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Summary

  • The dollar remains vulnerable to depreciation due to years of qualitative easing as well as Greenspan putting devaluation on the table.
  • The best ETFs to hedge against dollar depreciation are not metal or oil ETFs, but agricultural ETFs.
  • I'll discuss the application of Peter Lynch’s “local knowledge” to food prices.
  • Food prices are rising in part due to climate change effects including drought, too much rain, late planting due to snow, pests moving north, and too much heat.
  • The two agricultural ETFs, JJA and JJG, are comparable hedges against a weakening dollar and rising food costs, with a nod to JJA.

After the U.S. abandoned the gold standard, the main support for the dollar has been its role as the currency of international trade. The U.S. worked out a deal with Saudi Arabia and eventually with the OPEC so that only United States dollars could be used to purchase oil. As the international currency for oil, the dollar has remained strong. Yet in the past few years some countries, notably Iran, Russia, China and Brazil, have made efforts to reduce their need to hold dollars for settling their trade accounts. Any country dropping the dollar for another currency to settle international trade weakens confidence in the dollar and risks putting the dollar on a slippery slope.

The dollar's vulnerability in the 21st century comes largely from Bernanke's qualitative easing. The United States and other governments printed trillions of dollars, euros, pounds, francs, and yen to buttress their economies after the 2008 recession. This was reminiscent of "Goethe's 1831 drama Faust [in which] the devil persuades a bankrupt emperor to print and spend vast quantities of paper money as a short-term fix for his country's fiscal problems. As a consequence, the empire ultimately unravels and descends into chaos." Nothing that dramatic has happened or even seems likely, but printing $85 billion ex nihilo every month has diluted our currency. Although Janet Yellen has been slowing these dollar creations by $10 billion per month, the damage has been done.

Bernanke's qualitative easing was not "devaluation." Devaluation is a governmental action that has, as its main aim, the deliberate dilution of a currency. Unfortunately for international confidence in the dollar, former Federal Reserve Chairman Alan Greenspan recently put the possibility of the U.S. devaluing its currency in the public domain. In responding to a question about whether United States Treasury bonds were still a safe investment, Greenspan assured his audience that the U.S. will never renege on its foreign debt. "The United States can pay any debt it has because it can always print money to do that, so there is zero probability of default," said Greenspan.

The use of devaluation to insure that debts will be paid has done nothing to shore up confidence in the dollar or to encourage foreign banks to hold the dollar. If a loss of confidence in the dollar leads foreign countries not to purchase our debt, "given the United States' dependence on foreign capital to finance its large fiscal deficits, a reduction in foreign flows could cause Treasury securities to lose a significant amount of value. The Federal Reserve could then find itself having to support the price of the country's debt by becoming the buyer of last resort for Treasury securities. This scenario would closely resemble events unfolding in the periphery of Europe today."

Commodities as a Dollar Hedge

To hedge against deterioration in the dollar's value, investors tend to purchase commodities as gold, copper, and other hard assets. The idea is that the value of the commodity is independent of any currency so as a currency weakens, the commodity increases in value in that currency. For example, as the dollar gets weaker, one expects the dollar-value per unit of a commodity to increase. That's the reason commodities are considered a hedge against a falling dollar.

Not all commodities are created equal in this regard. Gold and copper, for example, are somewhat uncertain hedges because governments can directly or indirectly influence the prices of these commodities. An example of an indirect influence is the recent slowdown of the Chinese economy which has very negatively affected the price of copper futures. As for gold, it's been an utter loser. After two months of treading water, gold prices are starting to sink. "[Gold] Futures in New York reached a 15-week low today after investors sent U.S. equities to a record high," reported Bloomberg on May 28th. "Assets in global exchange-traded funds backed by bullion are near the smallest since 2009, and money managers have cut their bets on a rally by a third since this year's peak in March."

If we can't rely on the old standbys of gold and silver, are there any commodities upon which we can rely? There are. We can rely on the oldest standby that humans have relied upon for thousands of years: food. This is a commodity arena in which government decisions and policies cannot have much effect on reducing prices given that populations are increasing, the demand on these goods keeps rising, and food production cannot keep up. Under current conditions of increasing world populations and decreasing food production, food commodities are a safe hedge since they tend to be beyond the manipulation of governments. ETFs that follow the price of food are not only a hedge against a weakening dollar, they are also a hedge against rising food prices.

