Thursday May 22, 2008

Speculation wreaking havoc on food prices

By HANIM ADNAN

PETALING JAYA: Speculation is exerting pressure on agriculture-based commodities - now facing competition with regard to their use as food and a source of energy - and sending prices to unprecedented levels. This is in turn fuelling the current global food crisis, according to economists.

Economists contacted by StarBiz concur that exchange-traded fund and hedge fund players had been more visible in the commodity futures market than actual buyers and sellers of commodities.

This, they claimed, has created drastic changes in the traditional valuation of food commodities, especially staples like rice, soybean, wheat, corn and vegetable-based edible oils.

Traditionally, economists used variables like population growth, the wealth effect of developing countries getting richer, the consumption of higher quality foodstuffs and the weather to explain the supply and demand side of food commodities.

Joseph Tan

However, a new set of variables has emerged as food is also priced as an energy source.

On the supply side, global inventories of food commodities like corn, wheat and vegetable based edible oils are at historic lows.

Over the past three years, prices of agriculture commodities have increased substantially and the fluctuations in the US dollar have also led to inflation of food and transportation costs.

Since 2000, global food prices have risen 75%, with the price of wheat soaring about 200%. This year, rice, soybean and corn price also posted all-time highs and the increasing cost of grains has led to higher prices of meat, poultry, eggs and other diary products.

David Cohen, action economics director of Singapore-based Asian Forecasting Group said there was a growing tendency to invest in commodities futures over the past three years.

“Strong demand from China and India, the biofuels story and lower global food-based inventories have put pressure on the prices of most food commodities worldwide.''

In addition, the recent drought and floods in the world's largest food producing nations of US, Australia, Canada and China, have also stifled crop forecasts, thus putting further upward pressure on prices, he added.

However, Fortis Bank senior economist Joseph Tan said he believes that market players were over-reacting to the food crisis this year.

“No doubt there was panic buying in the staple commodities given strong food-price concerns but in the long term, commodity prices will naturally cool off as the world learns how to cope with higher prices,” he added.

A commodity trader said speculation in the commodity market had created an imbalance by reducing market liquidity instead of increasing it.

There are growing numbers of investors chasing too few commodities contracts, thus creating demand for the underlying commodity, which drives up the price.”

If inflation is on the rise, investors will take commodity stocks to new heights as they seek a safe haven from rising prices.

According to recent statistics, the total index fund investments in corn, soybeans, wheat, cattle and hogs escalated to US$47bil currently from US$10bil about two years ago.

Aseambankers senior economist Suhaimi IIias said the increasing number of new commodity-linked funds worldwide, including in Malaysia, reflected the direct investment interest in commodities versus equity.

“Fund managers are building up the demand in commodities not based on consumption alone but also for investment,” he said, adding that third world countries were the hardest hit by the global food crisis.

According to the United Nations, food represents about 60% to 80% of consumer spending in developing nations against 10% to 20% in industrialised countries.

Rice, a staple food for nearly half the world's population, drew concerns in recent weeks as spiralling prices prompted several countries to impose anti-inflationary measures as well as drastic limits on exports in order to protect domestic consumers.

India recently suspended futures trading in soybean oil, rubber, chickpeas and potatoes in an attempt to rein in inflation. Last year, the Government suspended the trading of rice and wheat futures.

Suhaimi said: “It is possible that other developing nations will follow suit with measures to address their food security concerns in the coming months.”

The Philippines, Indonesia and Malaysia have put in place anti-inflationary measures starting with rice.

Malaysia has over the past weeks announced measures to ensure adequate supplies of rice and to cap rising prices. These are estimated to cost the Government an additional RM725mil.

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