Sarasin and Partners reviews commodity prices for RL360

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Four frogs and a fridge

In 2012, the US experienced scorching temperatures and the worst drought in over 50 years, withering crops, sending soft commodity prices spiking higher and prompting headlines of a new global food crisis.



In contrast, the outlook this year is for a strong harvest from many of the major farming regions of the world and crop prices have settled back from their highs. In times of drought or other threats to food supplies, it is inevitable that fear of famine rises and people start to speculate on a Malthusian future in which there is insufficient food to go around. Since Thomas Malthus first wrote about the “inevitable famine” in the early 19th century the world has seen remarkable increases in food production. So should we worry about the annual volatility in harvests and crop prices, or should we pay attention to the raft of other, more subtle and long-term trends affecting the global food chain?


The Victorians had a helpful metaphor for describing slow-moving trends: the ‘boiling frog’. If a frog is placed in hot water, the theory goes, it will immediately jump out. But if it is placed in cold water and then slowly heated, it will not recognise the danger and will ultimately be boiled. We haven’t attempted this experiment, but the idea does capture rather well the way in which people often struggle to recognise or react to very gradual changes in their environment.


For the global food chain, the first gradual change – the first frog if you will – is the steady increase in the World population. In 2011 the number of people on the planet passed 7 billion for the first time. This is double the amount in 1970 and the number of mouths to feed keeps growing each year by about 70 million. Most of this growth is coming from large developing countries such as India and Nigeria (China’s population, though very big at over 1.3 billion, is not growing).


The second frog is the gradual improvement in incomes and living standards across the world. Studies from the OECD Development Centre, the IMF, McKinsey and others suggest that up to 3 billion more “middle class” consumers will emerge in the next 20 years. The growth of the emerging markets, led by the enormous populations in India and China, is happening at about 10 times the speed at which the UK increased average incomes during the industrial revolution, and at about 200 times the scale. For many consumers, this increase in wealth allows an improvement in diet: meat and fish are consumed more regularly, new fruits and vegetables are introduced into the daily diet, demand for processed and branded food rises and eating out at restaurants becomes more popular. In this process the value of the food economy increases but more volume of food is also required: producing a kilogram of pork in a modern piggery in China, for example, requires feed of about four kilograms of soybeans and other grains.


At the same time, there are also ‘frog trends’ affecting the supply of food. Monsoon and other rainfall patterns are changing, and the average temperature is rising. Meanwhile, land itself is in short supply but the scale of changes in land use also tends to slide under the radar. According to the UN Food and Agriculture Organisation, the UK has lost around 10% of its arable land since 1990.


These boiling frog trends, gradually building demand for food and constraining supply provide an inauspicious background to last summer’s US drought. Political leaders have long since realised the importance of securing a sustainable food supply for their populations, and panic stock-piling or export bans by governments can greatly exaggerate the impact of a drought. Indeed, we’ve come a long way since Joseph, in his technicolour dream coat, advised Pharaoh on grain stock management: a wide range of stockpiling systems, trade tariffs, restrictions and subsidy programmes now exist (farmers are often key swing voters), adding considerable complexity to the global impact of a food supply shock in one region.


Crucially, relatively little US corn production goes to feed people directly: over 80% is used for industrial purposes, animal feed and biofuels (like ethanol) for cars and trucks. The spike in prices has led to expectations that demand from most users will fall, but ironically there is little flexibility for demand to be cut back in ethanol production, as under the US government’s renewable fuel policies there is a mandated minimum level of ethanol that must be blended with gasoline. Over the last year, 4.5 billion bushels of corn were processed into ethanol under this programme; to give an idea of scale, that corn could have fed an estimated 140 million people for a year. Unsurprisingly, there are demands from many sources to remove the US Renewable Fuels Standard if the rise in US corn prices causes food price rises for the poorest people in the world. Jose Graziano da Silva, the director-general of the UN's Food and Agriculture Organization (FAO) has called on nations to reduce biofuels consumption: "We need to review and adjust, where applicable, policies currently in place that encourage alternative uses of grains". Rice and wheat are both more widely consumed than corn as a staple foodstuff, and a severe extended supply disruption in China or India – the number 1 and 2 producers of both commodities – would be much more concerning from a food security point of view (between them they produce more than three times as much wheat as the US).


So the fourth frog trend is the gradual upgrading in the productivity of agriculture in the developing world. Most emerging countries experience large losses in the food production process and, with both education and significant investment, there is scope for further improvements in the efficiency of the food chain. Building new storage facilities and transport links is part of a wider pattern of investment; improvements in water conservation, better seeds, fertiliser use, crop protection, machinery and enhanced farming techniques are all enhancing productivity. Whether this is enough to cope with the dramatic increases in demand is the key question and a major drought outside the US remains a really critical threat to food security.


This brings us finally to the fridge. The gradual improvement in emerging market infrastructure is not just a matter of new roads, railways and ports: new electricity supplies can have the most remarkable impact. A fridge requires a stable electricity supply and makes an extraordinary difference to how much and what kinds of food people buy. It allows a consumer to store perishable items and to succumb to the luxury temptations of meats, dairy products and fizzy drinks. The Chinese government’s 2009 programme to provide rural subsidies for domestic appliances led to refrigerator ownership in rural areas rising from 30.2% to 61.3% by the end of 2011. In Africa, electricity grids in several countries like Ghana are stabilising and fridge sales are rising, allowing supermarkets like South Africa’s Shoprite to open new stores and access new consumers. In short, a proliferation of fridges automatically multiplies the volume and the economic value of the food chain many times over.


So, while the prices of basic food crops will rise and fall every year depending on the weather, the boiling frog trends point to a more substantial and long-lasting economic change in the food chain - the increasing value of the food being sold as diets change. Investment is being attracted to the opportunities that are available from an inflating sub-economy in a deflating macro-economy.


Henry Boucher

Deputy Chief Investment Officer at Sarasin & Partners and manager of the Sarasin AgriSar fund
July 2013

Please note that these are the views of Henry Boucher, Deputy Chief Investment Officer at Sarasin & Partners and manager of the Sarasin AgriSar fund, and should not be interpreted as the views of RL360.

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