"We believe that most models significantly underestimate future food demand as they fail to take into account the wide income inequality in developing economies."
Nomura offered no specific forecast for how much prices will rise, but said Bangladesh, Morocco, Algeria, Nigeria and Lebanon are among the most exposed. New Zealand, Uruguay, Argentina, Denmark and the Netherlands, as net food exporters, are among the least. The US ranks 14th among least vulnerable economies to food inflation.
What It Means for Investors
For investors, the choices are difficult though growing, as advisors develop a slew of protection vehicles from the expected inflation.
Nomura recommends an array of strategies.
They include paying two-year credit swaps on 10 countries with the highest exposure to food prices and receiving the 10 with the lowest. A basket of currencies from countries that are net food exporters also is in the mix. And the firm suggests buying soft commodities and Asian exporters that stand to gain the most from food inflation.
"[T]here is a huge selection of investment alternatives available, such as grain transportation, fertilizers or seed manufacturers that can be acquired as part of an overall allocation to commodities," the Nomura analysis said. "Moreover, since there are relatively few soft commodity futures markets, the sector does not lend itself to large-scale speculation such as that seen in oil and base metals."
Yet there is rising concern that food price surges in fact will increase speculation, both in the fixed income and equity markets as investors choose between exchange-traded funds that play on interest rates, and try to guess which central bank will blink first and tighten monetary policy to control inflation.
Nomura predicted that the US Federal Reserve will be "more likely to take its time and not react immediately to a durable food price inflation shock."
That possibility is raising concern that food inflation could get out of control before anyone does anything about it.
The Fed faces the challenge in that it is struggling in its dual mandate of controlling unemployment while maintaining an acceptable rate of inflation. The US economy remains mired in slow growth, but the central bank's zero-interest-rate policy could come back to haunt it when inflation inevitably kicks in, said Kevin Ferry, president of Cronus Futures Management in Chicago.
"They can't control where their success (at creating inflation) occurs. This is the perversity of central bank policy oriented in this fashion," Ferry said. "Welcome to the pain trade."
Ferry said he worries that food inflation could lead to a "huge" cottage industry of ETFs that capitalize on food price increases and perpetuate painful food inflation around the globe, with consumers paying the price.
"The Street's really good at creating what they need to sell," he said. "They're playing with fire. They're building bombs."
The opposite of Ferry's argument is the old economic maxim that the best antidote for high food prices is high food prices. In other words, when prices get too high the market will self-correct and production will increase.
"For some poor countries, definitely, I think they're going to suffer due to high prices over a short period of time," Dominic Schnider, head of commodity research at UBS, told CNBC in a recent interview. "But 24 months down the road, the higher price is definitely going to lead to more supply. You're going probably to see less steep demand and I think everything should calm down."
But Nomura is telling investors to be prepared.
Some specific recommendations:
- A 5-year capital-protected structured note that invests in a basket of agricultural commodities.
- Shorting some emerging-market currencies, particularly those in parts of Asia and Latin America such as Mexico and Peru that are susceptible to higher food prices, while being long of currencies in net food exporters such as Brazil, Argentina and Indonesia.
- Buying stocks of companies "involved in the shipping and storage of soft commodities, seed and fertilizer producers, and those that produce farm machinery, tractors and irrigation systems. Equally, we would suggest investors also consider timber and other 'industrial' soft commodities."
Indeed, commodity prices have been surging lately, with wheat hitting a two-year high and corn near that point as well when grain commodities went parabolic in 2008.
"It is totally different to have the inflation occur in foodstuffs and have central banks that will not, cannot and are completely unable to lean against it. Only the markets can move against them," Ferry said. "If it happens in the proper context there are certainly ways this occurs and takes off. That's why people have to be ready for it."