Rice Crisis: Adverse Side Effect From Hefty Political Subsidies

``Inflation is like sin; every government denounces it and every government practices it." - Frederick Leith-Ross 1887 -1968 civil servant and authority on international finance

We have cited the negative impacts of the ongoing rice crisis in How Surging World Rice And Food Prices Could Impact the Philippines and Rice Crisis: The Superman Effect And Modern Agriculture to the heightening the risks of social instability, more intrusive government policies which may hamper market mechanisms that may have a lasting side effect and harm the economy over the long run aside from impairing the balance sheets of the national government. In addition, we attributed the inefficiencies and imbalances of the industry to the lack of market signals aside from the webs of laws that has severely distorted the marketplace.

Combined, these added risks may impose a hefty risk premium to our asset class, where the hurdle rate of investments returns must significantly be greater relative to the given risk environment. And with today’s risk averse environment, high risk premiums represents an unattractive proposition for investors.

Yet, in vigil to the unfolding crisis, what we have observed was that anecdotally speaking, the problem of rice shortages is one concerning government “subsidized” National Food Authority (NFA) rice more than a general or nationwide rice shortage.

We don’t see people lining up for commercial rice because commercial rice partially reflects market prices. Whereas subsidized rice is entirely and artificially sold cheap to the “poor”, at a loss to the account of the government and charged to future taxpayer’s money in order to buy political stability. As an aside, we don’t see “riots” in the street yet (as reported by some news accounts) although we do see snaking queues for NFA rice.

The problem is that government subsidies have been compounding on the dysfunctional government controlled market for rice. The greater the price difference between commercial rice and subsidized rice, the greater the tendency to have a “crisis”, as some people have used such opportunity to “arbitrage” for profit -buy subsidized NFA rice, repackage and resell them at commercial rates, thus leading to more speculative pressure.

The following news reports depicts of the harsh realities from perverted government policies,

``The governor also directed the mayors to assess economic conditions in their areas, investigate the reported adulteration of rice through the mixing of cheaper NFA rice with commercial supply, and to submit periodic reports and recommendations to his office.” (Inquirer.net)

``Justice Secretary Raul Gonzalez personally caught at least one dealer mixing National Food Authority (NFA) and commercial rice in his home province of Iloilo over the weekend.” (gmanews.tv)

As we have written earlier, government policies create the incentives from which the people respond to, yet they get arrested from skewed regulations.

Yes, there is indeed a global rice problem. But the problem in the domestic setting is a basically an adverse side effect from hefty political subsidies.

Price Signals Work In Some Areas

Just consider; record food prices have started to impact investments decisions elsewhere in the world.

For instance, Russia plans to be a major exporter of grains within 5 years banking on the unused 20 to 25 million hectares of land for such purposes. (agrimarket.info).

Amazingly, even in Afghanistan the food crisis have borne a rare positive unintended effect, swapping heroin for wheat, this excerpt from Telegraph’s Con Coughlin (highlight mine),

``In parts of Helmand Afghan farmers are this year sowing wheat instead of poppy - not because they have suddenly been converted to the argument that producing heroin is not in the national interest.

``Market forces have been the deciding factor - with wheat prices doubling in the past year, and the street price of heroin falling, it is now more cost effective to grow wheat.”

In the US, farmers have started to opt out of the cropland conservation program which HAD KEPT THEM FROM CULTIVATION to cash in on the booming agriculture industry pls. refer to figure 6. See how government policies even in the US have contributed to the underinvestment-overinvestment cycle?

In the past, depressed food prices benefited consumers, yet the program was designed aimed at sustaining US farmers by effectively curbing supply through subsidies. Farmers were paid for not producing on their cropland!

Figure 6 New York Times: As Prices Rise, Farmers Spurn Conservation

Now that agricultural prices are skyrocketing, half of those enlisted in the conservation program have dropped out.

This from New York Times’ David Streitfeld

``Born nearly 25 years ago in an era of abundance, the Conservation Reserve Program is having a rough transition to the age of scarcity. Its 35 million acres — about 8 percent of the cropland in the country — are the big prize in this brawl…

``Such problems were never contemplated when the Conservation Reserve was conceived as part of the 1985 Farm Bill. Participants bid to put their land in the program during special sign-ups, with the government selecting the acres most at risk environmentally. Average annual payments are $51 an acre. Contracts run for at least a decade and are nearly impossible to break — not that anyone wanted to until recently…

``The program peaked late last summer, with more than 400,000 farmers receiving nearly $1.8 billion for idling 36.8 million acres. Put all that land together and it would be bigger than the state of New York.”

Price Signals Don’t Work On Some

As you can see, market prices have impacted investment decisions in some parts of the world, but others have not responded to the price stimulus because agricultural inputs (as fertilizers, seeds and fuel) have likewise risen and have posed as a deterrent to increasing production.

