Gold Investors Taking Note of 'Agflation'

Rising world food prices are beginning to capture the attention of the news media and soon could be one more factor lifting gold prices higher.

According to the United Nations, global food prices rose 5% in August - and food price pressures will likely continue well into next year.

Although drought-related shortages and other supply/demand factors explain a good part of the current wave of agricultural inflation, US monetary policy - and the dollar's shrinking purchasing power - is also an important factor. Simply put, many internationally traded commodities priced in U.S. dollars are rising in price because America's central bank is debasing its currency.

With interest rates so low and stock-market prospects so uncertain, some speculators are betting that grain and other agricultural prices will go higher and their actions on futures markets are aggravating the rise in physical market prices around the world. This is one channel through which US monetary policy and excess liquidity affects commodity prices.

Agricultural experts and economists are focusing their attention on the Russian grain harvest and prospects for next year. Early this month, Prime Minister Vladimir Putin said that Russia's month-old ban on grain exports would be extended well into 2011 as a severe heat and drought, the worst on record, across the country's grain-producing region seems likely to cut this year's harvest by 25% to 35%.

Russia is the world's third-largest exporter of wheat after the United States and Canada - and the ban on grain exports is pushing the cost of wheat and other grains sharply higher in world markets. In addition, flooding or droughts in other important farming regions are raising more doubts about agricultural output in a long list of countries including Germany, Canada, Argentina, and Australia. Even across the United States we are seeing a rise in corn and grain prices due to the pervasive heat and dryness in recent months.

The rapid rise in agricultural prices has prompted concerns about food shortages in some of the developing economies that rely heavily on imports. Violent riots last week in Mozambique - triggered by a 30% rise in local bread prices - is a reminder that rising food prices or shortages can trigger political instability ... and political instability can fuel local gold demand.

Meat prices are also surging around the world, in part reflecting drought and rising feed prices - but also due to the longer-term trend of rising demand from a number of emerging or newly industrialized nations. With rising personal incomes, the growing middle classes in countries like China, India, Brazil and a number of other nations are demanding richer protein Western-style diets.

The United Nations Food and Agricultural Organization (FAO) just reported that world meat prices were up 16% in August from a year earlier to their highest level in two decades. Add to the list of inflating food commodities coffee and cocoa. Coffee is up about 30% this year and now near a 12-year high. Cocoa recently hit a 33-year peak, thanks to poor crops in the Ivory Coast, a run-down in inventories last year, and - like coffee - rising demand from the increasingly affluent emerging nations.

It's not just food prices that are rising down on the farm. Cotton prices last week high a 15-year high ... and are threatening consumers with higher clothing prices around the world. The International Cotton Advisory Committee, an intergovernmental agency, said recently that cotton prices could rise 15% in the year through next July 31st.

Rising agricultural prices are already showing up in America's supermarkets ... and in grocery stores around the world. But in the United States, thanks to the way we measure consumer prices, the U.S. Bureau of Labor Statistics consumer price index will not fully reflect the actual increase in food prices.

Instead, it assumes consumers will substitute cheaper choices for more expensive items (pork sausage for sirloin steak, for example) and then it increases the index weighting of the less expensive substitutes and decreases the weighting of the higher cost goods and, poof, the reported CPI inflation rate isn't as bad as the true but unreported rate.

You can fool some of the people some of the time - but you can't fool gold investors for long, not in the United States nor around the world.

It's only a matter of time before high and rising agricultural prices around the world trigger inflation-hedge demand for gold and contribute to the rise in prices we anticipate in the months ahead.

One more relevant point: India has traditionally been the world's largest gold-consuming nation and India's farmers and agrarian workers are often at the front of the line to buy gold jewelry, small bars, and coins. In years of good harvests, high agricultural prices, and robust farm income, India's appetite for gold is strong. This year, India has seen good monsoons, is enjoying healthy harvests, and farmers will benefit from higher world prices for much of their output.

Consequently, stronger Indian gold buying in the next few months could give the yellow metal's price a surprising boost.

Jeffrey Nichols, managing director of American Precious Metals Advisors and senior economic advisor to Rosland Capital, has been a precious metals economist for over 25 years.

About the Author
Jeffrey Nichols

Jeffrey Nichols, managing director of American Precious Metals Advisors and senior economic advisor to Rosland Capital, has been a precious metals economist for over 25 years.

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