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Withering crops lead to soaring issues

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Spike: The chart shows how the price of commodities, such as corn, have skyrocketed in recent weeks (Source: Bloomberg)

Bermudians have always been concerned about the rain due to a lack of other sources of fresh water. The island’s recent drought-like conditions (barring the rains last week) may have been difficult, but now a global drought is impacting the markets in various ways.You’ve probably noticed on almost every news source the coverage of the heatwave and lack of rainfall plaguing the US Midwest. The dearth of precipitation has led to the worst drought seen in North America in more than six decades and is wreaking havoc on agricultural crops. In fact the US National Oceanic and Atmospheric Administration (NOAA) has identified July 2012 as the single hottest month ever recorded in the United States, with records dating back to 1880!Farmers are seeing the price of grains rocket up. The GSCI Agricultural Index of commodities has risen about 16 percent since the beginning of the year. However, farmers are also watching the amount that will make it to market shrivel almost daily. Recently the US Department of Agriculture (USDA) reported that only 49 percent of the crops were either in “good” or “very good” condition.Yields per acre may hit the lowest levels since 1995. Seventy-five percent of the corn and soybeans used in food, livestock feed and biofuels comes from the Midwest. The US produces more than one-third of all of the corn grown in the world so these conditions are threatening to create another global food crisis much like that which we saw in 2007-2008.The implications of the drought will have ripple effects in the some of the following areas:Food inflation: According to estimates by Tyson Foods, it takes 2.1 pounds of corn to make one pound of chicken, 4.5 pounds of corn to make one pound of pork, and 6.2 pounds of corn to make one pound of beef.Escalating feed costs are causing a headache for livestock farmers. This has forced livestock farmers to send their cattle to the slaughter house in record numbers. In fact the beef herd has now tumbled to a 40-year low.In the next 12 months the USDA estimates cattle futures may rise some 8.1 percent sending beef prices to all-time high of $1.35 a pound. According to the Bureau of Labor Statistics (BLS) in the US, retail ground beef averaged $3.085 a pound in July, the highest since 1984, and whole chickens were $1.454 a pound last month, the highest in at least 32 years.Other ancillary food prices are also likely set to rise and the USDA also suggests consumers need to brace for increases of four percent in milk, bread and cereals. Feeding the family is only going to get more expensive.Crop insurance pricing: Standard & Poor’s recently suggested that private crop insurers could suffer losses in excess of $5 billion. This of course will be a drag on earnings for some Bermuda insurers but won’t likely effect capital levels significantly. In fact it may lead to a future underwriting opportunity for select insurers as pricing gets a boost.Discretionary spending headwinds: With escalating food and energy costs it is likely that discretionary spending will slow or dip as household budgets get squeezed. While the USDA expects food inflation of as much as four percent in 2013 a United Nations gauge of global food costs jumped 6.2 percent in July. Greater spending from the burgeoning emerging market middle class is one of those themes global and emerging market investors have keyed on as developed market consumers and governments continue to deleverage. But there’s a growing risk that emerging market consumers could start reducing spending as hard commodity prices fall (a major source of wealth for some emerging markets) and higher food prices lighten consumers’ wallets.Retail sales are also likely to suffer more in emerging markets where energy and food costs make up a proportionally larger share of overall household spending. In the US, for example, the BLS suggests food and transportation costs make up about 30 percent of a consumer’s budget. In emerging markets, however, this can make up to 55 percent to 60 percent of monthly income. Rising food prices can disproportionally affect China where it is a large importer of soybeans and the world’s second largest consumer of corn. The result is that food price inflation in the emerging markets tends to be a much greater problem, to the point of creating social instability, and even a possible humanitarian crisis.Emerging market stimulus plans curtailed: It is very likely that a sharper escalation in food inflation could dampen expected stimulus measures in emerging markets. Simply put, escalating inflation will likely curb governments’ ability to stimulate due to escalating cost pressures. In many emerging markets, governments subsidise energy and food cost and escalating prices reduce their ability to fund expansionary spending.They are also likely to be hesitant to increase spending that may stoke even higher inflation. This is likely to lower the market’s expectation of the size and effect of any potential stimulus efforts in China and India, for example. Unfortunately, this is coming at a time when it is needed as the Chinese economy appears to be decelerating at an alarming pace.These are just a few ripple effects associated with the Midwest drought. If conditions improve next year longer-term supply concerns may be unwarranted. Persistent and rising food inflation, however threatens geopolitical stability and consumer spending.Let’s all hope for rain.Nathan Kowalski is the chief financial officer of Anchor Investment Management Ltd.

Parched: Drought-damaged corn is seen in a field near Nickerson, Nebraska