Wheat looks tasty, even in recession

[jacob]

By James Saft
Fri Feb 22, 2008 8:41am EST

(James Saft is a Reuters columnist. The opinions expressed are his own)

LONDON (Reuters) - The global market for cereals looks well placed to withstand a U.S. recession, its resistance bolstered by climate change and new dietary tastes in rapidly developing economies.

The price of wheat traded in Chicago has risen 13 percent this year and more than doubled since June, now standing near $10.50 per bushel.

Declining water tables and unpredictable weather in major production areas have hit crops, while much arable land has been diverted to producing biofuels, further limiting supplies.

Meanwhile, consumers in emerging markets like China are eating more meat as they become wealthier, driving demand for animal feed.

And what's more these factors are not likely to go away soon, even as general economic conditions worsen.

"It is mostly driven by world population growth, which is about 75 million people per year, and also by the more protein rich nutrition trend in Asia," said Jochen Hitzfeld, a commodities strategist at Unicredit in Munich.

Hitzfeld is predicting a further 50 percent rise in wheat and expects prices to average $15 per bushel in 2009.

The trend, in fact, is not a new one. In seven of the past eight years demand for wheat has been bigger than supply, according to Unicredit, though thus far that has been made up by drawing down existing stockpiles.

The Department of Agriculture now expects wheat inventories in the U.S. to have fallen by 40 percent by June. That would take stocks to the lowest level in 30 years and the lowest level ever in terms of days of supply, according to Merrill Lynch.

Figures like these helped to touch off a recent surge higher in wheat prices. Between February 1 and 11, Chicago wheat rose more than 20 percent, prompting U.S. exchanges to increase the costs of betting on future prices as well as daily price move limits.

That helped prices to fall, but has done nothing to change the underlying fundamentals.

THE WHEAT TO MEAT CONNECTION

A crucial factor underpinning wheat is the long term move to a more meat-based diet in emerging markets.

Consumption of pork in China has more than quadrupled since 1980.

Meat, as both a source of calories and protein, is extremely inefficient, requiring a big investment of feed, in the form of grains, and water. For example, it takes two kilos of soybeans to produce one of chicken and 8 kilos to one for beef.

And though wheat gets only marginal demand from feed, the rising demand for soy, as well as biofuel crops, have limited the amount of land devoted to wheat.

So what happens if the U.S. falls into recession, as many believe it already has? One concern would surely be that the recession hurts emerging economies, prompting consumers there to cut back on expensive food.

However, "it is hard to believe that the nutrition trend will be altered," said Hitzfeld at Unicredit.

"These trends have been going on for 8-10 years and have survived many crises like 9/11 and the U.S. recession in 2001."

And, unlike other commodities that are sensitive to overall economic activity, such as metals used in manufacturing and homebuilding, wheat demand within the U.S. and Europe should be fairly well supported, even in the event of a recession.

After all, people still have to eat, even if they may lose jobs and consume less gasoline or buy fewer electronics or appliances.

Agricultural products have a pretty good track record in times of recession, though that is partly due to unexpected demand from Russia during recessions in the 1970s and 80s.

"However, we do view the broader agricultural space as relatively well supported in (recessions), as low inventories will likely require at least two more production cycles to ease even under comparatively pessimistic demand scenarios," JP Morgan Chase analyst Lewis Hagedorn wrote in a note to clients.

So what are the risks?

Food price inflation is rising and politically unpopular. Food inflation in the U.S. is running at 4.9 percent on an unadjusted basis in the year to January, raising hackles in an election year.

This, along with growing doubts about the environmental impact of biofuels, might prompt a re-think of policies designed to encourage the use of fuel made from plants.

If so, that could bring wheat back into production in areas where it has been cast aside.

It is also true that marginal land, such as in places like Brazil which are both remote and less productive, might be turned over to wheat.

But all of these have one thing in common - they take time.

So in a year when almost every other kind of investment faces very serious risks and headwinds, boring old wheat could be a big winner.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

Source: Reuters