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Markets: Food Fight!
New York: April 14, 2008
By John R. Stephenson

"I'm extremely worried.I have been for a while, but I just see things getting much worse this time around than I expected."

--Jim Rogers, Investor and Author

Markets have been anything but certain. One day it looks as if the stock market is about to stabilize and then the next day it rolls over and heads lower. Volatility is up, investors are glum and stocks are generally for sale. Is this the buying opportunity of a lifetime, or merely a head fake by the market?

Who knows! But for Jim Rogers, a legendary investor, who along with his partner George Soros launched the Quantum Fund in the 1970's, the answer is obvious. Sell and go away. In fact, Jim Rogers has done just that — he sold his beloved New York townhouse, moved to Singapore and has been aggressively shorting US investment banks for some time now. So what gives?

Banks are a mystery, surrounded by a riddle these days. The average bank levers its assets 14 to 1 times, turning an otherwise low margin business into a cash cow. But the problem is just what are bank assets really worth? Who knows! Management at Bear Stearns was busy telling anyone who would listen just how solvent they were, right up until the moment when they collapsed!

While a complete collapse of the U.S. banking sector is unlikely, can you as an investor really afford to take a chance on an investment in the banking sector? Likely not!

But it is always darkest before the dawn. While equities and bonds might be in the toilet, commodities and commodity producing companies are doing just fine. These securities are set to outperform, since their upside is linked to global demand, rather than US demand. For aggressive investors, who have a high tolerance for volatility, some of these stocks are starting to look attractive.

The stocks of agricultural based companies have been on a tear lately as rising food prices have hit the front pages of newspapers around the world. A swelling global population, soaring energy prices, a rising Asian middle class, competition from biofuels and hot money pouring into agricultural stocks have turned agriculture into the "it" sector of the stock market.

A doubling of the world's population to 6.6 billion since 1965, coupled with rising levels of wealth, record low food stockpiles, a biofuels craze that is using up valuable agricultural land and presto — you have the recipe for a sharp price increase in food prices.

Rice, a staple in the diets of half the world's population, has been rising fast. Since the end of 2007, the price of Thai medium-quality rice, a global benchmark, has more than doubled. This past February, stockpiles of wheat in the U.S. hit a 60-year low.

Scarce supplies and skyrocketing costs are stoking political unrest and riots around the globe. In the U.S., where 14 per cent of CPI is food, the problem of escalating food costs is relatively minor. But for many of the world's poor, escalating food costs is a matter of life and death.

In countries such as Cameroon and Senegal as well as other African countries, a large proportion of the population exists on $1 or less a day. In the poorest regions of the world, food expenditures amount to 70% of the total family budget. For many, increased food prices present a stark choice — riot or starve.

According to the World Bank, some 33 countries are now vulnerable to social and political unrest because of food scarcity. China and Vietnam are battening down the hatches by imposing legislation to curb the exports of food. According to Sir John Holmes of the United Nations, soaring food prices threaten political stability globally — most notably in Africa where a potent combination of urban congestion coupled with escalated food costs has set the stage for food rioting.

In countries such as Russia and Venezuela, rising food prices have become a political issue. In both oil-rich nations, the respective governments reacted swiftly to curb rising food prices and the discontent of their citizens by imposing price controls on food. But price controls invariably fail, as what is needed, is higher (a true price signal) not lower, prices to encourage farmers to increase the food supply, by planting additional crops. Dangerous policy initiatives, coupled with surging consumption, have set the table for a dramatic increase in the price of food in the years to come.

Could a full-blown global food crisis be in the making? Unfortunately, the answer is — yes! Demand for food has skyrocketed as hundreds of millions of people in Asia have switched from a diet of rice and bread to three square meals a day. As the economies of Asia have started to transform, so too has the diet of their citizens. No longer satisfied with simple starches, meat is the new, new thing in the diets of the newly affluent. In 1985, the average Chinese consumer ate 20 kg (44 lb) of meat a year; now he eats more than 50kg.

This trend looks unlikely to reverse with the most likely outcome being increasing meat consumption throughout the world. With more of the world's population sharing in the spoils of economic success, an already tight supply of grain, soy and corn should get even tighter in the years ahead. Within the developing world, change is already evident, as the consumption of cereals has been flat since 1980, but demand for meat has doubled.

As diets become increasingly meat-based, more and more grain is required to produce meat as compared to producing simple breads and rice. It takes seven pounds of grain to produce just one pound of beef and four pounds of grain to produce one pound of pork. So a shift in diet is multiplied many times over in the grain market.

With concern mounting about climate change, legislators in Europe and America have been hard at work drafting legislation to mandate the use of biofuels (fuel made from food). Next week, Britain is requiring that gasoline and diesel sold at the pumps contain 2.5 per cent biofuel and by 2020 at least 10 per cent. For Europe, the cost of these biofuel mandates is stark — at least 15 per cent of the arable land will be consumed for the production of biofuels.

Legislation in the U.S. has mandated that ethanol, a fuel additive, be blended with gasoline in increasing proportions to help combat climate change. But the economics of such an undertaking is questionable at best! Even if all the U.S. farmland were converted to grow corn for ethanol, only 12.5% of U.S. gasoline consumption would be replaced, according to Vaclav Smil who studies the impact of energy, food and the environment at the University of Manitoba

Food inflation is here to stay. Food and energy are two commodities that people just can't live without. With competition intensifying between food for people, food for animals and food for fuel, the stage is set for higher, rather than lower, food prices in the years ahead. The forces that have brought the world $100 oil and $12 nickel are now bringing us higher food prices and will for the foreseeable future. The only question is — what to do about it?

The answer for investors is simple — buy shares in companies that will be the biggest beneficiaries of the ag-attack that we are witnessing. Rather than slapping down a huge down payment on farmland in Iowa, investors should focus on the suppliers to the global agricultural business. Companies that supply farm equipment, fertilizer and genetically modified seed companies to the global marketplace are the likely winners in this evolving phenomenon. On stock pullbacks, investors should consider buying up shares in some of the few agricultural stocks, particularly for the fertilizer companies (fertilized crops grow twice as fast as unfertilized crops) whose growth is linked very directly to this agricultural bonanza.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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