Food prices run amuck!

There's been a lot of interest in food prices spiking, and there are many opinions on why food prices are running.

The most popular "cause" is, of course, speculation by hedge fund managers, futures traders, etc. Although this may be causing some of the short term spikes we are seeing, I don't believe it's the real, underlying cause.

In my opinion, there are significant, fundamental, underlying trends that are causing food prices to run up.

The first, and one I've written about before, is underlying inflation. When the central banks of the world print money to fight various economic problems, the result is almost always inflation.

Another major cause is government policy encouraging (read: subsidizing) bio-fuels production. When almost 20% of U.S. corn production goes to produce fuel instead of food, then food supply decreases and prices will rise (all things equal)--welcome to Economics 101.

Demand itself--especially from the rapidly growing developing economies in Asia, Latin America, the Middle East, etc.--is indeed a major factor in food price increases. We in the developed world cannot expect those in the developing world to continue living on the same amount and type of food they've been living on forever. This trend isn't going away any time soon.

Another less talked about reason is water. Yes, water. Water for growing crops is not as easy to come by in many parts of the world. Saudi Arabia is a great example of a country that must spend tremendous amounts of resources to produce water that can be used for growing food.

A bad crop in Australia is also to blame. Bad crops are not that unusual, though. In fact, they are quite predictable (that they will happen, not when). This only exacerbates the problem. It's not a primary cause.

So, food prices are going up and there are underlying, fundamental causes that probably won't make this issue go away quickly. So what?

If the global economy slows down, as it looks to be doing, then look for food prices to fall back a bit. But, as long as the underlying causes mentioned above persist--central bank money printing, bio-fuel subsidies, demand from developing countries, difficulties in producing usable water--food prices will probably remain higher than in the last 20 years.

Higher food prices matter because they have led to many wars throughout history. This isn't a prediction, merely an observation that when things get bad enough--people don't have enough food to eat--they can become angry enough to go to war.

Food prices don't seem like that big of a deal in the developed world like the U.S., western Europe and Japan, because food makes up only a small portion (10-15%) of the developed world's family budgets. In the developing world, though, food is a huge portion (80%). If 80% of our costs doubled or tripled, as food prices have in some parts of the world, you'd even see Americans ready and willing to go to war.

What's a poor investor to do? Prepare for this possibility. The forces of capitalism will tend to drive prices of commodities down over time. When these forces are interrupted, as described above, you get price spikes, shortages, surpluses, etc.

The backlash caused by food price spikes will, eventually, lead to the removal of the barriers to capitalism. Until these barriers are removed, expect food prices to remain high and perhaps even continue to climb.

As an investor, you can protect yourself by investing in areas with pricing power. Businesses with pricing power can do okay during difficult periods periods, and, if/when food prices decline, they will thrive. Win win.

Trying to bet on commodity price swings is risky business, and I wouldn't recommend it. If you don't know who the patsy is, then it's you.

Instead, look to quality businesses that can raise their prices without crushing the demand for their products. Such companies will always do well over the long term.

Another idea is to invest in areas of the food market that haven't yet benefited from price run-ups. First it was energy, then base metals, now food crops. As inflation works its way through the system each player along the way goes from being hurt to being benefited.

For instance, pork, chicken and beef producers have been hammered by higher input costs--corn, soybeans, wheat--but the price for their end products haven't climbed, yet. They are facing the perfect storm of higher costs and lower product prices! Perhaps this will change as marginal producers go bust and large producers trim back production until it's profitable again. It's Economics 101 again!!! (full disclosure: I and my clients are invested in a large pork producer).

Don't let higher food prices get you down. Invest wisely and you can benefit!

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.