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The Food Squeeze

Recs

11

January 20, 2008 – Comments (13)

I was just reading a blog by a writer from Alberta on his views on food inflation, which sent me looking a little closer at what is happening in the industry.  It is yet another recession red flag.

Liverliss concludes with his analysis:

 "My point is that we have not seen the impact of increasing grain prices being priced through into consumer food inflation.  But we soon will.  And when I see numbers like the above, where the cost of raising a hog right now exceeds the selling price by almost 100%, I become convinced that the inflation that we are about to see in foods is going knock everyone off their feet."

With that comment he is specifically referring to a commentary on Farms.com about the price of raising a hog compared to the current selling price, pricing that has gotten way out of wack due to grossly increasing feed costs.  The commentary suggests that farmers are currently loosing about $30/hog. 

As with all things dealing with supply and demand, there was a shortage of pigs, which lead to fantanstic profitability, and now over supply that is particularly harsh due to the gross increases in feed costs.  The article points out a one day slaughter record of 436,000.  Pork is a commodity that can not be stored for very long, so it must be sold or it will spoil.  Pork currently has enormous price power for consumers.  It is extremely cheap relative to production costs.  If you love pork and have capacity to freeze it, a good food cost saving strategy would be to be filling up your freezer as you see it on sale over the next few months as this incredible pork boom will lead to gross declines in production to the point the farmers will have the enormous price power and likely in a year or two we will be paying 50-100% more per pound of pork.

 The commentary points to large eggs as a recent example, farmer were getting 50c/dozen and losing money, they cut back and now they are getting $1.50/dozen and making record profits.

I also found a more researched article on hog producers that outlines the cycle over the past few years and the forecast for 2008. 

It goes back to 2004, which was the highest margin in 15 years.  This draws investment inflow and higher capitalization in the industry -- that is what happens with supply and demand.  2005 had a lower margin but was still an excellent year.  It says the return was $7.83/hundred weight, but that return declined to $1.21 for 2006, or higher feed costs and lower pork prices squeezed farmers by $6.62/hundred weight in a one year period.  The squeeze on farmers has continued and it looks like break even or slightly negative margins for 2007.  The article doesn't give any projected costs for 2008, but states negative margins are expected.

Looking at what is happening today, the record slaughter earlier this month gives the food packer the pricing power and ultimately the consumer.  It only tells me what the packers were paying over xmas, not the change in the price from a month earlier, or a year earlier, but their "farmers math" says that it was an awful xmas for hog farmers and by next fall there will be a major correction to supply and demand that will hit consumers.

The US is in a no win situation.  The Crammers of this world can scream about the need to lower interest rates, but that rapidly devalues the currency and dramatically increases input costs and hence inflation.  The highly understated, manipulated, reported inflation came in at 4.1% for last year.  When you consider the first 6 months did not show any significant increase, well it means inflation was considerably higher for the second half of the year.  This was easily predictable from the devaluation of the US dollar.  I did a very short post on the Canada/US effects from one day of devaluation.  The US dollar devaluated relative to most currencies, significantly, and the price increases simply have not worked their way into the economy, yet.

There will be no economic stimulation when consumers find that their costs are increasing faster than their wages.  There will be no wage leverage of workers when those not laid off are feeling grateful they still have a job when they see co-workers being let go.  There will be no wage leverage when employers find themselves with 10 resumes for every job they offer.

Historically lower interest rates stimulate the economy in three ways:

1) By enabling people to reduce their repayment debt burden by refinancing and either enabling them to pay back debt faster (which foolish consumers did not do) and enable them to get out of debt sooner.  Consumers with no debt have significant buying power and consumer choices.

2) Keep payments the same and increase disposible income now immediately stimulated the economy with more spending, but does little to increase financial security and tends to lead to living beyond one's means if it is all spent and none is put towards financial security.  It is dismal is all is spent on option 3, which is what masses of Americans did.

