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'

Tuesday, June 21, 2011

RECORD CORN PRICES HAVE LESSONS FOR OTHER MARKETS

The chances are that (weather permitting) the North American corn (maize) crop will be excellent.  But it won't make a difference to the price trend which is hitting new highs.  Some say that we'll see $9 corn.


If so, we need to pay attention to the lessons this will have for us in a number of linked industries.  The key takeaway: commodities are not stand-alone markets.  What happens in corn in the USA also affects the ability of Chinese middle class consumers to buy pork at reasonable prices.

Global production will rise 5.6 percent to 866.2 million metric tons in 2011-2012, still too little to meet demand of 871.7 million tons. Demand is being driven by China where both drought and floods have seriously damaged production. As it economic growth has spiralled China has also massively increase its consumption of meat products and corn provides a staple feed for pigs and poultry.

We might also see wheat being substituted for corn in animal feed. Wheat is at its cheapest relative to corn in 15 years.  US futures have hit a 6 month low on news that the harvest is reasonably good. But that doesn't mean its cheap - in fact in real terms (i.e., take out inflation) its at its highest real value since its peak in 2007-08. The markets are looking at what they say is "way too much grain" but we think that situation can change.  A great deal depends on the EU harvest (and rain suggests that might be good) and the position of Russia which may re-start wheat exports that were suspended following the fires of last year. 

If cheaper wheat can't absorb some of the extra cost of feeding animals (corn can account for as much as 40% of the cost of poultry feed), livestock owners could react by increasing the rate at which they slaughter. This has yet to occur and the situation is a little more complicated than one might expect: cattle slaughters in the Mid-West of the USA are lower than for this time last year.  Fewer cattle moved from grazing into feedlots during May from the same period last year. The smaller number of "feeders" reflects fewer calves being born during the last year as cattle producers tighten their herds before the fattening phase in the face of the doubling of corn pricesChina is in a different situation having already reduced its pig herd.  Huge middle class demand and rapidly rising pork prices will drive an expansion of production and so hit feed prices. Chicken production is also booming despite outbreaks of disease.

Corn prices are also being bid up by the ethanol industry. The U.S. will convert a record 5.05 billion bushels into ethanol in the next year, compared with 707 million in 2002. The high price of crude petroleum oil and continued uncertainty in the Middle East will see bio-fuels still in the money. The US Senate has voted to repeal the ethanol subsidy but this has not become law yet and the mandate for renewable energy remains in place and will continue to climb.  

While there appears not to be a world market for alternative fuels, high renewable prices overall suggest continued bullishness in other oilseeds that can be turned into fuel. That doesn't include soyabeans (which have a relatively low oil content) and which gets driven by the animal feed market for meal - overall soyabeans look a little weak, plantings are lagging as farmers focus on getting the new corn crop planted. But higher oil bearing crops, rapeseed/ canola and of course in the tropics palm oil will see benefits in the bio-fuel complex. 

What lessons are to be learned?  Our perspective is to look at the longer term and disregard short-term ups and downs.  The key lesson is that as never before this is a highly connected world where floods in the Yangtze River Basin can drive crop plantings in the Mid-West.  

Asia, and China in particular will play a more important role in all our markets; when China sneezes, we all catch cold, or in this case food prices everywhere will jump.  This helps make sense of food security strategies being employed elsewhere e.g., as Gulf Arab states secure their own physical supplies and as China looks to invest in Africa.  We remain convinced that the food commodity markets will become more finely balanced and more subject to sudden reversal.

For more information or to ask questions, please write to foodworks@quartermainesworld.com. We enjoy your comments and will respond to every question.



Sunday, June 12, 2011

FAO JUNE 2011 FOOD OUTLOOK - ASIA IN THE DRIVING SEAT

Whatever we think of the United Nations, and the Food and Agriculture Organisation in particular (don't let's get started on bureaucratic fumbling), FAO does collect and present the official world-wide government-eye view of what's happening to our markets, and the analysis is professional and comprehensive. So it's worth paying it some attention. 

