2008 :

Global Markets – 2nd quarter 2008 : Food prices in crisis

Did you read the article titled “World Food Riots Spread” that was published in the Business Times in April? We found it enlightening and rather disturbing.

The article confirms that global leaders have been raising serious concerns about the food crisis for some time…

Wheat prices have risen from $1000/ton to $4000/ton over the 6 years that Australia (one of the main wheat producing countries) has experienced severe drought conditions.

Trevor Manual’s reaction to this crisis has been “don’t panic” as he believes that “the poor should protect themselves with subsistence agriculture.” A perfect solution in theory - but as the article correctly points out neither Zimbabwe nor South Africa has ever had much success in this area.

A critique of the Business Times article states that “the ANC government has not spent much money on training this new generation of farmers. In fact they have failed dismally. A local agricultural college has to rely on overseas funding for its very existence.”

The secretary general of Cosatu’s reaction to the crisis was to suggest a series of “protests” [rolling mass action?] to force “negotiations” between farmers, the food processors, the retailers and the government on this issue. Trevor's response was to say that while he supported the right of workers to engage in legal protest, he cautioned that campaigns such as Cosatu’s needed to be focused on credible goals and should not undermine the economy on which everyone depends.

The topic of input costs was also addressed, highlighting specifically the record oil price and the far-reaching effects that this is having on food prices globally. Key input costs for our domestic farmers and producers (e.g. fuel and fertilizers, etc) have increased by some 50% over the last year. Add to that the proposed 53% increase proposed by Eskom, and we have a clear sense that the trend of rising food prices (especially here in South Africa) is likely to remain a reality for some time to come.

REGIONAL COMMENTARY UNITED STATES OF AMERICA

In a surprise move, the Federal Reserve cut interest rates by 0.75% in March. A further cut of 0.25% in April reduced rates to 2% - the seventh rate cut in as many months (from 5.25% in September 2007). Commenting after the announcement, Michael Woolfolk from the Bank of New York stated that “the Fed was somewhat more dovish this time and they can easily go both ways from here.”

Growth in the first quarter came in ahead of expectations, at an annualized rate of 0.60%. This is marginally better than the 0.58% recorded during the last quarter of 2007. The economics editor for the BBC, Stephanie Flanders commented that “the fact that today’s GDP figures showed positive growth in the first quarter offers some grounds for hoping that the US will not see two quarters of negative growth this year, at least if the fiscal stimulus package works
as intended and boosts spending over the summer.”

The Federal Reserve recently revised their 2008 growth forecast down to between 0.30% and 1.20% from a previous forecast of between 1.3% and 2%. The minutes from the latest meeting of the Fed also highlighted that the Fed remain concerned about inflation. They stated that “although downside risks for growth remained, members were also concerned about the upside risks to the inflation outlook, given the continued increases in oil and commodity prices.”

EUROPE

Interest rates remained unchanged at 4% during the quarter under review “as concerns about inflation outweigh evidence of slower economic growth.” Food and energy costs (currently the primary drivers of inflation) are likely to continue putting upward pressure on inflation in the region. Increasing concerns that economic growth could stall have resulted in critics calling for rates to be cut. However, according to the Bank of America’s chief European economist, Holger Schmieding, “while the US economy has succumbed to stagnation and the UK economy is decelerating sharply, the eurozone has so far held up fairly well.” Gavin Friend of Commerzbank has indicated that the ECB is likely to “keep the door shut for possible rate cuts in the foreseeable future.” Inflation is currently at 3.5%, which is well above the target of 2%.

The Euro has remained strong due to interest rates being kept on hold in the Eurozone while rates are being cut elsewhere. The Euro has reached record highs against the Pound during the quarter.

UNITED KINGDOM

Rates were reduced by 0.25% (to 5%) during the quarter under review. While no changes were made at the May meeting of the Bank of England (BoE), analysts do expect rates to be reduced by a further 0.25% in June.

Commenting after the latest meeting held by the BoE, Steve Radley of the EEF stated “further cuts to interest rates are needed to prevent the economy from drifting towards recession. The economy has been through a series of shocks since the credit crisis hit last summer and the Bank has been right so far in responding with a measured approach on rates.” According to the chief economic advisor to the CBI business group, Ian McCafferty, “the latest data shows the economy is slowing, albeit only gradually, and at the same time inflationary pressures continue to mount.” Economic adviser to Deloitte, Roger Bottle, is of the opinion that by the MPC not cutting rates at their latest
meeting in May, they risk “presiding over the deepest and longest economic downturn since the recession of the early 1990s.” He is of the opinion that interest rates would need to be reduced to around the 3.5% level (or perhaps even lower). However, his concern is that by the time this is done it may be “too late to prevent the economy from flirting with recession.”

Inflation remains stubbornly above the 2% target level. In commenting on the outlook for inflation, governor of the BoE, Mervyn King, has indicated that this has “deteriorated markedly”. Inflation is now at its highest level in 13 months and is expected to remain above the target level possibly over the next 2 years. He added that this is likely to cause house prices to deteriorate further.

The MPC now face the difficult challenge of slowing growth, with rising inflation. A recent BBC article commented on a recent address by Mervyn King stating that “he explained that if the Bank kept rates where they were, then the outlook for growth was dismal and the UK could be tipped into recession. If it cut rates, then its credibility as a crusader against the wickedness of inflation could be severely damaged, especially as it expected inflation to be well above target later this year.” The governor has also stated that “we are traveling along a bumpy road as the economy rebalances. Monetary policy cannot and should not try to prevent that adjustment.”