Rising Food Prices

The near- and long-range predictions for the price of food are identical: food is becoming more and more expensive.

We can verify the near-term rise in food costs if we employ Peter Lynch's method of "local knowledge." What's the best way to find out about food prices? Talk to the local "experts": the vegetable and meat wholesale buyers in our neighborhoods.

In 1977 Peter Lynch became the head of the obscure Magellan Fund which had $18 million in assets. Under Lynch's direction, the Magellan fund averaged a 29.2% return and, as of 2003, had the best 20-year return of any mutual fund ever as well as $14 billion in assets. Lynch is a savvy stock picker and his experience tells him that the ordinary investor can beat the street, as he tells us in One Up On Wall Street. Lynch thinks that the average investor has the advantage of local knowledge and "can pick tomorrow's big winners by paying attention to new developments" (p.16).

Since January I've been explicitly following Peter Lynch's advice and mining "local knowledge." I've been checking with the buyers for vegetables and for meat at two large supermarkets. Prices for the buyers were going up even before our retail prices began climbing. Of course, the retail prices did jump when the wholesale prices jumped too much. I was shocked by the price jump for lettuce and cauliflower during the late winter. The vegetable buyer told me that the drought in California was the culprit-it had wiped out most of the then current harvest of vegetables and foiled the next planting. I've also been told by people who live in Ohio that the farmers can't get in and work their fields. It's too wet and the freeze went on too long. It is this kind of knowledge that can give us a good chance, as Lynch puts it, to beat the professional traders who tend to follow the pack and generally won't trust their own experience and judgment when it points in a different direction. The facts about planting in the Ohio fields can also be found online, but I know I wouldn't have checked but for the personal conversation. Online we find that, in Ohio, "little to no corn has been planted."

Seeking out "local knowledge" turned up even more. The most devastating forecasts came from professional butchers. One butcher told me beef costs were going to rise for the next two and a half years. I pressed this butcher to tell me how he knew. "Look Bart," he said, "I've been in this business for forty years. You just know." When you've been at something long enough and had at least one eye open most of the time, there's an amazing amount that you do know and yet can't easily explain. Asking our local experts is an important way to doing due diligence.

I also began uncovering "new developments" (Lynch's phrase) that might give an investor like me an edge over some professional investors. I discovered that the foreseeable effects of weather on food production go beyond the rise in cost predictable because of the drought in California. Furthermore, these changes are a product of climate change.

I have no trouble using climate change science as a basis for due diligence, but this might be psychologically impossibility for many professional investors. Since many of them will be in firms or associated with groups that have close links to oil and coal, there will be a climate of skepticism of the science supporting climate change claims and even mockery of anyone who takes climate change seriously. It is plausible that many professional fund managers are in the ranks of climate deniers. What this means is that we who take science seriously as a predictor of physical continuities and changes have an advantage over those professionals who do not take this data into consideration.

When we begin looking at this data, it is clear that the various food prices are not only going up now but that this will be their price trajectory for years to come. Consider:

  1. The Fifth Assessment Report from the United Nations Intergovernmental Panel on Climate Change (NASDAQ:IPCC) made clear that climate change will affect the world's food supply.
  2. Drought may slash corn production in America's Corn Belt.
  3. The drought in California is driving farmers to extreme measures to protect their crops and fruit trees, and produce from California is a major source of America's for fresh food.
  4. Oxfam reports that food price spikes will get worse as extreme weather caused by climate change devastates food production. "The huge potential impact of extreme weather events on future food prices is missing from today's climate change debate. The world needs to wake up to the drastic consequences facing our food system of climate inaction," said Tim Gore, Oxfam's Climate Change Policy Adviser. Further modeling the impact of warming-driven extreme weather shocks leads Oxfam to conclude corn prices could increase a staggering 500% by 2030.

The scenarios above, however severe, rest on a view of climate change that involves gradual warming and gradual changes in weather patterns. That was not my experience of last winter. Ireland, which I had left for climate change reasons, was hammered last winter by floods and by unprecedented storms with hurricane force winds. The surprise and shock of the prolonged Arctic Vortexes over the Midwest and the East Coast are also not part of any gradual change. What seems to be happening is that we are experiencing the beginning of what scientists refer to as "abrupt climate change."

