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How Expensive is the Food for Food?


Fundamentals, not speculators, drive market.

I want to share my opinion in answer to a few questions I've received about the increased margin requirements imposed by the Chicago Mercantile Exchange (CME) for crops of agriculture futures.

This is one of a few tremendous clues in March alone to solve the mystery of whether or not our long positions in a worldwide food fight are in jeopardy. You don't get a much better test than removing certain speculators from bidding (increased margin requirements) combined with relentless efforts to control prices (crippling export taxes for farming countries).

There is true confusion in many markets right now. According to anybody I heard explain it, the announcement should have caused a violent sell-off of agricultural futures. And the Dow Jones-AIG Commodity Index is actually up on the week as I type this.

Make no mistake, the reduction in credit lines will affect all markets - levered longs in agricultural included. I've said since January I believe when this period ultimately gets written about, the stories of over-margined "smart money" will trump that of any group of over-mortgaged homeowners.

Looking Through a Different Lens

For some much needed perspective, two pictures can speak loudly on the topic of just how high we went, and now how far we've fallen. Historically, in a 40+year inflation adjusted chart of Soybeans (to name one of many examples that look just like this) the bubble gets harder to find.

Click to enlarge image

As for the much needed and severe correction in the price of most commodities this month, below is the "historic reversal" in that Bean. In this case all the way back to levels unseen since - January 31, 2008.

Click to enlarge image

Commodity prices have additional pressure from a growing roster of farming countries. Argentina, for example, imposed major export taxes in an effort to keep supplies at home to combat soaring food costs. Naturally, a crop growing even faster -- capitalists -- rioted because they want to sell at the highest price available. We'll stand by our ridiculous -- at the time -- prediction of four years ago that now seems unfortunately safe: we'll see more domestic fights over food than oil.

In the U.S., food costs rising a few percentage points in a year is a big deal. In some countries, spikes are far higher and are a life or death deal. Fertilizing those crops is costing a few percentage points more every couple of weeks. We're seeing new contracts being signed that add 50-60% -- or more -- to prices from just one year ago. I remain long this "food for the food."

CF Industries (CF), Mosaic (MOS), Agrium (AGU), Potash (POT), and Terra Industries (TRA) are the candidates to consider. I've written about these ever since Minyanville added this funny looking farmer to its roster. For those able to trade in foreign markets, it becomes even more interesting when you can locate a fertilizer plant right next to substantially cheaper natural gas - which is the primary input cost to manufacture this stuff.

If commodities are now a busted bubble then it will be breaking 250 years of history. If this bull dies now, it would be less than half way toward average CRB price moves and one-third the duration of the prior six major bull markets. That data excludes the fact that in none of those periods did I find a few billion new capitalists to feed.

Yes, some agricultural commodities and stocks have every reason in the world to sell off - and they did. But the action afterwards has thus far been even more striking. I've been in the minority in believing that at least in the agricultural space, this is not a rally based on dollar weakness or speculation. Although those factors have certainly played a role, the view through most of my lenses indicate that strength is based on demand and one other factor hardly ever discussed next to explanations of the rally - supply.

Perhaps still a misunderstood piece of this puzzle is acreage, so I thought I'd share some terribly simple perspective. The swelling demand for beans and wheat, just to name two, is matched up against a supply from U.S. farms that was planted on about 10 million fewer acres than just ten years ago. Now that's some food for thought.
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Position in Soybeans, CF, POT, MOS
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