The just published Food Outlook: Global Market Analysis Report for June 2011 bears out our concerns about world food supplies.

FAO's aggregate price index in May stood at 232, near the highest ever recorded.  The main theme is that with supply-side constraints in major producing countries, especially in the west (wheat and corn stocks are down in the USA and the EU is facing lower output of oilseeds and dairy products), it is Asia that holds the key to both demand (China has its own agricultural difficulties) and supply - rice, sugar and palm oil are major commodities being sustained from this region.  But the production upside is limited, so the question is, where next to invest? We think there are still niches to be found e.g., in Laos and Cambodia and Burma (Myanmar) stands out as a future massive supplier of staple food commodities. Equally, we have to look farther afield.

Weather may be the main underlying factor in higher world prices, but FAO also points to the wave of unrest in the Arab World, oil prices and even the Japanese tsunami as de-stabilizing the markets.  None of this is really news, of course, so the interesting analysis will be to look at the detail and see where the next unexpected turn of events will take us.

Inventories in the cereal markets are low, at least for corn (maize) and wheat; rice is something of an exception with bumper harvests. A recent road trip we took around the Thai North-east (Esarn) saw a wonderful new crop on the way and Thailand should hit record exports this year. But overall the grain stock situation is tight, although, says FAO, less so in importing countries. This is fortunate because high crude oil prices will hit freight rates adding to import bills.

The oilseeds and oils market is driven by two major items, the ratio of corn to soyabean prices in the Mid-West and the demand for palm oil.  Prices have pushed up since 2009 mainly because of strong demand for palm oil from China and tightening supplies of soyabeans which have given up land in the USA to corn produced for ethanol. In general, higher crude oil prices will favour that substitution and add to prices.  The current soy:corn price ratio favours corn and with poor weather in the EU for the rapeseed/ canola crop the tight supply situation is likely to continue.

The market segment to watch here is bio-fuel. FAO says that fully half the anticipated rise in consumption of vegetable oil is due to this market, with overall 12% of total demand being for bio-fuel.  FAO notes that the driver here is not just the crude: bio-fuel price ratio, but the mandatory inclusion of bio-fuels in gasoline - watch for news items that airlines are starting to use more bio-fuel.

High prices for cooking oil (along with high flour prices) strike directly at the relatively poor in developing countries.  First entrants into the commercial world usually set up food stalls,  retailing simple, high-carbohydrate foods. If they cannot afford their basic ingredients not only do their nascent businesses fail, but there is an immediate impact on urban working people who eat their food.  One result could be an increase in unrest everywhere and government attempts to control prices of basic foodstuffs.  Expect greater civil unrest in more African countries and (if it were possible) in Pakistan.

Higher income groups will also be affected by the  rising cost of livestock products (meat and dairy) which are at record levels. These commodities will be equally hit by feed costs and costs of cool storage and transport. Higher energy costs will also add to packaging. The good news is that there are ample stocks of feed meal (derived as a by-product of the oil extraction  from oilseeds) but massive demand for livestock products e.g., in China will keep prices firm. China has been hit by reductions in pork meat supply and imports are likely to be at record levels. Similarly poultry meat production increase could be as much as halved with outbreaks of avian flu in Asia. Milk, cheese and butter prices also stand at record highs as a result of a slow supply response and apparently unfavourable policies in key regions such as the EU. Hit by higher food prices and limits on her credit card, the middle class consumer will reduce other purchase so leading to a slowing world economic recovery.

Switching consumption to fish doesn't offer much relief to the housekeeper. As Robert Lindley wrote here recently (see archived post 2nd June), capture fisheries are in decline and this tight supply  has pushed demand for farmed fish which in turn are affected by high feed prices.  The FAO Fish Price Index shows that prices are higher than ever before - May this year 18% higher than the same period in 2010.

