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Jeff Saut: Price Hikes in Food and Energy


When you get these sorts of price increases it is merely a matter of time until they bleed over into prices at the supermarket.


Editor's Note: The following article was written by Raymond James Chief Investment Strategist Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

"A man lived by the side of the road and sold hot dogs. He was hard of hearing, so he had no radio. He had trouble with his eyes, so he had no newspapers. But he sold good hot dogs. He put up a sign on the highway telling how good they were. He stood by the side of the road and cried, 'Buy a hot dog, mister.' And people bought. He increased his meat and bun orders and he bought a bigger stove to take care of his trade.

He got his son home from college to help him. But then something happened. His son said, 'Father, haven't you been listening to the radio? There's a big depression on. The international situation is terrible, and the domestic situation is even worse.' Whereupon the father thought, 'Well, my son has been to college. He listens to the radio and reads the papers, so he ought to know.' So, the father cut down his bun order, took down his advertising signs and no longer bothered to stand on the highway to sell hot dogs. His hot dog sales fell almost overnight. 'You were right son,' the father said to the boy. 'We are certainly in the middle of a great depression!'" (Author Unknown)

I recalled the aforementioned story as I got off of the plane at LaGuardia last Monday and sauntered up to a hot dog stand. I said, "One hot dog, please." The vendor said, "That'll be $3.49." I said, "Isn't that a lot for one hot dog?" He said, "Just wait until next year!" After climbing into a cab and heading for Manhattan, I warped into my email and the hot dog vendor's comments became clearer. One email read:

"I bought the last 140 bales of hay in Hume this morning. The hay people in Pennsylvania are out, the hay people in Ohio are out and the Maryland people have been out for a while. The cattlemen are worried because the Rappahannock and the Jordan rivers are dried up, as are most of the ponds. We will have cheap steaks as they take this year's cattle to slaughter and expensive steaks next year. We really need rain. Water is a valuable commodity, just in case you didn't know!"

With that, I looked at gain prices y/y only to find corn up 40%, soybeans up 50%, and wheat surging 67%. Upon arriving at my hotel, I called the ex-CEO of a major meat processor that I used to cover as a research analyst. "Joe," I said, "What's going on with the price of grains and the meat processing business?" His answer was succinct:

"So far the explosion in grain prices hasn't really fed through into the price of meat because we have had commodity hedges in place, whereby we bought corn for future delivery when prices were low. However, those hedges are now expiring and nobody, but nobody, can feed a hog and bring it to market profitably at $0.70 a pound with corn above $3.00 a bushel. Consequently, it's just a matter of time until we get a big upside move in meat prices as they have already seen in China (food prices in China account for over one-third of the CPI, but here they are only 14%)."

Disingenuously, however, the US government excludes food and energy in the nation's "core" inflation statistics because of their alleged "short-term" volatility. But consider this: Since August of 2004 crude oil has averaged well above $50 per barrel. Surely three years is long enough to admit that maybe, just maybe, high oil prices are here to stay and ought to be included in the CPI, a point well argued in last Wednesday's Wall Street Journal. Speaking to grain prices, while their price rise is only a year old, it is hard for me to envision that higher food prices are not permanent as well. Indeed, when you examine the Producer Price Index (PPI) you find that the raw food component was up 25% in April and up more than 30% in May. Ladies and gentlemen, when you get these sorts of price increases it is merely a matter of time until they bleed over into prices at the supermarket. I think you are going to see this trend increasingly reflected in 4Q '07 and continuing for the foreseeable future.

For the last six years I have been an energy "bull" and remain so even though I think in the short-term that money flows, seasonality, and tough earnings comparisons are likely to provide a challenging backdrop for energy stocks over the next few months. Likewise, I have been an agriculture "bull" since Bunge Corporation (BG) and Potash (POT) were "teenagers" and Caterpillar (CAT) sported a 5% dividend yield. Unlike energy, however, I don't think the next three to four months will prove difficult for the agriculture complex.

Manifestly, I believe that we are in the early stages of the greatest agricultural bull market in history. Even the government's understated inflation figures suggest this could be the case as food inflation is rising at its fastest pace in 15 years. As these increased cash flows accrue to the farming complex, spending on farming equipment, irrigation gear, fertilizer, etc. should continue to rise.

What I am, and have been, suggesting is that the disinflationary environment of the last 20 years is in the "rearview mirror" and inflation is on the rise. How high it rises is unknowable, but it is plain that the pillars suppressing inflation for so long are eroding. And maybe that is what the markets sniffed out last week, for seemingly simultaneously, participants sold the U.S. dollar, which broke to new reaction lows, and/or converted their U.S. dollar cash reserves to stocks, commodities, base/precious-metals, art, farmland, etc. Even bonds rallied (i.e., lower long-term interest rates), which is pretty strange since it is difficult to find any instance where investors made money buying bonds when agriculture prices were strong. The result left most of the major indices I follow on upside breakouts to new all-time highs. Over the past few months I have suggested this might be the case, often noting:

"As for the equity markets, last week's holiday-shortened environment still saw stocks traveling higher. And, while participants should typically be cautious of drawing conclusions from such a low-volume, holiday-interrupted environment, last week's action was impressive. 'Impressive' because stocks rallied despite a rise in the 10-year Treasury yield from 5.03% to 5.19% as the Bank of England raised interest rates for the fifth time this year to a now 5.75% rate. 'Impressive' because the D-J Transports gained 2.6% for the 3½-session trading week despite crude oil's 3% weekly gain to a 10-month high of $72.81.

'Impressive' because crude oil continues to trade higher while natural gas continues to trade lower. 'Impressive' because private equity firms continued to pay some pretty fancy multiples for public companies. 'Impressive' because . . . well just plain impressive! The result left most of the indices we follow higher for the week and us with a short-term 'buy signal' on the S&P 500 (SPX)."

Speaking of upside breakouts and buy signals, General Electric (GE) tagged a new reaction high last week, as did Intermec (IN), NII Holdings (NIHD), and Covanta (CVA), to name but a few of my recommendations. For the ETF/closed-end fund crowd, Thai Fund (TTF), PS Water Shares (PHO), and PS Aerospace & Defense (PPA) continue to perform well. As for my numerous recommendations in the open-end mutual fund arena, in addition to many of the Quaker Funds, Pimco Funds, Ivy Funds, MFS Funds, etc., confidence in my newest addition, the MFS Sector Rotational Fund (SRFAX), was bolstered last week by a great article in last Thursday's Wall Street Journal titled "Asset-Allocation Funds May Help Returns." The gist of the article noted that, "Investors are likely to hold asset-allocation funds substantially longer than either equity or fixedincome funds, the 20-year analysis showed." And don't look now, but my position in the MFS International Diversification Fund (MDIDX) is up 14.82% for the year sans commissions.

The call for this week: I'll say it again; I am having one heck of a year, not because I have been so prescient on the major market indexes, but due to stock picking. And even though I have been too cautious on the major averages due to their optimistic valuations, last week's upside breakout of the potential triple-top by the S&P 500 reinforces my continuing mantra that, "the upside should be given the benefit of the doubt." Indeed, back in May with the Wilshire 5000 (WILL) at 15300, I stated that the Wilshire's price objective was 16000 and evidently the "bulls" that live by the side of the road are listening and not paying any attention to the bear growls.

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