This excerpt from MSN’s analyst Jim Jubak (underscore mine),

``There, higher costs for fuel, seed and fertilizer have led farmers to cut back on planted acreage. The promise of higher prices for crops harvested in the future doesn't work if you can't afford the materials you have to pay for now, especially when credit comes at ruinous interest rates -- if it's available at all. Farmers in these areas also don't have access to the commodities futures market, so they can't lock in today's higher prices for future grain delivery.

``That means paying today's high costs is too big a gamble for poorer farmers, who can't afford to bet that grain prices will be as high tomorrow as they are today. All this has led to situations like this one: In Pakistan, farmers will produce a smaller wheat crop this year because they've cut their use of fertilizers after a 50% price increase in the past year.”

As we have previously argued, the lack of commodity markets have prevented farmers in developing countries as the Philippines from capitalizing on today’s higher prices to fund their inputs or for capital investments, thus access to capital.

Whereas the complete dependence on the traditional networks (traders or merchants) for the sales of their products and limited access to funding has been a major obstacle to the farmers to increase output since they are subjected to market inefficiencies emanating from a wall of laws, distortive subsidies and are in bondage to special interest groups for their markets.

Technically speaking the market price signals have not filtered to these economic agents enough for them to allocate capital and resources efficiently.

Copious But Fallow Agricultural Lands

Yet, the irony is that the Philippines has been blessed with a sizeable area for agriculture, this according to the Philippine Department of Agriculture,

``The Total area devoted to agricultural crops is 13 million hectares. This is distributed among food grains, food crops and non-food crops. Food grains occupied 31% (4.01 million hectares), food crops utilized 52% (8.33 million hectares) while 17% (2.2 million hectares) were used for non-food crops.

``For food grains, the average area utilized by corn was 3.34 million while rice occupied 3.31 million hectares.

``Of the total area under food crops, coconut accounted for the biggest average harvest area of 4.25 million hectares. Sugarcane with 673 thousand hectares; Industrial crops with 591 thousand hectares; 148 thousand hectares for fruits; 270 thousand hectares for vegetables and rootcrops; 404 thousand hectares for pasture and 133 hectares for cutflower.

``According to land capability, 78.31% of the alienable and disposable land are prime agricultural areas, 6.1 million hectares are highly suitable for cultivation.

Statistics are a mirage. The assumption presented here is that these all these lands are in production, but somewhere somehow this doesn’t account for the complete picture as Philippine agriculture land is punctuated with idle lands following years of underinvestment.

In fact, last year, the Philippine government arranged to lease over ONE MILLION hectares or close to 10% of the country’s agricultural property to the China’s Jilin Fuhua Agricultural Science and Technology Development Co., Ltd. (Fuhua Co.) because of idle, uncultivated or undeveloped properties!

This from Gemma Bagayaua of GMA Newsbreak, ``Would you rather let a million hectares of agricultural land remain undeveloped due to lack of capital or lease them to a foreign company?

``This, according to a ranking official of the Department of Agriculture (DA), is the government’s main consideration when it decided to lease to China’s Jilin Fuhua Agricultural Science and Technology Development Co., Ltd. (Fuhua Co.) some one million hectares of Philippine land under vague terms. The area covers about a tenth of all Philippine agricultural land.

``The DA says that the memorandum of understanding (MOU) with the Chinese company is just an additional strategy to meet the department’s goal under the Medium Term Philippine Development Plan (MTPDP), which is to develop two million hectares of agricultural land…

``Fuhua Co. intends to plant hybrid rice, corn, and sorghum in these lands. The contract is expected to bring in about US$3.87 billion in investments.

As you can see low productivity from the lack of capital investments brought upon by market contorting policies are essentially responsible for this recent crisis.

Bottom line: the government’s predicament can be resolved by inducing more investments to the industry by eliminating these supply rigidity barriers through dramatic reforms by eliminating or reducing subsidies, by opening the industry to competition and the development of a commodity spot and futures market for increased capital access and for pricing efficiency. Yes, there will be some social costs, some people will starve with temporary high prices. But private socio-civic groups can work with government to provide for charitable donation instead of placing the burden squarely on the government.

The rice cropping cycle is a short one (3-6 months) from which fallow lands can easily be cultivated and contribute to the supply output and stabilize the present situation. Thus I think, this problem can be settled in the medium term.

Unfortunately, with the populist tendencies tilted towards more socialism, the next step by the leadership would probably be to force other croplands into rice production, thereby yes, providing short term solutions of having sufficient supplies but at the expense of the farmers (rice prices will go down and squeeze income) or for other crops which we will see prices go to the roof (think sugar, vegetables and others).

Philippine Peso and The US Dollar Burdened By Socialization

Finally, many argue that the Philippine Peso will fall as a consequence to the increased subsidies by the Philippine government. Our view is that they are only partially correct because in the analysis of the valuation of currencies requires studies on BOTH the circumstances underpinning the currencies to which are valued against. To illustrate, if the Philippine Peso is gauged against the US dollar (which is the traditional benchmark), then the factors in support of the probable value of the currencies, both the US and the Philippines, should be assessed. Remember, the currency market is a zero sum game where one wins, the other losses.

