understandable than stocks and the market is overall less inclined to panic. We also think that investment in emerging markets is the way to go; first such markets often offer lower production costs and second, we think this is a way that the problem of the lower income demand for food can be satisfied. But we hasten to add: agriculture has VERY nasty ways of catching one out and the supply-demand equation is a lot more complicated than many expect.  So be careful and be prepared for the unexpected!

Monday, August 1, 2011

"Amazing Thailand" - new rice policy will damage the market and Thai rice farmers

While the weather still keeps us on our toes in North America, let's take the opportunity to look at the rice industry.  Above all we need to understand the serious downside impact the ridiculous policy proposals of the incoming populist Pheu Thai government]will have on international supplies.

Rice represents 23 percent of the world's supply of major cereals and is the preferred staple food of much of Africa and most of Asia - in other words the regions of the world where the population is growing the fastest (a recurring theme in this Bulletin).  Although many Asian do consume wheat or corn products, in almost all these countries the word "rice" is synonymous with eating - the Thai will say, "gin khao mai?"  - "eaten rice?"when she asks if you've eaten a meal and it is an equally common greeting.  The Japanese word for cooked rice "Gohan" is synonymous with "meal".

Seventy-eight percent of the world's supply of rice is produced in China, the Indian sub-continent, the Mekong Sub-Region and Indonesia, while demand is similarly concentrated - 67 percent is consumed in China, the Indian SC and Indonesia.  Partly because of the deep-seated cultural importance of the crop Asian countries want to be self-sufficient and largely they are. Indonesia has been an exception switching from being an exporter to an importer depending on the harvested volume. The operations of the Indonesian government's procurement agency BULOG are important to watch.

This means that the international trade in rice is very "thin", i.e., the volume is a small proportion of the overall amount of rice in the market.   Exports represent just 7 percent of the total supply, and about half of that comes from just two countries, Thailand and Vietnam (Cambodia and Laos also contribute, but much of their rice is actually taken through the two main Mekong countries).

The small volume of internationally trade rice (relative to the overall supply) means that prices can swing rather dramatically depending on the volume available for export and the fact that there are few sources with a surplus to buy. For example, when BULOG enters the market on the buy side, rice process can jump by $100/ton.  Similarly a reduction of supply will raise prices dramatically.

So what happens in Thailand and Vietnam is critically important to those who DO import rice - many African countries and Europe. Countries like Ghana, Senegal and Tanzania (which actually do grow their own rice) have relied on cheap Thai and Vietnamese to meet growing demand.

Let's review the situation in Vietnam first: there are two main rice growing areas, in the north the Red River Delta (surrounding Hanoi) and in the south, the Mekong (Viet. Cuu Long) Delta are both intensively cultivated.  From being just self-sufficient in the early 1990s, Vietnam has raised production to the extent that it now exports the world's second largest volume of rice (6.4 million tons) and competes equally on quality with Thai white rice.

The issues for Vietnam are (a) paddy land is being lost to industrialisation, (b) industrial pollution is damaging yields that have hitherto been driving the production increase, and (c) the water in the Red River and the Mekong is being limited by dams built upstream by other riparian countries.  Vietnamese experts say they expect that rice exports will peak at around 7 million tons and may well come down.

And now for "Amazing Thailand" (those familiar with Thai tourist advertising will get the allusion).  Thailand has dominated the international rice trade both in terms of volume of exports (up to 10 million tons at the peak) and quality.  Thai "fragrant" or "jasmine" (Th. khao hom dork mali) is a premium product that sells for over $1,200/ton in e.g., Hong Kong.  The issue for this variety is that it grows only on  dry land in the North-east so overall production is limited. But Thai white rice is grown extensively throughout the central areas of the country  supported by an extensive and relatively well-managed irrigation system. Weather, soil, water, experienced and hard-working farmers, available seed, technical expertise and a sophisticated export trade.

What could possibly go wrong?

The answer is (as is often the case in developing countries - Thailand is "emerging"  - but one wonders what it will emerge as?) GOVERNMENT.

Of course all governments interfere in agriculture and the Thai government is no exception.  However the proposal of the incoming (elected by a huge majority) Pheu Thai government to establish a monopolistic farm-gate price for white rice of 15,000 Baht (about $517) per ton and more for fragrant/jasmine rice amounts to sheer unadulterated lunacy.

The current price paid to farmers by hundreds of millers is roughly half that amount; production costs amount to (at a guess) $400/acre, with a yield of, say 2.5 tons/acre and a farm sale price of the current $241/ton, the farmer gets a gross margin of roughly $200/acre.  About 60 percent of farmers have holdings of  less than 10 acres. But even at this level, with three crops a year under irrigation the farmer's gross income is around $6,000/year.  Although not large by western standards this is considerably more than the minimum wage.

So the average Thai rice farmer is not poor (by world standards). But of course he would like to be richer and the rural population voted almost exclusively for the Pheu Thai party and for a government-subsidised farm gate price about double what he or she gets now. Nice if you can get it, but unfortunately one of the basic rules of economics (not a subject well understood in Thailand, at least not in official circles) is "there is no free lunch".

At the subsidised price for paddy rice, millers and exporters estimate (see article in The Nation newspaper) that the F.O.B price would have to rise to over $800/ton - when Vietnam is exporting comfortably at $545.

The Thai government (we should say, the Royal Thai Government - RTG - to be correct) proposes to use its food security warehouses to buy all the paddy. It will become (that lovely word) a monopsonist - the sole buyer of farmer's paddy.  This will be milled on consignment and then packaged and sold ONLY from the government warehouses, it is said on "government-to-government" arrangements.  Official stocks are forecast to rise to well over 6 million tons for the current 3 million.

They could be even higher, because rice will flood into Thailand from, you guessed it, Vietnam, Laos and Cambodia. Hey folks, it's called arbitrage - absent effective border controls (and I can assure you they ARE absent) a commodity will simply follow the money.

So now we have the very real prospect because of this daft politician's promise, made for no other reason than to get elected, that not only will Thai rice - hitherto available competitively for export at a reasonable price relative to other cereals - back up in government warehouses, but export availability will be reduced in Vietnam and other neighboring countries.

One wonders what the WTO will make of this flagrant abuse of anything resembling free trade, and one is SURE that the prospect of "government-to-government" deals without the benefit of the current competition between dealers, will lead to rampant corruption.

In the end who will be the loser?  Unfortunately the very person the policy is intended to benefit, the Thai rice farmer, who will have priced himself out of the market. And the consumer, now without a supply of reasonably-priced rice. With rice removed from the thinly traded export market, prices will sky-rocket.

What could change the situation?  An outbreak of common-sense in Thailand is never a likely prospect. But India is set to lift a ban on rice exports and this may relieve pressure on the international price.  So then the RTG will be the proud owner of millions of tones of rice that it has bought for considerably more than the world price; you can keep  rice, but not forever:)

As we who live in Thailand  say, "TIT" - This is Thailand, and as the Thais say, "mai pen rai" - Never mind!