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The Rising Cost of Farming


There is rioting in the streets of developing markets running short on food and debates in the U.S. from those running short on votes.

Yesterday Starbucks (SBUX) raised U.S. prices on coffee and other drinks by an average of 9 cents a cup. The only surprising part of this press release to me was that the company still serves coffee.

When I go to a Starbucks and order a regular coffee I always feel like I am at a chic club and the music stops. Undaunted, I always add my own milk at the side table, and now I know why it's kept in those bullet-proof steel containers. When asked "Do you want room for milk?" I say, "Sure."

Of course this means I have to pour out a little coffee into what must be the most attentive garbage in the world because nobody ever gets room for milk. Heck, I hardly have room for a wooden stick and a pack of sugar. And since lumber and sugar are the only two agricultural commodities that have fallen in price over the past 12 months, why don't we call it even? There are about to be a lot more serious questions than mine that finally get asked about what we have done to the food chain.

Dairy Farming

I learned how to drive as a kid by sitting on a tractor with my grandpa as we circled his friend's dairy farm, hearing stories about how tough that business was. That farm is long gone, closed for business years ago along with plenty of others. They wouldn't believe their eyes today. I spoke to my buddy this week, a grains broker, who explained that dairy farmers are being paid about $21 per hundred pounds of milk. This time last year they were fetching around $11. The gradually shrinking supply here pales in comparison to the historic drought taking place in Australia, one of the world's largest dairy sources.

Supplies drying up would have been enough to see milk and cattle prices rise, but then their own pails of feed started climbing – all at the same time that global demand was relentlessly growing.

One customer sitting on the other end of that near-doubling in price is Dean Foods (DF), the largest milk producer in the world. A few months ago it explained how its costs were soaring, which has taken its stock down since then, inside an overall stock market that is up during that same period of time.

I wrote in Minyanville before the summer started that by the end of it, the dinner table discussion would turn from gasoline prices to dinner prices. At that time, speculation about skyrocketing energy costs could be found everywhere, from the commodity pits to the mats of play groups in the shadows of their mom's SUVs - so that was almost impossible to consider. Since the start of summer, the price of a gallon of gasoline is down. Yet, I paid almost twice as much this week for a gallon of milk.

There is a historic war just now lining up between drivers and eaters. Several million want to fill their tanks, a few billion need to fill their dairy cows. With the first discretionary Rupee, Yuan or Peso in hand, most folks want their first square meal before they worry about four wheels. There is rioting in the streets of developing markets running short on food and debates in the U.S. from those running short on votes.

We tainted the food chain with ethanol subsidies, but there is no recall in sight. My prediction is that soon we will no longer wonder about taxing the big oil companies for windfall profits from free markets. Instead, we will wonder why our own tax dollars are being used for subsidies sent to farmers that cheat free markets. I'll hold the rest of my opinions on the economics of ethanol – as a hint, I was quoted earlier this year as saying "I'll wear a Cornhusker hat to a Longhorn rally if we look back in three to five years and say ethanol was a tremendous investment opportunity." I think there is a better trade. Politicians and food producers are scrambling and bidding for the same crop – corn.

Picks and Shovels

For both right and wrong reasons more corn is going to be grown. As a money manager, I believe we can use a page from a playbook that worked the last time there was a gold rush like this. Before dying in 1889, Samuel Brannan taught us the real money was in the picks and shovels not the gold. He bought every shovel in and around San Francisco before running through the streets screaming, "Gold, Gold, Gold!"

Possible Picks and Shovels for this mad dash include the fertilizer needed to plant the crops, which comes from nitrogen produced by, among others, Terra Industries (TRA) and Agrium (AGU). Somebody has to ship the fertilizer to the farmers with little spare capacity. Dryships (DRYS) is among a small list of dry bulk shippers. Then those crops have to be irrigated, which Lindsay (LNN) can do. The referees of the battle royale are screaming on the floor of the Chicago Mercantile Exchange (CME), milking bidders from both sides for a little commission.

There are tremendous risks in this group as it crosses more Wall Street radar screens and the price action will be volatile. My greater fear is for the average consumer and that they are going to be surprised when they get what they thought they wanted - the beauty and the beast of democracy. Their gasoline costs are being trumped by the drive-through window. The best way to see this is watch the next time someone in line at a Starbucks orders a latte, which they are paying over $1,800 a barrel for. They'll likely say thank you, just before turning on the radio in the car and nodding in agreement that energy costs too much. Could they be sipping on a bigger problem?
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Position in TRA, DRYS
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