Food and Fuel

As an American man in my early 40s, I can say that for most of my life, I have taken certain things for granted. I don't mean that I have been ungrateful for the abundance this country has to offer. I would say, instead, that I've been oblivious.

Now don't get me wrong - as a child and young adult, I was fortunate enough to travel all over the world. My father made it a point to take us everywhere, and we often saw countries where there was poverty and no such things as running water, 7-Elevens or mega-malls, and where there were certainly no Starbucks, health care or gigantic well-stocked supermarkets. No, I was aware we had much more of everything in the U.S. - clearly, we had it better here. But as a child, I just never thought it could change.

Then I grew up.

When I was a kid, I would spend a lot of time at my grandparents' house on Sundays while my parents went to the Minnesota Vikings games - they were big fans. (Trust me, you had to be a big fan in those days - the stadium was outside, and it was darn cold in January. That was when NFL football was good.)

Anyway, my grandmother was in her 70s and had lived through the Great Depression and a couple of world wars, so she had seen hard times indeed. In her basement, she had a room that was filled from top to bottom with canned foods from her garden. It was an enormous garden filled with produce, not flowers. (Well, maybe a few flowers.) She also had a gigantic bin filled with coffee, and an even bigger industrial garbage can from Sears, filled with sugar. As a kid, I remember asking her why she had all that sugar in the garbage can. She replied, "Because you never know, Kevie." I had no idea what she meant. Now all I can think is how right she was.

Who knows, maybe she planted the seed right then and there for me to be interested in commodities trading? Heck, I would give a lot for Grandma's sugar-filled garbage can today, with sugar prices surging the way they have at the start of 2008.

As I have said for the last three years, the soft commodities are much undervalued, and we are seeing that move now just as we did in grains, and as we did in energies before that. The move higher in soft commodities like coffee, cocoa, sugar, cotton and others is just starting, not ending.

I really enjoy history. I can't say I am a scholar of history - I'm more like a History Channel buff. It's interesting that when we look at the history of food prices in America, we see that in 1901, people spent 43% - almost half - of their income on food, according to the Bureau of Labor Statistics. Do you know what that figure was in 2003? We will answer that in a minute.

It is true that since 1901, the percentage of our income spent on food has dropped dramatically, and it would seem to confirm a theory called Engel's Law. Engel's Law is the observation by 19th century German statistician Ernst Engel that "The proportion of income spent on food falls as income rises." But look deeper. Has spending gone down, or has it just shifted elsewhere?

Upon closer examination of my own spending, I realize that as I get older, my rising income has also meant more dining out. Restaurant dining and takeout food require even more energy, and are more expensive. Look at your own history, and you will see what I mean.

The extra money has certainly not gone into savings accounts, since the U.S. has one of the worst savings rates in the world, as well as some of the highest credit debt. According to the Bureau of Labor Statistics, the average American family spent $40,817 on goods and services in 2003. So where did all that money go?

OK, now the answer to our question. How much did the average family spend on food in 2003? Only about 14%, or a vast improvement over 1901, right?

Well, not really.

According to Advertising Age magazine, "Unlike in 1901, in 2003, the majority of the family budget went for the house (33 cents of every dollar) and car (19 cents). After paying for food (13 cents), medical bills (6 cents), a little booze (1 cent) and more, families had a nickel left to spend on entertainment." A nickel?

I just went to a Florida amusement park with my wife and baby, and at $200 for entry - trust me - a nickel is a little bit of an understatement.

And I will also say that in the area where I live in Connecticut, I see people living in these vast McMansions that cost $1-3 million. And they earn less than I do. I am just astonished. They must be spending 70%-plus of their incomes on their mortgages.

There is absolutely no doubt that consumer spending has increased exponentially since 1950. OK, let the good times roll. The government and die-hard bulls immediately point out that factoring in inflation, the increase is less dire. Maybe, but the "adjusted for inflation argument" won't feed your family or run your car. Try paying your mortgage and telling the bank that adjusted for inflation, your payment should be 30% less. See if they foreclose on only 30% of your house.

So we are all feeling the pinch of higher prices. We are used to increases in gasoline, health care and homes. We don't like it and we complain, but we expect it and we continue to fill up our Hummer and grumble and drive on. When it comes to groceries, however, and milk surging to $4.85 per gallon, look out.

How is this possible? How could it have happened? Ah, you can almost hear Marlon Brando saying, "The horror!"

My daughter turned 1 year-old in January. We always have to remind her not to play with her food. You would expect to have to do that with a 1-year-old. But you wouldn't expect to have to do that with our government leaders. (But come to think of it, many of them could use a good spanking.)

I am often asked by private clients, TV and radio interviewers, readers like yourself and others, "Why is this happening? Why are food prices surging?"

Simple. Stupidity, I think to myself.

The United States has some of the richest farmland in the world and more modern farming equipment than any other nation on Earth. The problem is we also use a lot of energy, and that is one thing we don't have much of. So what are we to do?

Then the political light bulb came on - dimly, but it came on. The idea was to turn a key staple of our food supply (corn) into fuel and thus create a panacea for the energy problem. This was a miracle, right? Wrong. Ethanol is nothing new; it has been around since cars first rolled out of Detroit. Ethanol from corn comes at a very high price. Not only does it require several steps to turn corn into ethanol, but it requires acres more of land, fertilizer, fuel, water, etc. At the end of the day, the only thing that widespread ethanol use is doing is destroying more of our natural resources while perpetuating the myth that we are doing something about our energy problem. It's almost criminal.

Now, don't get me wrong. Farmers have used ethanol for years locally, and in many instances, it makes complete sense. After all, growing a limited amount of corn on your own farm and refining it a few miles away at the co-op ethanol plant and then running your farm equipment and also pocketing a little coin at the same time - while providing some ethanol to the local community - made sense. Unfortunately, the government, lobbyists and politicians have perverted ethanol into a national mandate and thrown billions in subsidies to the industry.

It has become so absurd that farmers are becoming careless, throwing aside less-profitable crops like cotton and wheat.

In addition, being overlooked are prudent farming methods like crop rotation and not growing corn on corn, or the process of growing a different crop the year after you grow corn in a particular field. The environmental statistics are staggering, too.

In Wisconsin, for example, local rivers and tributaries have been dropping rapidly due to all of the extra water consumption - millions and millions of gallons. One local farmer in my farmers network says that he has lived in one location for 60 years and has never seen the lake near his farm so low. He says the local ethanol plant is talking about having water "shipped in." You have got to be kidding!

So what does all of this mean for us as investors? Plenty!

The days of cheap oil are already with us, and by adding certain key energy stocks to the OI portfolio, we, in essence, have a hedge against higher oil prices. We need to consider doing the same for food in our portfolio. I will tell you that in my own portfolios, I do have exposure to soybeans, wheat, corn and all the soft commodities. And they have done very well for me - as well as for our Resource Trader Alert members. In addition, stocks that will continue to benefit from rising food costs and global demand are companies like John Deere, Caterpillar, Monsanto, DuPont and The Andersons.

There is no doubt in my mind that oil prices will continue to go much higher, however. Eventually, when they get too high (that may be when oil is $600 per barrel), we may finally have a car that runs on switch grass, but clearly, this will not happen anytime soon. The difference between food and fuel is there is never going to be an alternative for food. We all need to eat, and there is no substitute. Did you ever chew on a piece of switch grass? I rest my case. The time to protect your portfolio from rising food costs is now. The days of cheap food are over.

Kevin Kerr
The Daily Reckoning Australia

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