STOCK MARKET WATCH -- Friday, 9 March 2012

[Demeter]

11. Model on food prices and social unrest predicts crisis in 2013

http://www.creditwritedowns.com/2012/03/food-crisis-2013.html

The people at NECSI sent me the following interesting blurb on the relationship between the rise in food prices and social unrest:

http://necsi.edu/research/social/foodvideos.html.

These videos illustrate the correlation between increasing costs of food and worldwide food riots, especially from 2000 until the present day. Both prices and riots peaked in 2008 and 2011 after a brief drop in 2009. This month, NECSI is publishing the results of its food prices update, in which the institute extends its food price model to January 2012, entering no modifications to the model and continuing to use its dynamics.

“The food price bubble of 2011 caused widespread hunger and helped trigger the Arab spring. In 2013 we expect prices to be even higher and may lead to major social disruptions.” said Professor Yaneer Bar-Yam President of NECSI, who has just returned from the World Economic Forum in Davos, Switzerland where he presented his findings on speculation in global commodity markets. His paper “The Food Crises: A Quantitative Model of Food Prices Including Speculators and Ethanol Conversion” was called one of the top 10 discoveries in science of 2011 by Wired magazine.

According to the new study, the next food price peak will take place in about a year. The results will be dramatically higher prices than we have encountered thus far. The study warns that should ethanol production continue to grow according to multiyear trends, even this underlying trend will reach social-crisis levels in just one year.

NECSI’s latest findings reveal that the model from their 2011 paper still fits food price price trends. Their update reveals one important shift, however, in price trends, which might add to, not reduce, global instability. “The current trend of prices suggests that in the immediate future market prices may become lower than equilibrium,” says the study, “consistent with bubble and crash market oscillations.” The next bubble is expected by the end of 2012.

NECSI’s researchers said the model they have used to examine food prices has proven to be robust and consistent with ongoing behavior of food prices. Bar-Yam, who co-authored last year’s food-price study as well as the latest study update, said that the fit with the FAO Food Price Index is still “strikingly quantitatively accurate, validating both the descriptive and predictive abilities of the model.

”To extend NECSI’s earlier model ten months out and still witness a fit is important,” he added. “This means we have validated it for data that was not around when we first made the model. It predicted the burst of the 2011 food bubble at the exact time it happened, when many were saying that high food prices were there to stay. Success in predictive validation is remarkable. The conclusions are reinforced greatly that high food prices are due to ethanol and speculators–with all the relevant policy implications.”

“The current equilibrium value is about 50% higher than the prices prior to the impact of the ethanol shock. And the projected time until the next food price bubble is about a year.” The results will be dramatically higher prices than encountered thus far.

As I commented before the Arab Spring:

The rise in food and energy prices should be taken into consideration by government officials conducting pro-inflationary policies. What should be of concern regarding commodity price inflation is how it represents a regressive tax on lower income workers and consumers in emerging markets and developing countries. Lower income consumers spend a much greater percentage of income on food and energy. So when commodity prices increase, it has a disproportionate effect on them. One reason we saw food riots in emerging markets in 2008 has much to do with this.

-On Food Price Inflation, Nov 2010

I don’t think things are any different now. I should add that emerging markets central banks were pushed to tighten in 2010 because of rising food prices and this has created a negative growth dynamic in countries like Brazil and India as high interest rates have combined with inflation to suppress demand growth. In Brazil’s case, the currency has also created even more problems.

If the NECSI’s models have any predictive value, policy makers in the developed economies addicted to easy money to cure the indebtedness in the private sector should take note because their policies can have unintended consequences as negative real yields bite and private portfolio preferences shift and drive up commodity prices.

As NECSI puts it in:

Our analysis shows that dominant causes of price increases are investor speculation and corn to ethanol conversion. Models that just treat supply and demand are not consistent with the actual price dynamics. The two sharp peaks in 2007/2008 and 2010/2011 are specifically due to investor speculation, while an underlying upward trend is due to increasing demand from ethanol conversion. The model includes investor trend following, as well as shifting assets between commodities, equities and bonds to take advantage of increased expected returns.

Source: UPDATE 2012 — The Food Crisis: Predictive Validation of a Quantitative Model of Food Prices Including Speculation and Ethanol Conversion

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Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages, a skill he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.