JAPAN

In line with expectations, interest rates remained unchanged at 0.50%. The Japanese economy grew by a reported annualized 3.3% in the first quarter of 2008, which was significantly better than market expectations. It is reported that, despite a slowing demand from the USA, demand from China and India have remained strong. However, analysts have cautioned that Japan is unlikely to escape the general slowdown being experienced by the global economy. According to the chief economist for the Norinchukin Research Institute, Takeshi Minami, “the strong growth suggests that there may be a backlash in the April-June quarter.” He believes that “exports hold the key to Japan’s economic outlook. An export slowdown would squeeze corporate revenues and keep companies from raising much profit.”

Despite the strong growth recorded in the first quarter, the Bank of Japan (BoJ) has revised its growth forecast down to 1.5% for the calendar year to March 2009 (from 2.1%) prompted largely by an increasing slowdown in USA demand for Japanese exports. It is reported that during the first three months of the year, exports to the USA declined by 11% - representing the largest quarterly decline since 2004. Commenting on the revised growth forecast, the new BoJ governor Masayuki Shirakawa stated “looking forward, the slowdown phase will continue in the near future. However, we see a high possibility that (Japan’s economy) will remain on a path of gradual growth.”

SOUTH AFRICA

The Prime Lending Rate and the Repo Rate were increased to 15% and 11.50%, respectively during the quarter under review. Global analysts, Lehman Brothers, expect domestic rates to increase at both the June and August meetings of the Monetary Policy Committee (MPC). These comments follow their review of the Monetary Policy Review released in mid May. The outcome of the proposed Eskom tariff decision on the 6th June may well impact on their view, depending on how the Eskom tariff increase is to be implemented.

The South African economy has faced a series of challenges in the last few months. Perhaps the most challenging and far reaching has been the Eskom debacle which has impacted on consumers and business alike. Political uncertainty, together with a fast changing political landscape, has affected sentiment. Double digit inflation (driven primarily by rocketing food, commodity and fuel prices) has started to influence consumer spending patterns, the effects of which are being felt by business. Consequently debt levels are also high. First quarter GDP came in at a disappointing annualised 2.1%, compared to 5.3% in the last quarter of 2007.

Inflation remains a cause for concern. The Monetary Policy Review released in May reflected the concern by the South African Reserve Bank about inflation expectations in that they “no longer appear to be anchored within the target range over time.” At a recent presentation Dr Cees Bruggemans indicated that, while it was not possible to accurately predict the level at which inflation would peak, his view was that CPIX inflation could rise to 12% (or more) within the next 3 to 6 months, from current levels of 10.4%. Citing reasons for this view, he touched briefly on the pending Eskom price adjustments, but was a lot more focused on the impact that sharply rising food and commodity prices could have on this number. Tito Mboweni, governor of the Reserve Bank, again gave his assurance to consumers in the recent Monetary Policy Review, confirming that he would do his utmost to bring inflation back to within the target band “come hell or high water”.

It is interesting to note that in a recent survey of Eskom employees by trade union Solidarity “about 94% of employees are of the opinion that the company is not doing enough to retain skills.” Furthermore, “according to the employees, the high levels of unplanned maintenance are the result of inadequate preventative maintenance, poor planning and a lack of skills, as well as wrong appointments and incompetence.” The survey found that “Eskom management is accused of being incompetent and incapable of proper planning.” The report noted that “72% of Eskom employees were thinking of leaving the company.” Commenting on the report, Solidarity deputy general secretary Dirk Hermann, stated that “if the employees carry out their threats to leave, the company may be facing an even greater crisis than the one in which it already finds itself. Eskom should come up with an urgent plan to ensure loyalty in its labour force, to appoint competent staff and to offer better pay and fair opportunities for promotion.”


OIL AND GOLD

The oil price continued its upward trajectory during the quarter, testing new intra period highs. Concerns about supply continue to drive the price, together with the fact that OPEC appear to have an unwillingness to increase output from current levels. It is reported that OPEC do not share the opinion that high oil prices are being fuelled by a shortage in supply, but rather by “speculation, a weak dollar and geopolitical problems.” OPEC are not expected to meet before their scheduled meeting in September and there is now speculation that they are unlikely to increase output at that stage. Continued violence and unrest in Nigeria have also raised renewed supply concerns from the region. A recent article confirms that “a recent spate of attacks and sabotage have shut in about 559 000 barrels per day of Nigerian production, about 19% of the installed output capacity of around 3-million bpd….”

Economic growth and development in both India and China continue to be the driving forces in the demand for oil. In addition, the “summer driving season” is about to commence in the USA, which will add to current demand levels. Goldman Sachs recently released a report by their energy strategist Argun Murti warning that “the price of crude oil could reach $200 a barrel in as little as six months.” Three years ago this same analyst predicted that oil would reach $100 a barrel – at a time when oil was priced at $55 a barrel. Economists are concerned about the long term effects that a sustained and a continuous rise in the oil price will have on global growth and inflation. The oil price ended the quarter under review at $128.16 a barrel.

The gold price lost some of its shine, retreating back to $885.80 an ounce from the $970.90 an ounce at the end of the previous quarter.


CONCLUSION

We are pleased to confirm that Old Mutual Investment Group of South Africa will be presenting to our clients at the Redlands Hotel on Thursday, the 26th June. The seminar will start at 17h00 for 17h30 - invitations were mailed out on the 26th May. Should you wish to invite a guest, kindly let us know before the RSVP date detailed on the invitation.