Recent price rises in foods, such as wheat, barley, and coffee, can be mostly attributed to poor harvests brought on by adverse weather conditions
Aside from the fragility of the agricultural system to shocks, there are structural factors affecting supply and demand that pressure the outlook for prices
Food price spikes have sparked panics in recent years, making the economics of food a serious issue in many countries
The need to produce more food, particularly meat, will have a multiplied effect on grain production
After years of underinvestment in farming and a decline in the amount of arable land, we should see renewed focus on increasing yields via fertilisers
A range of stocks are well placed to benefit but stock selection is critical to identify the most profitable parts of the food chain where there is pricing power
Food is back on the business pages. Recent price rises in food commodities, particularly wheat, are making investors think it’s 2008 again, when rampant food inflation led to social unrest in parts of the world. Here, we examine the long-term prospects for food in the context of an expanding global population, supply-side rigidities and dietary changes that could have a big impact on demand, prices and production intensity.
Wheat prices have risen around 70% since the start of the year. The spike was triggered by a drought in Russia that led premier Vladimir Putin to impose a ban on exports, recently extended to the end of 2011. It’s not a crisis situation yet as large exporters, especially the US, have good stockpiles, but it does mean the wheat market cannot afford any more shocks. There is mounting concern over the impact of ‘La Nina’ (a weather phenomenon that cools sea temperatures) on southern hemisphere harvests due in December.
While wheat is the standout, the prices of other foodstuffs such as coffee, cocoa and meat have also been in high gear recently. However, the recent spike in prices is different from 2007-08. The last spike included soybeans and, critically, rice - a staple in many developing countries. Fortunately, rice harvests have been healthy this year. Oil prices are also lower, meaning that the demand for bio-fuels is not as high. As a result we have not seen the same level of social unrest; however there have been riots in Mozambique over the cost of basic foods like bread. Like last time, the spike should ease back over time as higher prices encourage farmers to plant more wheat.
The World Bank estimates that demand for food will rise by 50% by 2030, largely as a result of population growth, rising affluence and changing diets. The population of the world is growing at around 1% per year. It might not sound much, but it means an additional 70 million mouths to feed every year. As the chart reveals, the overwhelming catalyst for this growth is the developing world. This population explosion poses a serious challenge for food production, particularly when you consider that the amount of arable land in the world has been reduced due to urbanisation.
With a growing number of mouths to feed yet declining arable land, we already have strong fundamentals that point to the need to increase crop yields. However, changing diets in the developing world add an extra dynamic.
Rising affluence in developing countries is allowing huge numbers of people to improve their diets by adding more protein, namely meat and dairy products. The direct impact is that global meat prices recently hit a 20-year high as strong developing world demand coincided with a drop in production by exporters such as the US and Australia.
The demand for more protein has a significant indirect impact on grain. Livestock is reared on grain, making production heavily resource-intensive. It takes 7 kilograms of grain to produce just 1 kilogram of meat. In a world growing ever hungrier for meat, the need for more grain and better yields is clear.
“Emerging markets are some of the world's lowest cost producers of commodities. While Brazil remains the world’s largest sugar producer, South Africa is the largest producer on the African continent, having grown supply strongly. Leading low-cost producer Illovo is well placed to benefit from growing demand as emerging consumers develop a sweeter tooth, much like their developed market cousins. “ Nick Price, Global Emerging Markets
The most efficient way to meet increasing demand is to increase crop yields by using fertilisers. Much of the arable land in the developing world is inefficient
and significant gains in yields can be made via the use of fertilisers. The demand for, and the price of, fertiliser is likely to grow strongly over the next decade.
During the 2007/08 food price spike, the cost of fertiliser commodities such as urea and potash rose around tenfold. While the financial crisis saw prices
fall back sharply, demand is now recovering strongly and is expected to challenge capacity in coming years; it takes around seven years to develop a new
potash operation. We are therefore likely to see healthy profits as well as more consolidation among the fertiliser companies.
“Fertiliser companies have been attractively valued, trading at a discount to replacement cost, and stand to benefit from strong supply and demand fundamentals. The world’s growing demand for food, especially in emerging markets, is encouraging farmers to use more fertilisers such as phosphate and potash to increase yields. Given the fact it can take several years to develop new potash sites, fertiliser supply is likely to be challenged by demand. This also helps explain the consolidation we are seeing in the sector, which I expect to continue.” Aris Vatis, US Equities
Note: Past performance is not a guide to what might happen in the future.
A number of stocks can be expected to benefit from the world’s growing need for food. Fertiliser stocks are one of the most direct beneficiaries of the need to increase crop yields. Stocks such as Potash Corp and Mosaic outperformed massively during the last episode of food inflation. Valuations are now more reasonable, yet, as we have discussed, the long term fundamentals remain very attractive, hence BHP Billiton’s interest in Potash Corp.
“Uralkali is a leading potash producer and one of the few publicly traded pure potash plays in Russia. Cheap energy and labour costs make the company one of the lowest cost producers in the growing market for fertilisers. The company has invested heavily to raise production and there is also the potential for consolidation in the Russian potash industry.” Nick Price, Global Emerging Markets
Low cost producers, such as Illovo in sugar, are set to take advantage of steadily rising global demand. And, while you might expect supermarkets to lose out from higher food prices, those with significant buying power and leading market positions, such as Tesco, have the ability to pass on more of the price rises to consumers.
A second ‘green revolution’? - China and India will be incentivised to lead a second ‘green revolution’, with many of the gains being made in sub-Saharan Africa. Increases in market prices will encourage arable land and irrigation projects. In the next 25 years, we should expect significant increases in African grain yields.
Precision agriculture - we can expect to see the development of something called “precision agriculture” over the next decade. This involves the integration of satellite observations, on-the-ground instruments and sophisticated farm machinery to apply the optimum amounts of seed, water and fertiliser for maximum efficiency.
Biotechnology and ‘GM’ crops – future GM developments could see drugs incorporated into foods: bananas that produce vaccines against infectious diseases such as hepatitis B; metabolically-engineered fish that mature more quickly; fruit and nut trees that yield earlier; as well as foods that lack the properties associated with intolerances.
‘Fast food’ from animal cells - Dutch scientists have found a way to create artificial meat by delivering an electric charge to a pig’s muscle cells, which causes the cells to multiply. Although this is currently a very expensive way to produce a piece of pork, it offers the potential to feed millions of people cheaply in the future.
How the world responds to the challenge of feeding a growing, more affluent population is set to become a prominent theme over the next few decades. As the United Nations has already cautioned, we can expect generally higher food prices going forward. By investing in companies that allow us to grow or create more food, investors can take advantage of these secular trends.
The value of an investment can go down as well as up so you may get back less than you invested. Overseas investments are subject to currency fluctuations and emerging markets may be more volatile than established markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. This information does not constitute investment advice and should not be used as the basis of any investment decision, nor should it be treated as a recommendation for any investment.