Institutional Investor's Alpha Magazine - February 2008 - (Page 30)

Commodities that we could have a serious global drought two years in a row, at a time when global inventories of corn and wheat are already at historical lows. We know that countries will go to war for oil. Now ask yourself what they would do to ensure that they have adequate supplies of food.” Although Greer hastened to explain that he was talking about economic warfare, not the advent of World War III, he is concerned that any sudden change in the global food supply could have a catastrophic effect because worldwide inventories are already deeply depleted. Countries could become more protectionist about their food supplies and reduce exports, causing more dramatic price spikes in the markets. Since Greer made that trip to Washington, drought has indeed been an issue in global grain markets, as a series of heat waves across Europe and North America in 2006 reduced wheat yields. Australia, one of the world’s largest wheat exporters, suffered a pro— DWIGHT ANDERSON, FOUNDER, longed drought last year that OSPRAIE MANAGEMENT drove prices to record highs. Although that was just one market, the effects were broadly felt; wheat futures broke through $10 a bushel for the ﬁrst time in October 2007. This is great for investors, but miserable for countries that have to import wheat. “We are in an exceptional situation right now,” says Paul Braks, a senior associate in commodities with the Food & Agribusiness Research and Advisory department at Rabobank’s offices in Utrecht in the Netherlands. “Global stocks are really low, and we need at least two normal crop years, without any adverse weather effects, before stock levels are again at acceptable levels. We used to have four months of stocks to fulﬁll demand needs; we are now down to only two months.” Consumers in the industrialized world typically have enough disposable income to absorb incremental food price increases, but workers in developing nations don’t have that luxury. In some countries the cost of buying dietary staples has increased so dramatically over the past 12 months that desperation is taking hold: In Chongqing, China, last November, a promotional sale of cooking oil at a Carrefour store resulted in a stampede of customers, leaving three people dead and 31 injured. In January in Jakarta, an estimated 10,000 people marched outside the presidential palace after soybean prices soared more than 50 percent in a month, and 125 percent over the preceding year. “Unfortunately, one of the side effects of strong global demand for biofuel may well be food shortages and political unrest in developing countries,” says Francisco Blanch, head of commodities research at Merrill Lynch in London. “We’ve already seen demonstrations from Mexico to Indonesia over corn and soybean prices, and we’re likely to see more in the months ahead.” Some countries that have been exporters are now becoming more protectionist, reducing the ﬂow of commodities globally. China’s decision last month to set new export tariffs on a whole range of food commodities helped drive U.S. corn futures to a new 11-year high. Human consumption, of course, also powers higher commodities prices — particularly in China and India, whose economies have been exploding. During the past three years, China’s GDP has grown at an average of nearly 11 percent annually and India’s at more than 9 percent, according to the World Bank. As wealth accrues to newly urbanized middle classes, patterns of food consumption change markedly. According to the U.N.’s Food and Agriculture Organization, China has seen an increased demand for meat. A Chinese consumer who ate just 40 pounds of meat in 1985 now consumes 132 pounds in a year — and a single pound of beef takes seven to eight pounds of grain to produce. The problem with increasing urbanization is that it tends to depopulate the countryside and draw people away from farms. As they move into cities to make more money and try to improve their standard of living, capital is diverted to infrastructure development, and food production tends to dwindle. That pattern, which has already played out in Japan, South Korea and Taiwan, became obvious to Stephan Wrobel, chief executive of Diapason, while he was researching grain inventories in China. “Grain production in China peaked in 1998, and inventory peaked in 2000,” says the 35-year-old French investment manager, who began his career as a commodities trader at Société Générale in London and then developed and implemented macro and arbitrage strategies for hedge fund clients at BNP Paribas and later at Lehman Brothers in London. Ever since 2000, he says, the Chinese have been tapping their inventories because they’re expanding their cities and using more land for industry. “As more and more people move into the cities, there are fewer and fewer left in the countryside,” adds Wrobel, who co-founded Diapason in 2003 with Motière, then head of arbitrage and hedge funds for Barep Asset Management. “But farming is still an activity that requires human capital and good-quality land to expand the yield, and those are factors that we have to take into account — which is why we believe that China will become a large importer of grain.” Despite the increased levels of consumption, Ospraie’s Anderson believes that agricultural producers might be able to cope with rising demand were it not for the U.S.’s and Europe’s insistence on the conversion of food into fuel. The U.S. Department of Agriculture projects that by 2010 biofuel production will consume a third of the U.S. corn harvest. The impact on prices has already been profound: Corn futures have jumped nearly 40 percent in the past ﬁve months. Farmers will undoubtedly meet higher prices with more investment and greater produc- “If the only hurdle that we had to face in the world was rising meat consumption, we could handle that relatively easily.” 30 • INSTITUTIONAL INVESTOR’S ALPHA • FEBRUARY 2008

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - February 2008

Institutional Investor's Alpha Magazine - February 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Alternative Perspective The Good Guys: A Simple Plan Cover Story: Energy and Commodities: Fueling Opportunity Regulation: Energy Trading: The Brawl on the Hill Interview: Master of Values Regulation: Hedge Fund Registration: Way Out West Research Center: Top Hedge Fund Analysts Alpha Bytes: Rocket Man Unhedged: Commentary: Structured for Success

Institutional Investor's Alpha Magazine - February 2008

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