Of the major staple foods, only sugar has shown weakness in price as a result of large supply in key countries - again favourable growing conditions in Thailand and India pushed up stocks. These gains offset reduction in supply in the developed countries. Demand is expected to increase only in line with population as the world economic recovery lags, but the volume of trade could be smaller because the main producing countries need to hang on to their own production to ensure demand is met.

What to make of all this?  One recurring theme in the FAO Report is the importance of the Asian markets, both in terms of demand, with China absorbing increasingly large volumes of all the key commodities and where its own production difficulties suggest this import demand will only increase, and for supply with countries like Thailand, Indonesia and India supporting vegetable oil, sugar and rice production.

The question is to what extent is Asia reaching the limits of its productive capacity? Rice is cultivated with great intensity in these countries so without yield increases and with land lost to industrial use Asia's traditional suppliers are unlikely to be able to bear the brunt of any production shortfall in the western countries.

One answer may be for Asian countries to diversify into higher-value crops that return more per unit of land area and indeed this is a strategy the Thai government is considering (encouraging farmers not to plant a third rice crop). Also Africa today appears mainly on the demand side of the equation - rice exports to Africa are at record levels. But Africa and perhaps Central Asia provide the only areas where large production increases can be projected in the long term.

FoodWorks is located in the heart of Agricultural Asia with outreach to Africa, the Middle East and Central Asia via its network of Project Partners.  Contact us for more information about our expert services for investment and project implementation and management.

Thursday, June 9, 2011

ENERGY AND FOOD PRICES SHOOT UP TOGETHER

energy and food price chart
Agriculture and food prices are all about good soil, sunshine and water and the hard labour of farmers, right?


Well.... partly, yes of course. But they are also highly dependent on the cost of energy.  So the fact that crude oil prices are shooting up with the collapse of OPEC talks to increase production has strong implications for our industries.


The above-mentioned basic natural factors are key to cultivating crops. Drought years particularly impact agricultural supplies and the current worry is that water shortages in North America and China will drive prices further up. At the same time, however, energy costs impact directly on fertilizer prices and the cost of running tractors, harvesters and other farm machinery.  Increased diesel oil prices for pump irrigation, cultivation and harvesting and post-harvest handling reduce farmer's margins quite sharply much quicker than farm-gate prices can properly adjust.  Lower margins mean less supply in a market where demand has been increasing.

Food prices are probably even more linked to energy costs than on-farm costs.  Energy is used from the moment e.g., cooling systems are used to take out field heat from fruits and vegetables or in the drying of grain.  Perishables have to be transported in refrigerated trucks which typically use more gas than regular transport. Bulk commodities are shipped internationally in oil-burning freighters, raw food materials are processed in energy intensive factories and packaged in plastics for sale in supermarkets that use electricity often generated from oil-burning power stations. So every link in the farm-to-fork value chain uses energy.

The chart (calculated from World Bank data) shows the clear relationship between food and energy (fertilizer is not shown because it is almost identical to the energy line).

So where does the present crude oil price hike (Brent Crude at $118/barrel at the  time of writing and maybe going higher) leave the food industries already facing what we believe to be a crisis?  There's a chance that some of the speculative surge in food prices may be taken out of the market in the short-term as traders expect more crude price hikes, but by far the greatest impact will be on processed and shipped foodstuffs in the developed country markets. These are the most highly processed and packaged products produced by farmers who are mostly capital intensive.

The good news is for smallholders in developed countries who use labour rather than capital and whose energy footprint is smaller.  To the extent that they can use local fertilizers and their own backs and hands, the market price hikes may leave them unscathed; indeed they may find a better market price for their products relative to their own costs of production. But they'll still be hurt by marketing cost increases.

Equally farmers growing bio-fuel may find themselves in a seller's market.  Bio-fuels only make sense when the base price of crude is high and there is an argument that crude oil prices need to remain high to encourage alternative energies to be developed and used. That's a difficult one because we recognize that land used for bio-fuel is not available for food production.

In addition, the developing countries will also face higher milling costs (e.g., for rice) and the storage and shipment of staple foods.  Urban dwellers will almost certainly face higher food costs wherever they live, and that's bad news for the poor.

