US Drought – Jury Out On The Knock-on Effects

on Jul 24, 2012
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In John Steinbeck’s The Grapes of Wrath, tens of thousands of American farming families across the Corn Belt states are driven from their land by years of drought – leading to the infamous ‘Dust Bowl’ era – and forced to seek a new life in a hostile California. Now, nearly eight decades later, the United States is in the grip of a drought rivalling that of August 1936, with over 54 percent of the territory of the contiguous states officially drought-designated – the sixth largest since records began in the late 19th Century. Twenty six states have been declared disaster areas as both the federal and state governments mobilise financial and logistical assistance for mid-western farmers unheard of in Steinbeck’s day.

!m[](/uploads/story/188/thumbs/pic1_inline.png)A lot of lessons were learned from the Dust Bowl, not least being the importance of crop rotation in drought management. As well, advances in plant-breeding have introduced strains of maize, corn, soy and sunflower much more resilient to extreme aridity. But still, both domestic US and international commodity markets are showing signs of being spooked by the seemingly relentless march of this year’s drought. As reported by the Financial Times on 20 July, prices of corn and soya have soared to new, record highs in the past week, raising fears of a repeat of the global food price crisis of 2008. The news coming out of the US mid-west is pretty much all bad, with the Department of Agriculture being obliged to constantly adjust – downwards – its yield estimates for staple food and animal feed crops. In the ‘good to excellent’ category, corn fell from 40 percent two weeks ago to just 31 percent in the USDA’s latest weekly report. Similarly with soyabeans, down from 40 to 34 percent. And August hasn’t yet arrived.

From an investment perspective, there are two main schools of thought on the likely impact of this situation on world food prices. The ‘she’ll be right’ school has it that there won’t be a price shock of 2008 proportions because (a) that crisis was brought on by shortages of rice and grains, especially wheat, which is not the case now and (b) the countries most affected by those shortages have learned from the crisis and are in better shape to deal with future shortages. Whereas the doom-mongers say that the plunging production of US corn this summer is going to reverberate around the world over the year to come because of the pervasive reliance on American corn, for human foods, animal feed and as a biofuel. Add to which the fact – according to experts at the UN’s Food & Agriculture Organisation and elsewhere – that as world supplies of corn dry up, wheat will be used as a substitute, and then – if the situation deteriorates enough – rice. The knock-on effects, so the argument goes, will be rapid and high increases in the price of all staples and a reproduction of the 2008 shock.

To this point, while prices of corn and soya are rising, the markets are not being subjected to speculative forays. But as the drought conditions persist, and especially if Russia’s perversely sodden summer chimes in with low international wheat supplies, commodities prices could come under sustained speculative attack. For the commodities investor, there are bound to be challenging times ahead.

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