The real push on food costs
Darden Restaurants, which own Olive Garden and Longhorn Outlets, believes food prices and net energy costs will rise 1.5 to 2 percnet this year and 3.5 to 4 percent in 2012. Darden has locked in 100 percent of its seafood for this year and 30 percent for 2012. It has bought 75 percent of its beef needs for 2011 and 40 percent for 2012. These two foodstuffs, fish and beef, account for 80 percent of Darden’s food costs. The Restaurant’s holding company thinks that it will make money, boosting its profit projections. Darden is running a good business. What we are going to find out, what I believe will be a revelation to many, is that raw commodity prices can rise so much, products like corn can double, and yet it will have “little” impact on retail food prices. At $4/bushel for corn, a 10-ounce box of cornflakes has 5 cents of corn in it. At $8/bushel, it’s 10 cents. When that happens, it triggers this reaction in food companies. They raise the price of cornflakes 45 cents a box and blame it on ethanol. The truth is that ethanol, used as a scapegoat, is making food processors richer. Food ingredients make up such small price components of finished foodstuffs that they can double, triple or even quadruple without much impact on net costs to processers. When corn prices fell as they did in 2009, food processors didn’t lower prices. They profited. When the price of cotton doubles, the price of clothing won’t double. Clothing manufacturers spend more on labor, energy and marketing than they do on cotton. Many will be surprised at how easily commodity cost increases are absorbed by mills and processors, although as their margins will be squeezed, they will want everyone to think that is the reason that they are raising prices so much. I think what we will find out is that commodity prices in terms of relative value to equities, wages, salaries and Wall Street bonuses, had gotten just too cheap and a long delayed adjustment was necessary. It took China and biofuels to unleash ag values. Many don’t like it. The complaining will get louder. They loved the cheap food policy that kept farmers farming for the government, living off subsidies that depressed prices for endusers. That period, which has passed, will be thought of as the good old days for endusers. China’s economic growth is the primary driver behind world food price inflation, soaking up world commodity production capacity. Other factors include European rejection of biotechnology by limiting crop production to lower productivity non-GMO crops and raising prices by restricting market access, accepting only non-GMO commodities, when GMO food/feedstuffs are much lower cost. The rising cost of energy, factoring into production, processing, and transportation costs is the primary direct food cost inflation factor. One time weather events have significantly impacted grain prices. Drought in the Black Sea region, floods in Pakistan, floods in Australia, drought in Argentina and numerous other weather events trimming acreage and yields elsewhere combined to tighten stocks. I believe biofuels as a factor raising food prices comes in below all these others in significance, contrary to how ethanol is portrayed in the media. Ben Bernanke doesn’t see inflation as a major threat. The 1970s saw a wage and price inflation spiral. We are so far away from producing any wage inflation as the U.S. workforce is so much more worried about getting a job than what it pays, business labor costs are low with no prospect of any tightening of the labor market enough to significantly raise wages. QE2 was absorbed into credit markets so fast that the tidal wave of liquidity feared by inflationists, is imaginary. Wage and price inflation occurs when labor and product market capacity gets too tight. Agricultural products are only one small ingredient in general consumer products and proving that they can adjust without triggering a general wage and price inflation spike. If one occurs, it won’t be because of what the Fed has done. The Economist magazine advises, “Central bankers should not be very alarmed either by the scale or by the dynamics of overall inflation. Inflation is up, but hardly high. In no big economy, emerging or rich, is it at the peaks reached in 2008 (in America it is merely 1.5 percent.) Much of its recent rise is driven by what are clearly one-off factors, from weak Russian harvests that sent grain prices soaring to the rise in value-added tax in Britain. Central bankers should ignore such temporary shocks. Their role is to prevent one-off surges from translating into persistently higher pressure on prices. So far, there is little evidence of that.” I don’t believe that surging commodity prices will necessarily turn into the inflation that so many fear. I think that it is just a necessary repricing of an under-valued sector. Food has been too cheap too long. I think that China and populations of newly economically emancipated consumers being created by global economic growth in emerging nations is the primary driver for higher commodity prices.
David Kruse is president of CommStock Investments Inc., author and producer of The CommStock Report, an ag commentary and market analysis available daily by radio and by subscription on DTN/FarmDayta and the Internet.
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