True enough, the present actions to subsidize the poor with cheap rice by the Philippine government may impair its fiscal conditions, BUT the US government is likewise undertaking a massive nationalization of its financial and banking system aside from the borrowers afflicted by the US housing bust. In other words, two countries whose currencies are valued against each other are both effectively debasing their currencies for political expediency.

One thing we can be sure with, the more government intervenes with our lives the more we are likely to see a diminished standard of living.

Starve thy Neighbor: From Food to Fertilizers

The global “Starve thy Neighbor” policies continue. First, food exporting countries have been curtailing exports. Now, they are restricting sales of fertilizers, which may come at the expense of expanding output…

Excerpted from William Bi of Bloomberg,

“China, the world's largest grain producer, will increase export duties on all fertilizers and some related raw materials by 100 percentage points to ensure domestic supply for farmers during the main growing season.

“The changes will be effective from April 20 to Sept. 30 and will increase export taxes on fertilizer products to between 100 percent and 135 percent, the Ministry of Finance said in a statement on its Web site today. Current tariffs on fertilizers are zero, 30 percent or 35 percent, depending on the category, according to the site.

“China, grappling with soaring food costs, has boosted subsidies and grain prices to stem declining interest in farming. Lower exports from China, a major supplier of some products such as urea and ammonium phosphate, may further stoke global prices of fertilizers, with some trading at records on demand for food and biofuels.

``The government is sacrificing the fertilizer industry to protect farming,'' as grain production is critical to China's struggle with inflation, Xu Hongzhi, a Beijing-based fertilizer analyst at Beijing Orient Agribusiness Consultant Ltd., said in an interview yesterday.

“If China effectively restricts exporting fertilizers, it could be ``fatal'' to global supplies of some products, such as ammonium phosphate, as it supplies between 20 to 30 percent of global trade volume of the plant feed, Xu said.

Read entire link here.

Nonetheless fertilizer prices have skyrocketed as shown below…

Decyfer DAP Fertilise fob Gulf Coast courtesy of Fullermoney.com

Other fertilizer charts at fullermoney.com…Decyfer MOP Fertiliser Vancouver, Decyfer Sulfur fertiliser fob Vancouver, Morocco Phosphate Rock.

More restrictions equal increased marketplace tensions and political instability…

Food Crisis: Farming In A Warmer World

Drought from a warmer weather in Australia and elsewhere is one of the factors contributing to the strains in the global food supply…

courtesy of New York Times

According to the NYT’s Keith Bradsher

“It is difficult to definitely link short-term changes in weather to long-term climate change, but the unusually severe drought is consistent with what climatologists predict will be a problem of increasing frequency…

“Drought has already spurred significant changes in Australia’s agricultural heartland. Some farmers are abandoning rice, which requires large amounts of water, to plant less water-intensive crops like wheat or, especially here in southeastern Australia, wine grapes. Other rice farmers have sold fields or water rights, usually to grape growers.

“Scientists and economists worry that the reallocation of scarce water resources — away from rice and other grains and toward more lucrative crops and livestock — threatens poor countries that import rice as a dietary staple.

“The global agricultural crisis is threatening to become political, pitting the United States and other developed countries against the developing world over the need for affordable food versus the need for renewable energy. Many poorer nations worry that subsidies from rich countries to support biofuels, which turn food, like corn, into fuel, are pushing up the price of staples. The World Bank and the United Nations Educational, Scientific and Cultural Organization called on major agricultural nations to overhaul policies to avoid a social explosion from rising food prices.

“With rice, which is not used to make biofuel, the problem is availability. Even in normal times, little of the world’s rice is actually exported — more than 90 percent is consumed in the countries where it is grown. In the last quarter-century, rice consumption has outpaced production, with global reserves plunging by half just since 2000. A plant disease is hurting harvests in Vietnam, reducing supply. And economic uncertainty has led producers to hoard rice and speculators and investors to see it as a lucrative or at least safe bet.

“All these factors have made countries that buy rice on the global market vulnerable to extreme price swings.”

Read the entire article here

Does having more money bring happiness?

Does having more money bring happiness?

Yes…if you ask Betsey Stevenson and Freakonomics' Justin Wolfers as shown in the map below…

From NYT’s David Leonhardt, “In the paper, Betsey Stevenson and Justin Wolfers argue that money indeed tends to bring happiness, even if it doesn’t guarantee it. They point out that in the 34 years since Mr. Easterlin published his paper, an explosion of public opinion surveys has allowed for a better look at the question. “The central message,” Ms. Stevenson said, “is that income does matter."

Read the entire article here or more from Freakonomics.

World's Hardest Working?