3) Borrowing beyond ones means, which is what happened in masses.  The average debt load has increased by one times the average wage in the US over the past 5-6 years.  This option no longer exists from lowering interest rates as risk was not priced into this lending.  The gross level of living beyond one's means was not immediately apparent, but is quickly becoming very apparent.

Today only options one and two exist and given that Americans were spending 30% more than their income over the past 5 years, the non-existance of option 3 means there is no longer stimulation from lowering interest rates.  The only thing it can do is help people convert their debt to that which will not increase their burden down the line. 

The inflation from lowering interest rate may very well make the lowering of interest rates more harmful than if they just left them because the inflation will likely be far greater than any reduction in interest burden.

The coming food squeeze in pork is but one example. 

13 Comments – Post Your Own

#1) On January 20, 2008 at 1:45 PM, dwot (40.33) wrote:

I just read Roubini and something I did not consider is:

During the coming recession, demand for goods will fall, jobs will be lost and oil prices will drop. Inflationary pressures will be reduced, and rising prices will become the last problem the Fed needs to worry about.

I still think inflationary pressures will exceed the benefit of reducing rates, and what you really need is a strong movement to stop any more excessive borrowing (which is mostly happening but there is the odd idiot lending still happening), but that the same time get people refinanced into something manageable and then hold the line on rates.

Also, forget spending on any stimulation package, spend on educating the public about the need to support local jobs.  Every job lost hurts the economy and as long as money is being spent on imports that's less American jobs and money leaving and more hurt.  Tax incentives for local goods that leads to local jobs is what the economy needs.

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#2) On January 20, 2008 at 2:13 PM, abitare (35.12) wrote:

dwot,

Good post. During the depression, farmers could not get prices they wanted / needed for products, so they burned crops and poured out milk etc... while people in some parts of the country were starving.

The govenment also has just created a debacle with the ethanol subsidy that is making grain expensive that is fed to the live stock. Plus the lowering of interests rates has sent farmland way up in price. Farmers, who bought in the last three years, maybe in the same circumstance as home buyers. Also rising fuel costs, affects cost of fertalizer and shipping.  

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#3) On January 20, 2008 at 2:21 PM, abitare (35.12) wrote:

Also from Roubini:

But compared to 2007, 2008 may be real bearish for stocks: in a typical US recession the S&P 500 falls by an average of 28% in nominal terms and 21% in real terms.

No wonder as recessions are associated with sharp drops - of the order of 15-20% - in earnings. Many sectors earnings have already taken a major beating in 2007: financials, home builders, consumer discretionary, retailers. The next shoe to drop will be all the other cyclical sectors of the economy that will seriously suffer from the forthcoming recession. So while 2007 was lousy for the US market 2008 may end up being much worse.  Even more than in 2007, in 2008 cash will be king.

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#4) On January 20, 2008 at 2:54 PM, dwot (40.33) wrote:

Abitarecatania, I think the earnings squeeze will be worse on stocks because like credit, there is practically no risk priced into the stock market.

If you were an investor say in 1980 and you looked at the market today, you'd damn near have a heart attack in terms of the difference in valuation of stocks.  So, this time I suspect not only will there be a repricing due to the margin squeezes, there will also be some repricing to include reasonable risk again.  It seems to be well accepted to pay a P/E of 20-25 for a stock and I think that is insane, and then fantasy future growth is also priced into stocks.

The position that the stock market always beats all other investments is highly premature and short sighted.  That statement is comparing stock prices in a market with sentiment that priced risks into stocks when there was no credit bubble. Give the market 2-3 years and lets make the comparison again and see what conclusions are made.  

Something else the market has had in its favour that hardly exists anymore was enormous opportunities to reduce costs through massive technological advances and out sourcing to cheaper labour.  Technological advances aren't nearly as stellar any more relative to current production.  For example, agricultural land is about 2-3 times more productive, or 100-200% more productive.  A new advance might give another 5-10%, marginal by comparison, and that is the way it is for the marjority of new advances.  Humanity has been fantastic in making advances and there has been huge leveraged profits.  All sources of leverage and advancement are marginal in comparison to what they were able to do in the past.  So it is also comparing the market through the world's greatest achievements in technology and cost reductions.

