By Priyanka Sachdeva, Senior Market Analyst, Phillip Nova
The cost of food staples like wheat, rice, dairy, and poultry was on a flight well before Russian tanks invaded Ukraine. Covid scared the manpower involvement and pushed up the cost of procurement and transportation. The war added to supply chain atrocities and soaring energy further boosted the cost of food on retail outlets. While core inflation might be showing signs of easing across the globe, I wish I could corroborate the same and say the recent easing inflationary downtrend is sustainable. But to my surprise, I am much more inclined towards a rebound in Food inflation than a slide.
El Nino is officially here, the next challenge for the world of commodities! Before it even landed in June, it has started churning commodity markets already! The first half of the year has seen agricultural commodities like sugar, cocoa, and orange juice skyrocketing while wheat and corn had bountiful production in the United States during this production cycle. Commodities have broadly rebounded, putting in higher highs and lower lows for the last 4-6 weeks.
An El Niño condition lasts around 9 to 12 months and occurs when surface water in the equatorial pacific becomes warmer than average and causes climatic changes in the Pacific Rim countries, and warmer weather and droughts in the Asia-Pacific region. El Nino this year is broadly anticipated to damage a wide range of crops globally and bring back food inflation and a larger adverse effect on global growth.
There is an aisle of the grocery store where inflation is looking exceptionally sticky: indulgent treats. In Britain, retailers are locking instant coffee jars in security cases to prevent theft. In Japan, Kirin Beverage Company suspended the sale of Tropicana orange juice because of a shortage. And in Germany, chocolate and biscuit makers complained of soaring sugar and cocoa costs.
Sugar prices reached an 11-year high in April driven by tighter supplies in physical markets, which threatened to core on the news of El Nino. The weather patterns are associated with bringing droughts to Brazil and minimal rainfall to India and Thailand threatening harvest in all key producing zones. According to Reuters, India can extend the sugar export ban till early 2024 as the farmers struggle to fetch enough irrigational water to feed massive plantations. Sugar prices are up 26% year-to-date which should have been cheered by farmers, but sadly this is not the scenario currently.
Cocoa is predominantly the hottest agricultural commodity in 2023 topping charts with over 30% upside swing year-to-date attributed to the unusual drop in harvest from key production regions like Ivory Coast and Ghana which contributes over 70% of global supplies. The intense rains in the Ivory Coast flooded plantations and lashed Cocoa plants causing tiny flowers and cherelles, which were expected to develop and become the first pods of main crop yield between October to March 2024, to fall from trees leaving yield under severe threat. Ivory Coast, a nation whose majority export earnings are heavily reliant on Cocoa produce, has stopped selling contracts for Cocoa exports for the 2023-2024 season, a blow to chocolate manufacturers like Hersey and Nestle.
Robusta bean production is expected to fall by 5% in Brazil, while in Indonesia, the world’s second-biggest Robusta exporter, output is projected to drop by 20%. Admittedly, I know how addictive coffee, sugar and cocoa can be, so expecting some drop in consumption due to elevated prices is just unrealistic. Consumption will likely hold up strong, as they are considered small luxuries that people are unwilling to give up compared to an expensive house loan or travel to a luxury destination.
Orange juice, the popular breakfast drink has seen a spectacular rise since the onset of 2023 and is showing no signs of slowing. Bloomberg estimates show that overall raw materials have fallen by 11% in the first six months of the year and its impressive how orange juice prices have risen over 30% in the same time frame. The resilience of orange juice’s sustained hold over year-to-date gains has forced vendors to forfeit selling Orange juice. Florida, the hub of orange juice concentrate, has been hit by disease and hurricane damage that have pushed prices from $90/lbs at the beginning of 2020 to $305/lbs recently. Concerns of citrus greening disease are hurting citrus crop production in both Florida and Brazil and global supplies are dwindling.
India recently announced an export ban on rice (excluding Basmati) putting over 2 million tonnes of forward delivery contracts in jeopardy. This came against the backdrop of soaring high Thai rice prices, the highest in 2 years. Keeping the drought in mind and the scarcity of irrigational water to support rice plantations, Thai authorities have urged farmers to cut rice plantations to only one crop this year. Due to El Nino, Thailand is facing widespread drought conditions starting early 2024 and this is likely to dampen the production of both rubber and sugar, and could even threaten the nation’s position as the world’s second-biggest supplier of rice.
Russia backed out from the grain deal putting the future of global wheat and corn supplies in jeopardy. The deal brokered by UN intervention between Russia and Ukraine, aimed to help avert famine by injecting more wheat, sunflower oil, corn fertilisers and other products into the world markets, including for humanitarian needs. The deal kept global food prices in check and eased the food crisis. Ukraine, the breadbasket of Europe is snatched away by Russia leaving the globe exposed to malnutrition and food insecurity.
El Nino from 2014 to 2016 was followed by a steep drop in oil prices owing to the abundant supplies from higher shale oil production and OPEC production. This time round, oil markets are entering a deficiently supplied second half of the year due to bans on Russian barrels. Cherry on the top is the producer cartel’s adamance to keep prices elevated by tweaking production capacities. It’s still uncertain to which side the oil coin will eventually flip but my bets are still bullish, pushing the cost of food even more.
El Nino is expected to lead to milder hurricanes in the Atlantic ocean, causing less disruption in the Gulf of Mexico, which would mean oil and gas rigs will not have to close. Liquefied natural gas supplies will be less disrupted alongside milder temperatures in the US which would also mean lesser demand for natural gas to fuel air-conditioning. Meanwhile, the growing scorching heat in Eurozone is just what is needed to offset lesser demand from the US.
Markets seem to be in denial and have been painting a rosy picture of a possible “soft landing” for global economies. While the constantly evolving weather pattern and inter-mingled commodity space dynamics may sound confusing to a layman investor, being on the defensive and informed about developing extreme weather atrocities might help investors mitigate some risks.
We might be able to navigate the recession thanks to lots of stimulus injected by economies. Additionally, it also seems like the FED is nearing the end of its hiking cycle. So markets are thinking that with an end to tightening and no recession, the good days are back but inflation can rebound any day. Energy and soft commodities are playing an undeniable role in putting a rebound in inflation right back to the front and centre.
But if your question is still referring to what will happen to precious metals? Well, if economies can survive a downturn amid rising rates, precious metals that are considered safe-haven can do so too, and are sustaining pretty well. So in all possible scenarios which would eventually lead to FED “cutting rates”, the precious metal will have their time of the day, however, at this point this seems somewhat ambiguous. However, if there is any traction for inflation stepping up and the US Dollar diving, precious metals might just consolidate for some time. If we even have a minor downturn, it can shoot gold much ahead of the record levels. The only downside to the gold rally right now is the optimism and resilience in risky equities that has managed to bind investor interest, despite the atrocities of higher borrowing cost, shaky banking sector, and economic hurdles. In my opinion, it’s possible to have a leg higher in Commodities, ahead of a mild recession and a flight in precious metals.
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