What spiking food prices mean for your portfolio

America's worst drought in 50 years has sent the price of grain soaring. The effects will be felt by consumers and businesses worldwide. John Stepek looks at what it means for you and your investments.

What's behind the latest spike in food prices?

In 2007 and 2008, when surging food prices led to riots in more than 30 countries, the spike was at least partly down to speculation. Commodities in general were enjoying a final surge before the credit crunch demolished asset prices across the board in late 2008.

America's second batch of quantitative easing (QE) shouldered some of the blame for higher prices. This helped fuel the 'Arab Spring' protests in the Middle East.

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But this time around, it's hard to pin the blame on speculation or loose monetary policy. There's little sign of further QE on the horizon. As a result, the dollar is steady to strengthening, which would normally mean lower commodity prices in general.

Instead, the current spike is very much down to Mother Nature. And the impact will stretch far beyond farmers in the American Midwest.

Soaring corn prices will have a domino effect

The US is experiencing its worst drought in more than 50 years. Needless to say, crops don't cope well without water.

This is a serious problem: the US is the world's largest exporter of corn. It's also unexpected, which makes it even worse. Indeed, until very recently, the US Department of Agriculture had expected a record corn crop this year. Last week, it had to slash its production forecasts by 12%, "the most in a quarter of a century", notes the FT.

Corn and soyabean prices have now jumped to all-time highs. Wheat prices aren't at record levels yet, but they have risen by more than 50% in a matter of weeks.

This will have a severe knock-on effect on consumers and businesses around the world. Some farmers will be in trouble, but those who manage to grow corn will make more money from it. Others will have insurance. Indeed, as Reuters reports, some experts are worried that government-backed crop insurance programmes mean that many farmers will just write off their whole crop rather than spending money to try to save it, making the situation even worse.

So what about other businesses? Richer farmers normally means a boost for agricultural equipment makers. However, poorer crop yields may mean that even those who can afford it won't need to buy new equipment, as another analyst tells Bloomberg.

Further down the line, any industry that uses corn will be affected. About a third of the corn crop goes on feeding livestock; if corn gets too expensive, then cattle will be slaughtered early to avoid the cost of feeding them. That means there'll be less meat further down the line.

So, as David Fuller points out on Fullermoney.com, we can expect a big impact on general food prices "later this year, and for at least the first nine months of 2013". That's bad news for consumers who might have been hoping for a bit of respite from rising prices.

Demand for food will keep rising here's how to profit

What does all this mean for investors? As we've pointed out in the past, we're not keen on playing soft commodities directly. Leaving aside the issue of how speculation affects prices, the factors driving softs' on a day-to-day basis are too complicated for non-specialists to risk betting on.

Also, if prices keep rising, there's a potential safety valve in the form of the ethanol market. An incredible 40% of the US corn crop is used to make ethanol; petrol companies have to buy a minimum amount each year to turn into biofuel, by blending it with petrol. This subsidy for crop farmers is mainly down to the power of the farming lobby in US politics, as it makes neither environmental nor economic sense.

However, rising corn prices have seen some ethanol plants shut down, as the cost of making the fuel hurts profits. Meanwhile, because biofuel output was so high last year, oil companies can use a system of credits to meet this year's quota without actually buying more ethanol.

Yet in the longer run, we can expect food price shocks to come more frequently. Even if extreme weather events can't be predicted, population growth, and increasing wealth in emerging markets, make it all but certain that demand for food will continue to grow.

Those of a more Malthusian bent argue that we might even see peak food'. However, just as rising oil prices have led oil companies to explore more expensive, higher-risk ways of getting oil and energy out of the ground.

As a result, in the past ten years, we've extracted oil from places that would once have been considered impractical or even impossible: tar sands, shale oil, deep beneath the waves.

The same will happen with food. While some worry about peak food', Africa holds two-thirds of the world's uncultivated arable land, and as The Sunday Times points out, "even the land used for crops is farmed so inefficiently that training programmes and rudimentary solutions could vastly increase outputs".

Paul Conway of agribusiness giant Cargill argues that "average production is so far below the known potential that this argument about whether the earth's potential [to feed people] is tapped out is almost irrelevant".

There will also be constant efforts to get more out of the resources we already have. One way to profit from all this is to invest in companies that are trying to improve farm yields. On this front, my colleague Phil Oakley recently looked at crop protection specialist Syngenta.

Ironically, this is all happening at a time when the world is also threatened by an epidemic of obesity. My colleague James McKeigue will be looking at this trend - and how to profit from it - in MoneyWeek early next month. (If you're not already a subscriber, subscribe to MoneyWeek magazine).

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.