Sunday, January 20, 2008

The Food Squeeze

I was just reading a blog by a writer from Alberta on his views on food inflation, which sent me looking a little closer at what is happening in the industry. It is yet another recession red flag.

Liverliss concludes with his analysis:

"My point is that we have not seen the impact of increasing grain prices being priced through into consumer food inflation. But we soon will. And when I see numbers like the above, where the cost of raising a hog right now exceeds the selling price by almost 100%, I become convinced that the inflation that we are about to see in foods is going knock everyone off their feet."

With that comment he is specifically referring to a commentary on about the price of raising a hog compared to the current selling price, pricing that has gotten way out of wack due to grossly increasing feed costs. The commentary suggests that farmers are currently loosing about $30/hog.

As with all things dealing with supply and demand, there was a shortage of pigs, which lead to fantanstic profitability, and now over supply that is particularly harsh due to the gross increases in feed costs. The article points out a one day slaughter record of 436,000. Pork is a commodity that can not be stored for very long, so it must be sold or it will spoil. Pork currently has enormous price power for consumers. It is extremely cheap relative to production costs. If you love pork and have capacity to freeze it, a good food cost saving strategy would be to be filling up your freezer as you see it on sale over the next few months as this incredible pork boom will lead to gross declines in production to the point the farmers will have the enormous price power and likely in a year or two we will be paying 50-100% more per pound of pork.

The commentary points to large eggs as a recent example, farmer were getting 50c/dozen and losing money, they cut back and now they are getting $1.50/dozen and making record profits.

I also found a more researched article on hog producers that outlines the cycle over the past few years and the forecast for 2008.

It goes back to 2004, which was the highest margin in 15 years. This draws investment inflow and higher capitalization in the industry -- that is what happens with supply and demand. 2005 had a lower margin but was still an excellent year. It says the return was $7.83/hundred weight, but that return declined to $1.21 for 2006, or higher feed costs and lower pork prices squeezed farmers by $6.62/hundred weight in a one year period. The squeeze on farmers has continued and it looks like break even or slightly negative margins for 2007. The article doesn't give any projected costs for 2008, but states negative margins are expected.

Looking at what is happening today, the record slaughter earlier this month gives the food packer the pricing power and ultimately the consumer. It only tells me what the packers were paying over xmas, not the change in the price from a month earlier, or a year earlier, but their "farmers math" says that it was an awful xmas for hog farmers and by next fall there will be a major correction to supply and demand that will hit consumers.

The US is in a no win situation. The Crammers of this world can scream about the need to lower interest rates, but that rapidly devalues the currency and dramatically increases input costs and hence inflation. The highly understated, manipulated, reported inflation came in at 4.1% for last year. When you consider the first 6 months did not show any significant increase, well it means inflation was considerably higher for the second half of the year. This was easily predictable from the devaluation of the US dollar. I did a very short post on the Canada/US effects from one day of devaluation. The US dollar devaluated relative to most currencies, significantly, and the price increases simply have not worked their way into the economy, yet.

There will be no economic stimulation when consumers find that their costs are increasing faster than their wages. There will be no wage leverage of workers when those not laid off are feeling grateful they still have a job when they see co-workers being let go. There will be no wage leverage when employers find themselves with 10 resumes for every job they offer.

Historically lower interest rates stimulate the economy in three ways:

1) By enabling people to reduce their repayment debt burden by refinancing and either enabling them to pay back debt faster (which foolish consumers did not do) and enable them to get out of debt sooner. Consumers with no debt have significant buying power and consumer choices.

2) Keep payments the same and increase disposible income now immediately stimulated the economy with more spending, but does little to increase financial security and tends to lead to living beyond one's means if it is all spent and none is put towards financial security. It is dismal is all is spent on option 3, which is what masses of Americans did.

3) Borrowing beyond ones means, which is what happened in masses. The average debt load has increased by one times the average wage in the US over the past 5-6 years. This option no longer exists from lowering interest rates as risk was not priced into this lending. The gross level of living beyond one's means was not immediately apparent, but is quickly becoming very apparent.

Today only options one and two exist and given that Americans were spending 30% more than their income over the past 5 years, the non-existance of option 3 means there is no longer stimulation from lowering interest rates. The only thing it can do is help people convert their debt to that which will not increase their burden down the line.

The inflation from lowering interest rate may very well make the lowering of interest rates more harmful than if they just left them because the inflation will likely be far greater than any reduction in interest burden.

The coming food squeeze in pork is but one example.

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