A chart of the most industrious workers of the world…

courtesy of the Economist

According to the Economist, “SOUTH KOREAN workers toil for over 45 hours every week on average, nearly seven hours longer than workers in any other OECD country. Americans put in 15% more hours on average than workers in the western (richer) bit of the European Union. Poorer Eastern Europeans work considerably longer. Flexible arrangements for part-time workers, generous welfare systems and a limit on the working week all contribute to western Europe's seeming indolence. But where more people work part-time the average working week is likely to be shorter. The Netherlands, where 45% of workers are part-timers, the highest proportion in any OECD country, has the shortest working week.”

10 Investment Themes from Credit Suisse

Giles Keating head of the Credit Suisse Global Economics and Strategy Group (GESG) outlines 10 investment themes for 2008 in the Credit Suisse Magazine, namely:

One: Frontier Markets-underpinned by growth stories of undeveloped financial markets as the Indian subcontinent like Pakistan, Parts of Africa and smaller markets in Asia and Latin America.

Two: Asian Currencies- a play on relative undervaluation and expectations of continued economic outperformance

Three: US Presidential Elections- a punt on the cyclicality of the US Presidential elections and industries likely to benefit from the biases/preferences of the incoming President or of the political party behind the new president, e.g. broad health care

Four: Inflation-Linked Bonds-a wager on the possible impact of monetary policies, “inflation-linked bonds do well in an environment where real interest rates tend to go down because of economic weakness, and when inflation remains an issue”

Five: Chinese Brand Names-a position on the growth potentials of China’s consumers

Six: Climate Change-today’s highly compelling political and economic theme focusing on environmental preservation ranging from alternative energy to water issues

Seven: Commodities- a bet on the commodity cycle.

Eight: Community Investment- themes focusing on the concept of “charitable giving” or “socially responsible” investing as microfinancing

Nine: Cheap Distressed Assets-"value" investments from the recent turmoil

Ten: Quality Credits-fixed income investments which ensures cash flows from quality issues in a slowing economy

World Economic Growth: Mixed Picture But No Depression

Through the IMF’s World Economic Outlook, economic growth forecasts for 2008-2009 are expected to deliver mixed results. From the Economist, “The world economy as a whole is expected to grow by 3.7% this year, well down on the fund's last estimate in January of 4.2%. America is expected to enter a mild recession this year—its growth forecast has been cut from 1.5% to just 0.5%. The prospects for Spain, Canada and Italy are also gloomy. But the forecast is sunnier for the developing world, whose economies are predicted to grow by 6.7% in 2008, led by China and India.”

courtesy of the Economist

So despite signs the US housing slowdown seems slowly spreading to the world compounded by continuing indications of credit strains, hopefully these projections are right…no global depression ahead.

US Housing Bust Goes Global?

Has the US housing Bust now turned into a contagion? It seems so. From Mark Lander of the New York Times (emphasis mine),

"The collapse of the housing bubble in the United States is mutating into a global phenomenon, with real estate prices swooning from the Irish countryside and the Spanish coast to Baltic seaports and even parts of northern India.

"This synchronized global slowdown, which has become increasingly stark in recent months, is hobbling economic growth worldwide, affecting not just homes but jobs as well...

"That reality is spreading. Once-sizzling housing markets in Eastern Europe and the Baltic states are cooling rapidly, as nervous Western Europeans stop buying investment properties in Warsaw, Tallinn, Estonia and other real estate Klondikes.

"Further east, in India and southern China, prices are no longer surging. With stock markets down sharply after reaching heady levels, people do not have as much cash to buy property. Sales of apartments in Hong Kong, a normally hyperactive market, have slowed recently, with prices for mass-market flats starting to drop.

"In New Delhi and other parts of northern India, prices have fallen 20 percent over the last year. Sanjay Dutt, an executive director in the Mumbai office of Cushman & Wakefield, the real estate firm, describes it as an erosion of confidence.

"Much of the retrenchment seems to be following the basic law of gravity: what goes up must come down. With low interest rates helping to inflate housing bubbles in many countries, economists said the confluence of falling prices was predictable, if unsettling.

"This is not the first housing downturn to cross borders, but its reverberations have been amplified by the integration of financial markets. When faulty American mortgages end up on the books of European banks, the problems of the United States aggravate the world’s problems."

A Nation Of Shoppers??!!

Forbes magazine recently unveiled the TEN world’s largest mall…

Here is the list:

1. South China Mall
Location: Dongguan, China
Year Opened: 2005
Gross Leasable Area: 7.1 million square feet

2. Golden Resources Shopping Mall
Location: Beijing, China
Year Opened: 2004
Gross Leasable Area: 6 million square feet

3. SM Mall of Asia

Courtesy of Forbes.com

4. Cevahir Istanbul
Location: Istanbul, Turkey
Year Opened: 2005
Gross Leasable Area: 3.8 million square feet

5. West Edmonton Mall
Location: Edmonton, Alberta, Canada
Year Opened: 1981
Gross Leasable Area: 3.8 million square feet

6. SM Megamall

Courtesy of Forbes.com

7. Berjaya Times Square
Location: Kuala Lumpur, Malaysia
Year Opened: 2005
Gross Leasable Area: 3.4 million square feet

8. Beijing Mall
Location: Beijing, China
Year Opened: 2005
Gross Leasable Area: 3.4 million square feet

9. Zhengjia Plaza
Location: Guangzhou, China
Year Opened: 2005
Gross Leasable Area: 3 million square feet

10. SM City North Edsa

courtesy of Forbes.com

From Forbes’ Tom Van Riper…

``They're springing up in Asia, but will they all last?