And the last point, it is also through a period of an aging population, where pension funds have increasing amounts to invest and they inflate the market.  When they start to reverse, the market may end up being under priced. 

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#5) On January 20, 2008 at 2:58 PM, joeykid13 wrote:

Awesome post dwot!  You are way ahead of the curve, and I hope everyone is paying attention.  Abitarecatania...with wheat prices doubled, and corn being turned into gas, we are completely unprepared to handle what is coming next.  We have taken for granted how fortunate we were, and now the reset button is being pushed.

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#6) On January 20, 2008 at 3:16 PM, dwot (40.33) wrote:

Here's a poster that I've been dismissive of in my reading.  I read Safehaven which has a range of contributors.  Most are very good, but there are a couple that I skim, shake my head and delete.  Posts by Angelo Campione are in the shake my head and delete category, and today's post is why.

A 35.86% one month loss is at the higher end of their spectrum... I would hope so...  So, 2007 for them was 107.8% gain, mine was about 118%.  So far their 2008 loss is 35.86%.  Mine is 0.33% gain.  In this market I don't care it I don't make anything.

Not sure how anyone can brag about how their system saved them when they lost over 1/3rd in a month.  The risk they took could have resulted in a 90% loss.  "Dramatic market movements are not able to be anticipated..."   I anticipated them.

So, they are staying their course...  I suppose if they get a dead cat bounce and exit they can recover some...

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#7) On January 20, 2008 at 3:18 PM, dwot (40.33) wrote:

Thanks Joeykid.

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#8) On January 20, 2008 at 7:38 PM, abitare (35.12) wrote:

I am hoped for a bigger rally on Friday to aquire more SKF, SRS
 and SCC. But the market keeps selling off. I might look back to the FXP.

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#9) On January 20, 2008 at 8:05 PM, dwot (40.33) wrote:

Nikkie looks ugly today... I'm reading down 373 points, about 2.5%...

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#10) On January 20, 2008 at 8:30 PM, floridabuilder2 (99.33) wrote:

Great article....  i have been criticized a little about my recent pick of fertilizer stocks on caps when they pulled back significantly... however, i have a large amount of money in FEED a hog feed supplier in China that is now buying hog operations...  Pork is a mainstay staple of Chinese food and it will grow as the country gets wealthier... however, the Chinese gov't is getting worried about food inflation and they think there is some price gouging involved...  Food and shelter are two things everyone needs, FEED is a risky bet, but there are number of ETFs that track futures pricing of everything from pork bellies to wheat to soybeans....  I think ETFs related to agriculture futures may be a good play... i am with you on the deflationary pressures....  i wasn't quite sure back in december and back then i felt oil was a bad bet... however, all the caps players except for you were saying oil was a good bet... it just didn't add up in my head, but i went along and did some long calls on caps in oil companies... but now things are much clearer... we are heading for a global slowdown and IT WILL effect all commodities from oil to copper....

great post

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#11) On January 20, 2008 at 8:51 PM, dwot (40.33) wrote:

FB, I think you probably have to look at the pork market in China to see how it is doing there.  I suspect there are lags in different countries, for example, Canada is just peaking in Real Estate now, about 2 years behind the US. 

I think best to watch the hurting and be patient...

Oil is still very high.  I expect it to see $70 again.  There might be enough inflationary forces that that is the lowest it sees.   

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#12) On January 20, 2008 at 9:15 PM, dwot (40.33) wrote:

Yikes, yikes, yikes!!! Nikkei now down 466, 3.4%....

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#13) On January 21, 2008 at 12:49 AM, dwot (40.33) wrote:

I wonder if the Nikkei free fall is over for the day, down 518.8 now.

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