What should agribusiness do? Energy efficiency is clearly the key and any large-scale food processor would be a fool not to have hedged his or her energy costs and looked at the technical aspects of using raw material wastes as a fuel source and re-cycling energy use (e.g., managing the heat dispersal systems).  We'd also be looking at alternative energy supplies based on a long-term analysis of crude prices. Now is a good time also to be thinking of those bio-fuels and how to build using them into an integrated energy supply and utilisation strategy that includes one's carbon footprint and credits to be gained from reducing it.

If you'd like FoodWorks to help design an integrated energy strategy for your agribusiness, then contact us via that link to our company web site.  We have an experienced team that can look holistically at your entire value space and provide technical and management solutions.

Thursday, June 2, 2011

FISHERY: CATCHES ARE ON THE DECLINE

Wild fisheries are in crisis.  Management has failed.  Nations have been unable to manage their own capture fisheries leading to massive overfishing.  As incomes rise, more people want to eat fish and seafood precisely at the time that the catch is declining, writes our Fishery Analyst Robert Lindley.

Pakistan is a good example, where the catch is declining, the numbers of fishermen going up, where the government does nothing to control entry to the fishery.  Other examples are Thailand, where the catch has been at a low level for more than 35 years, Malawi, which has a lake that should produce 30% more fish than it is now and of course the Europe, which is devoted to subsidies to keep its fishermen employed (and the fish stocks overfished).  

But there is no realistic other livelihood for the coastal people who would be stopped from fishing under any attempts to control effort or access to the fishery.  People would just starve, and politicians won’t let that happen, due to the rioting and civil unrest that will occur,  and neither have the countries got the money to “buy them out”, (which is the approach taken in the UK).

Those fish stocks that straddle national boundaries are also gradually being destroyed by a failure of nations to agree on quotas or limits to catches.  The Bigeye and Yellowfin tuna in the Pacific area are now both now overfished despite the efforts of the Forum Fisheries Agency, South Pacific Commission (now South Pacific Community) and Western & Central Pacific Fisheries Commission all supposedly assisting the Pacific Nations for 20 years or more to manage their resources sustainably.

The chart (above) shows the increase in world capture since 1950.  There is a classic exponential rise in in the catch as the world recovered from the austerities of the Second World War, and then a more normal S-shaped curve associated with the use of a limited natural resource from 1970.  The key point is that in recent years it can be seen that the catch is absolutely flat and indeed has declined. It will go on doing so unless drastic action is taken.

Things are not helped by those counties who just rape and plunder, the Chinese being the greatest offenders, but the Spanish, Italians, Greeks, Japanese, Taiwanese and Koreans are also serial delinquents.  Countries without adequate controls are also guilty, such as Pakistan, where their boats just go out and fish, using illegal methods, and without permits.  This is called IUU fishing, Illegal, Unregulated and Unreported, and there is a lot of it about.

It is a feature of common property resources,  a failure to limit access sufficiently.  Things are going to get a worse before they get better, and improvements will be slow coming.  There are also the problems of climate change and pollution, coupled with degradation of habitat in coastal areas which also affect capture fisheries.

Capture fisheries, whilst not completely a write off, are in a period of stagnation, which is likely to last for many years.  All is not lost however; opportunities exist.  Value will not come from increasing catches, but from increasing the value of the catch. 

This can be achieved by:-

  1. Improving the quality of the existing catch by looking after it better, from capture to consumer, throughout the whole cool chain.  The same fish is worth more, merely by not allowing it to deteriorate.  It is surprising how much of the world catch is allowed to lose quality, and hence value, even before it is landed, merely through the failure to apply ice to the fish at sea.
  2. Adding value to the catch directly, by making it into something which sells for more.  Even simple processing, like filleting or steaking to make the product more acceptable to the consumer can vastly increase value and thus profits.  Most prawns for instance are now peeled & deveined prior to sale, since the consumer prefers this.  Even small improvements in packaging, such as vacuum packing, can make a big difference to the value of a fish product.
  3. Moving existing fish to places where the price is better.  Many countries are finding out that the appetite for fish in rich countries is insatiable, due in part for its reputation for being a healthy protein source.  A fish worth little in one place may fetch far more if moved to a better market.
So there are opportunities in capture fisheries, but the catching segment itself is probably not where they are.  Processing and marketing is the opportunity.  Let the others scrabble about trying to catch the fish !