``Heading out to the mall--isn't that yesterday's way to shop?

``Not in Asia, where land is cheap and labor costs are low. A building boom has enormous shopping malls popping up in China, Malaysia and the Philippines, with India expected to jump into the fold soon. Based on gross leasable area, or the amount of space devoted to revenue-producing operations like stores, amusements and food, the continent is home to nine of the world's 10 largest malls, six of which have been built since 2004. That's added some 27 million square feet of shopping space to cities like Beijing and Guangzhou in China and Kuala Lumpur in Malaysia.”

Implications:

For Asia: does this signify signs of times…a booming Asia???

For the Philippines: 3 out of the 10 largest among the world’s malls! What an irony! Statistics say that the Philippines is classified as a “poor” country.

Yet to sustain 3 of the world largest malls (+more coming!) suggest that statistics “more than meets the eye”.

RGE on Philippine Rice Crisis

RGE Monitor recently posted a synopsis on the Philippines rice crisis entitled “Philippine Rice Shortage: A Homegrown Crisis?” on in their “SPOTLIGHT ISSUES”.

Listed below are some of the litany of sins (focusing mostly on internal problems; highlight mine) + my comments.

RGE: “Despite being an agricultural economy, Philippines turned into world's top rice importer (esp. long grain) after Marcos' deposition in 1986. Other rice shortages occurred during Spanish colonial era and US occupation.

RGE: “Rice shortages had common cause: Public policies encouraging production of crops for export rather than local demand

My comment: Previously depressed prices of rice prodded government to encourage this policy; still the unintended impact of regulations.

RGE: “Other internal causes of current rice shortage:

RGE:- “trade barriers that tighten rice supply - high import tariffs (50%) paid to NFA (National Food Administration) by private sector rice distributors/retailers, ban on private importation

My comment: subsidies always cause distortions

RGE:- “landlords convert agricultural land for non-farm use to avoid govt's land distribution program

My comment: When investments to the agricultural sector become a losing proposition then it is natural for landowners to diversify. This represents more of an effect and an aggravating circumstance.

RGE:- “low productivity due to poor irrigation, poor seed and fertilizer technology, higher cost of imported fertilizer due to higher feed and energy costs

My comment: Same premise, low returns equals low incentive for increasing productivity.

RGE - “use of rice as a political salve - subsidized rice diverted to the poor

My comment: Bullseye!

RGE - “uncompetitive local rice industry plagued with monopolies by special interest groups (in and out of gov't), inadequate marketing

My comment: Subsidies bestows undue privileges to favored groups. Here they monopolize the rice trade. And since farmers totally depend on “special interest groups” and the government for sales, market price signals have not diffused to them. Consequently, “special interest groups” control a bigger share of the income at the expense of the producers or farmers.

RGE: “NFA interventions unsuccessful at stabilizing rice prices”

My comment: Touché!

Rice Crisis: The Superman Effect And Modern Agriculture

``Everyman who hoards does it for his own protection; yet by hoarding he aggravates the very condition that started his fear.”- Irving Fisher in “Booms and Depressions”

The “superman effect” intensifies as governments around the world step up interventionist measures.

Aside from throwing of more taxpayer money and other market distortive policies as a stopgap to the ongoing rice shortage, the arrest of so called “hoarders” a.k.a economic saboteurs becomes one good political photo op- the portrayal of government in action or the superman effect in motion- of course, coming at the expense of private property.

Where government fails, we the citizenry pays.

Calls for even more subsidies, an end to liberalization, extension of agrarian reform and disallowing imports by leftist groups is like closing the barn door when all the horses have left. From a hindsight perspective, everyone seems to know how to resolve this predicament, especially in using public funds, yet none of them seems to have foreseen this.

Although like the rest of the commodities from oil and energy to precious and base metals to other agriculture products, the story of the rice crisis is principally an offshoot to the seeds of global monetary inflation and its accompanying imbalances and the overinvestment-underinvestment cycle mainly underpinned by the unintended consequences following years of massive government manipulation of the marketplace.

