Agflation About to Take Center Stage

 |  Includes: DBA, MOO
by: Russell Bailyn

I have a hunch that food inflation is about to take center stage. Some may have noticed the increase in chatter about farm subsidies and commodity prices already in the early rounds of presidential debate. This is likely to continue into 2008 because agriculture prices are currently in ‘spike’ mode. Take a look at the Deutsche Bank Liquid Commodity Index--up 18.6% since January 1st--as proof (as of 12/10/2007). This index covers wheat, corn, soybeans, and sugar among other commodities. So what’s driving these prices higher? And what can you do to protect a portfolio against agflation (agriculture inflation)?

The Economist ran a cover story on this issue last week, citing the growing wealth in emerging economies as the primary driver behind food prices. More specifically, the change in diet which accompanies this greater wealth ultimately leads to these higher prices. And the stats are very interesting. Did you know that it takes 8kg of grain to produce 1kg of beef? Studying the food chain sheds some light on where and how these price increases may expose themselves. Most reports also cite government intervention, specifically regarding ethanol, as a major price driver. However, camps differ on how effective ethanol will ultimately be as a fuel supplement.

What people seem particularly united about these days is cutting farm subsidies to American companies, along with trade barriers to bring food prices back down. Along with cheaper food, we could dramatically reduce poverty as a result of jobs and trade opportunities realized through greater globalization. Alan Greenspan hammered this point into his speeches as often as possible. Of course there are quite a few old-timers who may go under without those government checks, which partially explains why they still exist.

The higher food prices we’re seeing typically benefit farmers first along with others in the business of food production. Studies show that these higher prices typically don’t affect wealthier people who may already be overspending on food and disregard it as a budget item. In theory, it will affect poor people the most, who count food as a substantial portion of expenses. The Economist seemed to think it would specifically harm the urban poor, and could actually help the rural poor in the form of job growth and new opportunities.

What can you do as an investor? Similar to oil, you can hedge against price increases by picking up an investment which tracks a commodity index, such as the one mentioned above. For compliance reasons, I can’t point out individual stocks which I think could benefit from higher corn, wheat, soybean, and sugar prices--but do some research and you should find plenty of other people who have already done this research. In my world, buying an index, rather than individual stocks, is the safer way to speculate or hedge in your portfolio.