Why food will cost you more in 2008

Why is Christmas dinner in the news?

Because it's getting more expensive. The British Retail Consortium says the cost of ingredients for a turkey and trimmings lunch is up around 14% on last year.

It's not just Christmas dinner; the average UK family spends about £750 more a year on food now than it did 12 months ago. Examples of soaring prices abound basmati rice is up around 180% this year, while wheat has risen more than 143% since April to a level the UN describes as "the agricultural equivalent of $100 a barrel oil".

Yet, as The Economist points out, record prices for many cereals are coming "at a time not of scarcity but abundance". Until quite recently, most of the world enjoyed falling food prices. As the UN's Food and Agriculture Organisation (FAO) notes, even though the global population has grown by 38% between 1986 and 2000, food production rose by about 50% over the same period.

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In fact, the International Grains Council declared this year's global cereals crop to be the largest on record, defying fears about the impact of recent droughts and floods.

So why are food prices rising?

Supply is not the problem it's demand. Economic revolutions in countries such as India and China have led to the emergence of a new Asian middle class who can afford to eat meat. In 1985, the typical Chinese consumer ate about 20kg of meat per year. Now it's more like 50kg and to produce that quantity of pork, you need anything up to 150kg of grain. And we should be thankful that pork is China's meat of choice a similar portion of lamb or beef can take as much as 350kg of grain to produce.

Is it all down to Asian consumers?

Not at all. Rapid growth in agricultural prices has coincided with a massive expansion of the US ethanol programme since 2005. Many Western politicians believe biofuels are the answer to petrol's two weaknesses its rising cost, due to a spiralling oil price, and its impact on the environment, owing to the toxic gases released when making or burning it.

The problem, as the World Bank notes, is that the grain needed to fill up an SUV would feed a person for a year. Taken as a whole, the demands of America's ethanol programme account for around three-fifths of the global decline in grain stockpiles this year, of around 53 million tons.

Worse, the diversion of corn to create ethanol is having a domino-effect on the price of commodities such as wheat and soyabeans, sacrificed to make way for what The Economist describes as a "jaw-dropping" US corn harvest this year.

So what can be done?

Several options need urgent consideration if the UN's forecast of a 40% rise in food production by 2030 is to be hit. One is to convert existing land into farms. But this throws up two problems. It will only provide about a fifth of the required food increase; and the implied destruction of natural habitats (much of the suitable land is currently forest) is bad news for the environment.

The other option is to raise crop yields. These, say the UN, could be raised 10%-30% with better irrigation, particularly in India and China. Other options include improved fertilisation and the planting of genetically modified foods. A strain of "golden rice" that contains extra vitamin A and iron and a "supercorn" resistant to weeds and bugs are being developed.

But the use of GM crops is still controversial because fears about new GM-resistant "superbugs" and the long-term health impact of GM food have yet to be quashed. The other big problem is that all of these solutions take time.

Are there any short-term solutions?

Killing the biofuels initiative would help according to Capital Economics, enthusiasm is already waning in some governments, who realise that "upward pressure on energy prices is simply being diverted into upward pressure on food prices".

Then there's the reduction of food subsidies and tariffs. As the FT notes, government tariffs on imports or exports may help the local economy, but they also artificially raise global food costs. Consumers in places such as Nigeria and Bangladesh, where up to 60% of household income is spent on food, are hit especially hard and any benefit they enjoy from subsidised farm incomes is offset by higher food costs.

There is some progress the EU has announced zero import duties for cereal until June 2008 following similar moves from other countries. But there are few long-term commitments to tariff reduction a recent Chinese concession on soyabeans, for example, was more of a quick fix for domestic inflation, now at an 11-year high.

While rising food prices will eventually force us to find a solution, we suspect that next year's Christmas turkey will be even dearer than it is today.

How to profit from rising food prices

JP Morgan Stanley recently described agriculture as the "most recession-proof of all asset classes". For low-cost exposure to a mixed bag of grains, London-listed exchange-traded fund AGGP (AGGP) is a good bet.

As for agribusiness stocks, Deutsche Bank tips Syngenta (SYNN:VX). The share price rose 35% this year and a p/e of 21 isn't cheap, but it's set to launch a modified corn product ahead of rival Monsanto.

Another option is fertiliser manufacturer Agrium (NYSE:AGU), on a p/e of 19 and a price-to-earnings growth ratio of one.

For the adventurous, Hong-Kong listed Xinjiang Tiange Water Savings Systems (HK:8280) designs irrigation systems (a priority in China, where only 2.8% of arable land uses efficient irrigation) and trades on a p/e of 20.