This noteworthy observation from Professor Michael Pettis of Peking University's Guanghua School of Management wrote, ``Inflation is not just a Chinese concern, of course. It seems to be a rising problem around the world, especially in countries that intervened regularly in the currency markets to promote mercantilist export policies. This is more evidence, I think, that my theory that the recent policies among several developing countries, aimed at protecting them from the threat of another Asian-Crisis-style meltdown, may have simply transformed one kind of balance sheet mismanagement into another kind. In their determination to protect themselves from one kind of unstable balance sheet, they seem to have constructed a different, but equally unstable, kind of balance sheet.” (underscore mine)

Prescribing more interventionist palliatives is like giving more alcohol to an alcoholic; it will satisfy the temporal desires of the inebriate, but worsens his physical condition.

Remember, land is a constant factor. So, while subsidies may serve as panacea, the impending crop substitutions emanating from the incentive shift from these policies will mean possible shortages of other crops or other items/produce that depends on land for output in the future.

One may argue that at least such measures may not be as politically destabilizing or that the opportunity costs won’t be politically sensitive in nature, but for us these suppositions signifies imprudent assumption. The impact from these asymmetries will be seen later, perhaps through other channels or through output changes and whose political implications are likely to be unanticipated.

Modern Agriculture Requires Market Pricing Efficiency

Yet, decades of “self sufficiency” programs have not met their desired goals primarily because the efficiency of price signals has not permeated into the marketplace via productive capital investments.

Domestic farmers have not been able to increase productivity and output and manage risk because they have been entirely dependent on middlemen and traders or the government (through the National Food Authority) for price information and as exclusive buyers of their produce, thus have been shielded from the market pricing signals as discussed last week.

An organized commodity futures market would have been a primary conduit for such price mechanism transmission, which soberly said, we don’t have. Thailand’s Agricultural Futures Exchange is one such example of a productivity enhancement for its farmer constituents.

Figure 1: IMF Weather Derivatives: Strong Growth

If developed countries have utilized futures and derivatives markets to hedge for ‘weather conditions’ shown in Figure 1, example CME’s weather derivatives and Weekly weather futures, why shouldn’t we provide our farmers financial sophistication through risk management market facilities which should enable them to increase productivity and output, reconfigure the present inefficient trade structure and to even provide for insurance?

Just to give you an idea on weather derivatives, this from IMF (highlight mine), ``Weather derivatives offer a way for producers vulnerable to short-term fluctuations in temperature or rainfall to hedge their exposure. Exchange-traded contracts are typically linked to the number of days hotter or colder than the seasonal average within a future period…Weather derivatives are now complemented by weather swaps and insurance contracts that can be used to hedge adverse weather and agricultural outcomes. Governments in some lower-income countries (for example, India and Mongolia) now offer crop and livestock insurance as a way to protect their most vulnerable farmers. Ethiopia pioneered drought insurance in 2006.”

In short, profits or incomes by both farmers and investors alike can be optimized while inversely mitigating losses by the use of such sophisticated “price based” financial instruments without the needless involvement of added taxpayer funds. Greater productivity ensures adequate supplies. This is the modern approach to develop the agricultural sector over the long term.

Fiscal Impact of Subsidies

Last week we excerpted from a leading newspaper an estimate of the food component to the Philippine Consumer Price Index as only 13.5%. Apparently this turns out to only account for select items, and not the broader food basket as shown in Figure 2.

Figure 2: Financial Times: Unbalanced Diet

From the Lex column of the Financial Times (highlight mine), ``In the Philippines, a country that spent years turning round its fiscal deficit, the rice subsidy is expected to reach $520m this year, according to the Asian Development Bank, about 1.5 per cent of state spending. Indonesia will cough up a whopping $2.2bn for food subsidies – about 3 per cent of expenditure – according to the ADB, almost three times the size of earlier estimates. These subsidies add an estimated 0.4-1.7 per cent to the fiscal deficit as a percentage of gross domestic product in the Philippines, Indonesia and India (including off-budget items). If sustained, the measures will dent fiscal balances and raise the spectre of higher funding costs for governments. This will be most painful for countries already forking out on big fuel and fertilizer subsidies, such as Indonesia and India. There are other drawbacks. Most worrying is inflation – the very beast governments are seeking to tame.”

As the chart shows the Philippines appears to be the most price sensitive to food (see right chart) in the region with over 40% share of the CPI, thereby subjecting us to higher security and political stability risks. The series of attempts to pour taxpayers money to the present crisis seems to be a desperate reaction out of fear and another act of political survival.

A Possible Strain To the Philippine Peso

As the Financial Times observed, subsidies will pose as an additional burden to the country’s balance sheets and weigh on the fiscal conditions (which have seen a marked improvement-see left chart) that could lead to increased financing costs at the expense of the business climate. All of which could signify a strain on the performance of the Philippine Peso.

Again this is to emphasize that the Peso’s performance will be relative to the degree of social spending by the country whose national currency the Peso is compared to.

For instance, while Asia and emerging markets are trying to address the heightening political risks from rising food prices by increasing regulations and restrictions on food aside from massive subsidies, the US is undergoing the same process of imposing more regulations and providing of more subsidies (monetary and administrative) but aimed at alleviating or cushioning the economy from a risk of depression and from a financial meltdown.

