Inflation, Bonds & Gold

 

By Adrian Ash

BullionVault

September 11, 2007

 

Food-price inflation is soaring across the world. Yet investment funds are buying fixed-income US bonds...

ADAM LEYLAND, editor of The Grocer magazine – the British food & drink industry's favorite weekly reading – warns that the cost of the average weekly shopping bill could rise 30% by December.

   Yes – thirty per cent. By Christmas.

   The cost of food here in the United Kingdom has already risen 6% from this time last year, outpacing the official Consumer Price Index by a factor of two. And yet, even with runaway inflation set to kick in this autumn, Leyland sees the threat as just somebody else's problem.

   "If I were [the UK finance minister] Alistair Darling or a pensioner, I’d be very worried," he tells the British press. So it's a good job, then, that he's the editor of a weekly business-to-business magazine instead. Right?

   Maybe William Reed, the magazine's publishers, have agreed to index-link Leyland's salary to the cost of Flora – the UK's best-selling margarine. This weekend, the bright yellow goo cost 41% more per tub than it did a week earlier according to The Grocer's own data.

   "Butter and spread prices are moving," Leyland tells The Daily Star newspaper, because "in recent weeks we have seen milk prices lurch up." Domestic milk supplies shrank dramatically last month, thanks to the UK government-sponsored foot and mouth outbreak, coupled with the heaviest summer rainfall to hit England's farmland since records began.

   "The situation is going to be very tight over winter," warns the Milk Development Council. Butter stocks in the European Union are now 50% below last year. But it's not only lactose that will cost UK consumers more at the check-out today. Indeed, consumers everywhere face a genuine threat of sharply higher food costs, too.

   Which makes you wonder: Why is the financial world piling into fixed-income government bonds at the fastest rate since 2003...?

   Sainsbury's, the UK's third-largest supermarket, just hiked the price of its cheapest apples by 140% to nearly £1.20 per kilo ($1.10 per pound). Given that the vast bulk of British apples now come from South Africa and New Zealand, this price hike is unlikely to remain a British problem alone.

   Similarly, a loaf of Hovis bread – one of the best-selling brands – now costs £1.04 (some $2.11) after rising 8.3% in the last week alone. Analysts think another 5% or 6% rise is on the way for the price of bread, adds The Guardian, if global wheat prices just keep on rising.

   And lo! Just today wheat futures rose to a new all-time high in Asia, more than twice last Sept.'s price after adding nearly 9% last week on top of the 23% rise seen in August. Thanks to a hot wind sweeping Australia's wheat farms late last month, the US Dept. of Agriculture reckons that the world's stockpile of the grain will shrink to a quarter-century low by the end of May.

   In India to date, the domestic price of wheat has yet to turn higher, reports the Economic Times. But once the initial buffer of outstanding stockpiles wanes in the developing world, surging prices for wheat – as well as corn and milk – have the "potential for social tension, leading to social reactions and eventually even political problems," says Jacques Diouf, director-general of the UN’s Food and Agriculture Organization.

   "Global supplies of wheat are very short," says Takaki Shigemoto, analyst at Okachi & Co. in Tokyo. "At the same time, we can't see any sign of slowing demand."

   Nor is it just foodstuffs. "Cotton is one of the cheapest commodities around," says Roland Jansen, manager of the $129 million Mother Earth Resources fund in Liechtenstein. He forecasts that cotton prices could rise by 66% to $1 a pound next year, driven in part by Indian farmers switching from cotton to wheat production.

   The point being, yet again, that those daily staples we've come to take for granted are about to get much more expensive. The "Great Moderation" as Fed economists would like us to view the last 15 years of gentle inflation and lower interest rates, is finished.

   "Over the past 30 years the cost of food as a proportion of [UK] disposable income has come down from 30% to less than 10%," notes Robert Schofield, chief executive of Premier Foods plc, the UK's largest food group. "It is going to edge back up...We face three years’ inflation."

   Add the rising cost of daily staples to the lurch upwards in mortgage-interest rates now hitting UK and US home-buyers alike, and what hope is there for discretionary Western spending this Christmas? In Spain, desperate farmers are selling young pigs at half-price since to avoid paying the new, doubled, price of feed. In Italy, the price of pasta has risen so fast, consumers are plotting a boycott on Thursday. The average Italian's basic food bill has risen by 30% from last summer.

   Hell, food prices are rising even in Japan! Land of the falling salary since 1998, it just reported 1.2% contraction in economic growth for the second quarter of this year. But the price of instant noodles, a must-have item squeezed into every Japanese kitchen cupboard, has just turned higher for the first time in 17 years.

   And yet, in the glass towers of Canary Wharf, Wall Street, Frankfurt and Tokyo, investment-fund managers – like the editors of food-industry journals – must somehow be insulated from the rising cost of eating. US Treasury bonds, those fixed-income assets denominated and paid in Dollars – the world's most-hated currency outside Zimbabwe – just put in their best one-month performance in more than four years.

   Perhaps the Western world's fund managers are planning to get by on the free biscuits and coffee delivered by trolley to their meeting-room suites every time they start a new pow-wow. They'll find thick-pile carpet to sleep on, too – plus some bad conceptual art to stare at on the walls, in lieu of watching Bloomberg on an LCD television. Which should prove useful. Two-year US Treasuries returned 1.09% in August judging by Merrill Lynch's data. Who cares about inflation? Not the Western world's major institutions, that's for sure!

   But while your pension-fund manager snaps up all the fixed-income US debt he can get, the amount of US bonds held by foreign governments and central banks at the Federal Reserve fell by nearly 4% last month – the steepest decline since 1992.

   This is no straw in the wind; it's a bale of hay whipped up by a storm. China had already cut its US debt holdings by 3.4% during the second quarter. Taiwan cut its holding by 10% in the year-to-June. South Korea cut its holdings by 25%.

   And now the Western world and his broker expects the Fed to slash Dollar interest rates...despite a genuine upturn in the world cost of staple consumer items.

   "The Fed needs to ease and will ease," says Paul McCulley, second-in-command at Pimco, the world's biggest bond fund. "Here's saying a prayer that 100 basis points of Fed funds cuts, by the end of 2007, will not be too late."

   Here at BullionVault, we invoke once again the spirit of St.Teresa of Ávila, patron saint of headache sufferers. "There are more tears shed over answered prayers than over unanswered prayers," noted the Spanish mystic in the 16th century. Paul McCulley might want to beware lower Fed rates.

   The central banks got their wish after fighting to fend off deflation in 2003. Japanese and Italian food manufacturers have got their wish for better pricing power, too. Now fund managers looking to beat the credit crunch of 2007 are looking for a cut in US interest rates.

   We reckon they'll get it, too...good and proper! So does the Price of Gold. The only asset to preserve and grow its purchasing power during the late '70s inflation, gold opened the week in London today at its highest weekly start since Sept. 1980.

   A cut in the Fed funds rate now would crash into a global lurch higher in the price of pretty much everything except housing and equities. The last time that happened, US Treasury bonds became known as "certificates of confiscation".

   The Price of Gold rose eight times over inside three years as private investors and even their fund managers caught onto the scam. Physical Gold Bullion then retained five times its 1977 value against the Dollar for a further 12 months – by which time, at the start of 1981, US interest rates stood at 19%.

   McCulley is looking for the Fed target rate to reach 4.25% by Christmas. If you have trouble finding a turkey or goose to cook, you'll know who to thank.