We now know that Earth's climate normally changes through abrupt shifts. Climate change is mostly not the slow measured process we thought it was. The changes are fast and violent and disrupt ecosystems. The changes generally start out slowly, but then a threshold is crossed, and the temperature changes far more quickly than the slow and modest warming projected by almost all climate change models today. These abrupt climate changes dwarf the significance of the gradual climate changes projected by our world's scientific institutions.

Abrupt climate change is a much more serious threat to food production and our own lifestyles than the gradual approach that science had assumed and that most of us presuppose. "New policy needs to focus on abrupt climate change, not the relatively slow changes we see in climate models of our future," writes Bruce Melton. "The social, economic and biological disruptive potential of abrupt climate change is far greater than that of the gradual climate change present policy is predicated upon."

Since the effect of climate change on food production is essential to the longer-range forecasts of rising food prices in the analysis above, we need to investigate our former belief that "the higher temperatures that bring floods, droughts and wildfires also, broadly speaking, expand growing seasons and improve crop yields." What we discovered instead is that "temperature increases of more than one degree Celsius above pre-Industrial temperatures are 'projected to have negative effects on yields for the major crops (wheat, rice and maize) in both tropical and temperate regions.'" Our mid-range and long-range predictions that food production will be more difficult and food costs will rise are plausible on the evidence.

The hedges against dollar depreciation and rising food costs are two exchange traded funds or ETFs: JJA and JJG. (For more on what an ETF is, please see the excellent discussion by John Dowdee.)

"[The] ETF vehicle [JJA] tracks the 'big seven' food contracts: soybeans, corn, wheat, cotton, soybean oil, coffee and sugar. You're talking about the basis of nearly everything else we consume: feed for animals, grains for ourselves, materials for clothing and, of course, the caffeine and sugar the world craves. It's a nearly perfect cross-section of the goods we consume on a daily basis, all over the planet," wrote Sean Hyman in the November 2012 issue of the Middle Class Prosperity Package. The other agricultural ETF, JJG, tracks only three main grain contracts and "of 41% corn, 37% soybeans, and 22% wheat."

We are going to experience breakdowns in food supply due to growing populations and the effects of climate change (drought, heat, planting time, harvest time, rain, pests). These breakdowns may hit cotton or coffee or sugar and not hit corn, soybeans or wheat. When they do, food prices will go up and so will JJA. On the other hand, if one of the grains shoots up in price, both JJA and JJG will go up. These examples illustrate why I am inclined to think that the more broadly diversified agricultural ETF will be a safer hedge against scarcity of food than one based on just three grain commodities. The more diversified the commodity mix, the more likely that one or more of the included commodities will be hammered as scarcity sets in due to everything from population growth, too much rain, Artic Vortexes, spread of bacteria, die-offs of bees, and all the challenges farmers will face as farming becomes even more difficult in our climatically changing world.

In terms of their market track records, JJA and JJG are relatively similar in terms of the changes in their market values. A main difference between them is that JJG's daily volume is roughly twice the average daily volume of JJA. JJA has gained roughly 1.98% since its inception whereas JJG has lost 4.56%. Given the weekly fluctuations, these small differences are lost in the background noise. But because of JJA's broader and more diverse collection of food commodities, I give a nod to JJA. For example, Starbucks is raising its coffee prices in July and that commodity is part of the JJA package but not the JJG package. John Dowdee, to whom I referred above, would also give a nod to JJA, "at least if you use limit orders and buy relatively small quantities." For these reasons I prefer JJA over JJG but both are reasonable hedges against rising food prices.

Moral Qualms

The effects of Climate Change and the ramifications of rising food prices typically affect the poor first. If you, like I, should feel a moral qualm about profiting from the very condition (rising food prices) that causes the worse off to suffer, you have two choices. Choice one: do not protect your resources against the weakening dollar or rising food prices. Choice two: protect your own resources. If you pick the first choice, end of story. If you pick the second choice and decide to protect yourself against dollar depreciation and rising food prices, and if the narrative unfolds along the lines I've suggested, then you can always do what Peter Lynch does: find a way to give your money to those who need it and apply "local knowledge" in your search for recipients. Your local food bank might be your best way of giving to those suffering from higher food costs. If you do need to look outside your local area, remember that the advertisements for charities that you might see on TV are excruciatingly expensive. Find charities that have low administrative and salaried overhead. Oxfam is one.

Source: 2 Agricultural ETFs Are Best Hedge Against Dollar Depreciation And Rising Food Costs