So while both countries are engaged in currency debasing (protectionist) programs, they represent distinct political objectives.

Thus, the divergent scale of the interventions in support of these objectives will likely determine the relative price values of their currencies.

Higher Interest Rates and More Currency Arbitrage?

Likewise, we are told by the administration that despite the drastic and dramatic increase in expenditures to meet such contingencies, they will try to “balance the budget”.

This implies sacrificing other parts of social spending such as prospective infrastructure investment programs. This diversion of funds is likely to negatively impact the country’s economic growth prospects.

Figure 3: Asianbondsonline.com: 2 and 10 years Local Currency Yield

With consumer price inflation rising to its fastest pace in 20 months to 6.4% from last year (which we have been expecting), present monetary settings brings us deeper into a negative real rates.

As we have repeatedly said, negative real rates will likely trigger more speculative activities as the search for the alternative monetary function of “store of value” intensifies. This further reinforces more “inflation” within the domestic economic and financial system.

So we may likewise expect the domestic central bank, the Bangko Sentral ng Pilipinas (BSP), to raise policy rates to keep up with rising treasury yields (falling bond prices) see figure 3.

Otherwise maintaining present rates amidst surging consumer price could lead to negative real rates across the entire yield curve, which should further aggravate the opportunity costs of holding cash.

On the other hand, rising yields could lead to resurgent foreign capital portfolio flows predicated on currency yield spread arbitrages or carry trades.

It is a wonder; could last week’s reemergence of foreign capital flows into the Phisix, the largest since the last week of December 2007, signal the return of foreign capital? While it would be hasty to interpret a data of one week as a future trend, these developments are certainly worth the look.

Global Liquidity’s Impact To Food; Divergences Between Stocks and Commodity Prices

``The gold standard makes the money's purchasing power independent of the changing, ambitions and doctrines of political parties and pressure groups. This is not a defect of the gold standard; it is its main excellence." - Ludwig von Mises, Human Action
Yet, global liquidity continues to impact the real economy.

Figure 4: Brad Setser Dollar Reserves versus US Current Account Deficit

Figure 4 from Brad Setser exhibits how world foreign exchange dollar reserves growth continues to explode to the upside as global central banks, broken down into emerging markets (green), industrial economies (yellow) and total reserves (blue line) continue to heavily accumulate US dollars in excess of the US current account deficit (red dotted line). This signifies the tremendous flow of global liquidity even amidst the ongoing credit crunch in the US and in other parts of the world.

To quote Brad Setser, ``The basic story of 2007 is that central banks were buying more of everything.” (highlight mine) The increase in emerging world’s share of global reserves, more purchases of euros, pounds and other currencies but importantly more dollar purchases which dwarfed all.

The point is that the massive surge of global forex reserves appears to flow into commodities or that the commodity spectrum has been functioning as the “lightning rod” in absorbing the flush of liquidity generated by global central banks.

Yet, all is not equal in the world of commodities. Hard assets have clearly outperformed the stock prices of companies engaged in them as shown in Figure 5.

Figure 5 US Global: Hard Assets versus Paper Assets

Stock prices of natural resource companies have been weighed by sentiment, forced selling and investor redemption as investors worldwide pulled out nearly $100 billion of equity funds during the first quarter despite better earnings prospects.

Eventually when the turmoil subsides we should expect a return to reality. ``The value of resources equities will eventually catch up to the underlying commodities, so we believe this divergence creates an excellent opportunity for investors to acquire natural resources stocks at bargain prices” wrote Evan Smith of the Global Resource Fund.

Once again, the commodity cycle is a long process shaped by repeated government’s attempt to control the marketplace. Such distortions eventually surface through the disequilibrium in the demand and supply equation which gets to be reflected in prices as seen today.

Earlier it had been manifested through rising oil and energy prices. Next, precious metals and industrial metals caught up. Today, it has spread to “food” or agricultural or soft commodities. Will a US Dollar Crisis be next?

This also means that all attempts to restrict trade will ensure an extended crisis. With marginal global reserves at the lowest level since 1976 and where several countries are reportedly joining the fray to secure grain supplies in Africa as Liberia, Nigeria Senegal and Ivory Coast (Financial Times), rice prices continue to climb to the stratosphere (guardian.co.uk).

Thus any form of disruption (such as unexpected climate changes) could further exacerbate today’s shortages.

Philippine Mining: Supply Shortages Will Draw Investments

``You can observe a lot by watching.” Yogi Berra

Recently an article downplayed the sanguine picture of the Philippine mining industry. It attributed the drab outlook to emerging investor’s qualms over “Land ownership disputes, communist and Muslim insurgencies and bureaucratic red tape” as main reasons why resource based investors are having second thoughts on the Philippines.

The main fallacy with the argument is that the so called obstacles have been nothing new; they have long existed even long before the commodity boom. The fact that the present thrust by the government to reinvigorate the sector should signify as welcome news; even when confronted with some political resistance.

