Friday, September 5, 2008

Mistaking Cycles for Trends?

This year I've gotten a lot of inquiries about Chinese agricultural data from individuals whose email signature sounds like some kind of investment firm. They are usually interested in statistics on meat consumption. I don't ask questions, but one individual told me his boss wanted a list of Chinese companies to invest in. I think another was working on a major investment in Chinese poultry that was in the news recently.

I infer from this that agriculture, especially anything that has to do with or can be influenced by Chinese demand for meat, is the latest investment fad. There have been several big investments in Chinese livestock industry in the news lately. An article in the Aug 31 Washington Post seems to confirm this trend toward ag investments and notes that the shine has quickly rubbed off farm-related stocks. Many of "the smartest guys in the room" working in investment houses and banks have never been through a big agricultural boom and bust before. They may have mistaken the upside of a cycle for a long-term trend.

China's pork and vegetable oil prices shot up 50-60% last year--what many interpreted as an upward trend they can't afford to miss out on. But we need to put price fluctuations in historical context. Historically, Chinese agriculture has gone through cycles with surprisingly little long-term upward trend in food prices. In the chart below you can see that there was a 50% surge in pork prices in 2004. In response, farmers added more hogs (boosting the price for feeder pigs even faster). The result was a similar plunge in prices after those hogs got big enough to go to market in 2005. Prices got so low in 2006 that farmers started liquidating their herds, even killing off the sows that produce more pigs. This, combined with disease epidemics caused prices to start shooting up in 2007. It looks like we have reached the top of the cycle and prices are starting to come down now. Has there been a fundamental change in Chna's pork sector or will we see prices dive in the next 6 months?

Heard about the surging wheat prices over the past year? Chinese demand outstripping supply? Look at the trend in Chinese wheat prices below. (Prices are for Jinan, Shandong Province, at the center of China's wheat production belt but reflect national trends.) There was a steep increase in 2004. Officials took steps to increase production and since then wheat prices in China have been pretty tame. Flour prices have gone up more than wheat prices, reflecting increased wages and other nonfarm costs.Compared to North America and Australia China is short of resources, but it is surprising how agricultural production has been consistently able to bounce back in response to high prices.

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