The author, Robert Lindley, has more than 30 years experience of international fisheries.

Contact him by email on:
rhlindley@yahoo.co.uk

A second article by Mr. Lindley will concern itself with Aquaculture

WORLD FOOD SUPPLIES: A MAJOR FOOD CRISIS LOOMS

There can be no doubt that the world is heading for a food crisis in the coming summer. Rising food prices drive more people into poverty and put brakes on the world's recovery from recession. Poor, hungry people lead to civil instability and a slower recovery means less jobs.

We need to act now!




Some of the main factors that have been pushing world food price indices include:

Demand side

* Rising population – the world is adding 80 million people every year. Moreover, the majority of these people are in developing countries which have a limited agricultural resource base. As an aside, health programs, laudable as they are, impact more rapidly than food supply initiatives. So in countries where the population growth rate is highest, the Malthusian boundary is closer than we think.

* Rising incomes – the fastest income growth rates are also in those countries with large populations and above-average growth. Whereas the aim in the high income countries is to cut back on food consumption (we worry about obesity), a large proportion of the world’s population is moving towards increased consumption of eggs, meat and milk. All these commodities are poor converters of food adding pressure to the demand for staple foods.

* Bio-fuel – We are less concerned about bio-fuels. While the USA grew about 420 million tons of grain in 2009 and put 28 percent of that into bio-fuel, it is surely the case that without the ethanol program this amount of grain would not have been grown. It is disingenuous to take the bi-fuel grain and say “it could have fed millions of people”. Not so, without the demand for ethanol, at least a proportion wouldn’t have been grown. That said, this area of consumption represents a significant part of the demand for natural resources and has its own impact on the environment.

Supply side

* Water deficits – water is the elephant in the room. Aquifers are being depleted everywhere. Sanaa, the capital of Yemen, will soon have no water supply whatsoever. Melting glaciers in the Himalayas will first flood Pakistan (as they did last year) and then the absence of water will starve the largest irrigation system in the world.

* Climate change – however it is measured, and despite the skeptics, there seems enough evidence that the pattern of the world’s climate is changing with large dustbowls developing in Central Asia and Sub-Saharan Africa. Soil erosion and the damage to the eco-system from e.g., oil palm being grown in Indonesia also give huge cause for concern.

* Loss of land to non-farm use – as the human population grows people migrate to cities in search of jobs that are almost always more remunerative than agriculture. Mega-cities are consuming land for housing and industrial use at an enormous rate.

* Technical limits to productivity (yields) – the “Green Revolution” of the 1960s and ‘70s was based on large increases in land productivity. But the growth in yields cannot be exponential. Already many developed countries have reached the limits of what the land will yield. In the developing world yield increases, obtained at considerable cost, are frittered away because of lack of infrastructure, e.g., for storage and drying. Perhaps 40 percent of the production of food in these countries is simply wasted before it ever reaches the table.

All this has happened in the context of the public sector – national governments, multi-lateral aid agencies and the other donors – losing heart for agricultural development. Lack of investment in agriculture, its infrastructure and its skills has eroded the capability of many countries to deal with the crisis that is now on us.

With all the above in mind, FoodWorks has recognized that there are nevertheless opportunities. If governments will not or cannot act, then they should stand aside and let the private sector and the profit motive take over.

It's an urgent priority to mobilize capital and expertise and get it to work!

If you'd like to us to answer specific questions - free - by all means just email foodworks@quartermainesworld.com

Background note: This post also appears at our main site introducing this service.