Next, the cited alternative venues to the Philippines have almost equal risks measures, be it in the context of political stability, red tape or cost of doing business. For instance going back to Figure 2 Vietnam is second to the Philippines in terms of price sensitivity to food. This implies of a marginal difference in the risk potential relative to political stability.

Third, figure 6 should validate the veracity of claims of meaningful alternatives.

Figure 6: US Global Investors: Copper Inventory with 3-4 days of global demand

With global reserves of copper at a hairline thin 3-4 days of demand, this posits that copper stocks have been in a chronic shortage and continues to deteriorate sharply which is reflected in current prices. In short, record sky high prices have yet to incite an equal response to supplies enough to stabilize or depress prices.

Yet, investments to increase reserves have been conspicuous see figure 7…

Figure 7: US Global Investors: Mining Deals Review

but mostly in deals which involves global mergers and acquisition.

According to US Global Investors (emphasis mine) ``PricewaterhouseCoopers International Ltd. released its latest Mining Deals 2007 publication. In it, PwC says that the merger-and-acquisition records set in 2007 are poised to continue in 2008 due to increased vertical integration in the industry, as well as Chinese, Russian and Indian companies assuming larger roles each year.” This means that global resource based companies have been doing less exploration which could imply limited access to areas for exploration.

Thus, we find it strange for an article to articulate on the availability of potential replacement sites as premise to the cynicism to the industry’s potential. Instead the major risk faced by the industry, in our view, is the rise of a populist leadership which may opt to retard the industry by prohibition edict or via nationalism. But that would be tantamount to shooting ourselves in the foot.

Of course, as we mentioned copper prices is just off from its recent peak, but is presently knocking at the doors of a fresh landmark high in prices.

Figure 8: Kitco.com: Base Metal Index

Nonetheless, it is not just an issue of copper; figure 8 shows the Kitco base metal index trading sideways following a huge bullmarket stretching from 2003 to mid 2007. Yet, like copper, stockpiles of lead and zinc are near historical lows.

Moreover, the economically recoverable reserves of lead, tin, and copper could be depleted within the next 25 years if their extraction expands at current rates, says Lester Brown of the Earth Policy. This means that unless a substitute for copper is found, the current pace of consumption would lead to severe shortages in the future. And severe shortage leads to high prices enough to cover the costs of undertaking a high risk project profitably.

So where there are real shortages, there isn’t much of an option.

The Shadow Banking System

A diagram of the simplified structure of the Shadow Banking System according to Hervé Hannoun of the Bank of International Settlements…

Missing Rallies or Catching A Falling Knife?

The recent stock market activities has stimulated the urge for some to consider today’s rally as a possible turning point -that some of us may harbor the feeling of “missing the train”.

First, we do not have the power of clairvoyance as to really know when the market bottoms or peaks out. We do not also know where the short term market path will go, simply because we can’t read the emotional impulses of every market participants.

Even if my first lessons in the stock market had been in technical or chart reading, I eventually discovered that these are not foolproof, entirely depends on past performance (pattern and signal reading), and is a tool mainly utilized by brokers who are itching for trading churns and not measured risk reward output.

The chart above shows that during this bearmarket cycle, rallies have been significant (see ellipses) or V-shaped but they tend to give them away as the tide reverses.

New York Times’ Floyd Norris: For Stocks, It’s the Wild West, East ...

Can today mark the bottom? Maybe or maybe not. My impression is that for as long as the world markets continue to track the developments in the US and forced liquidations represent a significant driving force weighing down on global markets (see volatility chart from NYT's Floyd Norris), then a major bullish run on our markets or to any stock markets elsewhere will likely remain suspect.

Second, the important lesson I learned about the market is to understand the interplay of different cycles and try to project on how these are likely to impact prices of assets or securities and thus allocate portfolio according to our risk profile.

Yet looking at the how regional and other contemporary markets have performed none of which has yet revealed signs of conspicuous decoupling. All of them, World Index, Emerging Markets and Asia ex-Japan continue to manifest downside action and bias.

So regarding risk, a downside bias could still be the dominant driver, although global monetary conditions and idiosyncratic fundamentals may support or cushion the decline of individual markets.

My point is: to hinge on the idea of missing a train ride is tantamount to catching a falling knife.

We simply shouldn’t believe in “missing rallies” today simply because different cycles seem to converge and point towards greater downside risks than a precipitate recovery. Remember, bearmarkets draws in hopes of investors until they capitulate.

If a decision has been made to enter the market today, then the expectation should be geared towards the longer horizon since the risks is likely tilted towards more potential downside actions or the risks of a portfolio going underwater. For me, trying to bottom fish or picking market tops is a game of vanity.

We should get aggressive when the trend suggests of a complete reversal. This is like paying for an insurance premium, by buying high because they are likely to go higher and importantly because the risks are likely to be reduced.

Thus, conservative portfolio exposure and allocation is best recommended.