The Global Food Crisis & Gold's Valuable Role

Emanuel Balarie
Apr 15, 2008

With all the discussion about housing, a declining US dollar, and the inevitable recession, I feel that many people may be overlooking a potentially more devastating economic factor - rising food costs. Before I continue with why I believe this is the case, I want to mention an article that I wrote several months ago titled, Food Inflation: What's The Story. The article provides an introductory view on food inflation. I must also point out that food prices are even higher now than when the article was first published in September.

One of the reasons why I decided to write this article is because I recently experienced a situation at the local food market in California. I was visiting my parents and we decided to go to the store to pick up some food for a barbeque. Having recently moved to Chicago from southern California, a backyard barbeque in warm weather sounded much better than a steak at a fancy steak house!

In any case, when I arrived at the supermarket, I was surprised to see the store absolutely packed at 1:30pm on a Thursday afternoon. There were probably 5 or 6 cashiers and each cashier had a line that went back 25 people deep. My father, who grew up in communist Romania, quickly mentioned that this reminded him of the bread lines during the Ceausescu era! As I looked around the store, I realized that about 80% of the people lined up only had 4 items in their carts. Those 4 items, I quickly found out, were advertised on a flyer that touted an '8 hour-only sale'. We ended up waiting in line for about a half hour.

I would guess the net savings for those 4 items were around $10-$15. That doesn't seem like a lot of money. Yet, the shoppers were willing to change their shopping schedules, wait in line for 30 minutes, and perhaps even purchase food items that were not necessarily on their usual shopping lists. Why is that?

Now, I have to admit the market was located in a blue collar/middle income neighborhood. However, this does not take away from the fact that my father, who shops at the store regularly, stated that he has never experienced this before. In addition, economic hardship is first noticed by the lower and middle classes. These families typically do not have much money saved up, and their paychecks often only cover their mortgage, car payments, and bills, leaving them particularly exposed in the event of an economic contraction.

But even though it starts at the bottom, you better believe that the hardships of the lower class will affect the middle class. For instance, Mr. Blue Collar might not go out to eat at the local neighborhood restaurant. Now the local restaurant owner experiences the slowdown and he may decide to layoff one of his employees. Additionally, he will decide to keep his used truck several years longer. Now the car dealer and their salesmen will suffer from decreased sales. And so on and so on.

But what specifically about food prices? Why are rising food costs any different from rising energy costs? First, it is clear that rising costs across the board will affect the consumer. That's just basic inflation. When it comes to rising food prices however, we are now talking about something people cannot overlook, or cut back their in their spending. In short, people need to eat.

It's Not Just Rising Prices

Beyond the fact that food prices are already rising at record rates, there is also a concern about the upcoming supply of food commodities. At first glance, one would imagine that the world's population will be okay when it comes to any type of renewable commodity. In other words, while there might be less corn due to the demand for ethanol, additional acres will be planted to meet this food void. While it might take a couple of years for supply to come to the market, it will eventually arrive.

This argument, however, fails to take into account the finite amount of arable farm land and the negative impact of industrialization in developing economies. Already, growing cities in China and India are quickly turning farmland into cities and manufacturing plants. This naturally takes away from planted acres of food. In addition, certain types of commodities can only grow in climate-specific regions. For example, one can't grow sugar cane in the arid deserts of Arizona...

Industrialization also impacts the amount of food people consume. Think of it from this perspective: industrialization breeds wealth and wealth breeds a more lavish (think meat, coffee, sweets, etc.) and substantive lifestyle. The net effect is more mouths are now vying for the same amount of food.

The Global Food Crisis

While western economies are not even close to experiencing a food crisis, other economies have already started to experience the impact of higher prices. Several news articles over the weekend highlighted the fact that the Food and Agriculture Organization (FAO), a UN agency, recently released a study that stated that rising food prices will continue for the next several years. The FAO also issued the following statement:

"A combination of factors, including reduced production due to climate change, historically low levels of stocks, higher consumption of meat and dairy products in emerging economies, increased demand for biofuels production and the higher cost of energy and transport have led to surges in food prices."

For commodity bulls, the above comment is fairly obvious. What is alarming, however, is that the FAO also warned that the food shortages and rising prices would most likely contribute to food riots in all parts of the globe. The president of the World Bank, Robert Zooellick, also stated that he believed 33 nations are currently at risk because of rising food prices. He went on to state that, "For countries where food comprises from half to three-quarters of consumption, there is no margin for survival"

In fact, food riots - in various degrees - have already taken place in India, Mexico (tortilla strike), The Philippines, Haiti, among others. Here is a recent headline from Haiti:

PORT-AU-PRINCE, Haiti - Aid organizations said Sunday they feared the food crisis could deepen in impoverished Haiti, where skyrocketing food prices have already led to deadly protests and the ouster of the nation's No. 2 politician.

The Negative Impact

In the same ways that lower to middle income households are the first to notice economic downturn and inflationary pressures, underdeveloped economies are the first to experience the negative impact of rising food prices. A big reason has to do with the fact that many citizens of poor countries spend as much as 75% of their income on food. While the struggle of these economies might not have an immediate impact on the lives of westerners, the instability that will develop in these regions will clearly have an impact global productivity; ultimately, this will translate into impacts for even the economies of developed nations.

Focusing on the specific regions that are currently in a "food crisis", it is evident that this environment has the potential to breed civil war and regional unrest in many parts of the globe. Already in Haiti, the number 2 politician was ousted. Why? Well, when people are starving the first to get blamed is the government in power. The second step is to get food by all means necessary. This ultimately means political crisis and chaos.

On a broader level, countries (whether developed or developing) are now battling for the same type of food commodities. Whereas many nations (like China) used to be net exporters of food commodities (like corn), they have now become net importers. This means, they have to look elsewhere to import food commodities just to meet their internal demand. In short, the same way that history has many examples of battles and wars that have broken out over water, oil, and other natural resources, one can imagine that, if this crisis would continue - there will be battles that erupt over food.

While I majored in Political Science at UC Berkeley, I do not make any claims that I am an expert in geopolitics. The above is simply my assessment on an oft-overlooked factor that may potentially affect economic stability over the next several years. More importantly, I bring this up to revisit the reason why investors should continue with their commodity investments, specifically their investments in gold.

The Gold and Commodities Hedge

The obvious way to combat rising food costs is to invest in the commodities that are increasing in price. If food prices are going to continue to rise, then it might make sense to invest in wheat, corn, soybeans, coffee, meats, sugar, cocoa, and other food commodities. Think of it as a hedge against rising food costs at the local supermarket. In fact, from a value-basis, I have made the claim in my book, Commodities For Every Portfolio: How You Can Profit From The Long-Term Commodity Boom, that food commodities are still the most undervalued. As China and India bring onboard hundreds of millions of "western-like" eaters, you can expect the price of food commodities to continue to head higher.

The other viable way investors can protect themselves is by investing in the one monetary investment that has survived countless empires, wars, and governments. The answer of course, is gold.

The way I see it, gold continues to make sense as an investment for several reasons. First, if inflationary pressures continue - gold prices will rise alongside and hedge your portfolio against decline in purchasing power. A clear example of this is to consider that gold has moved up from under $300/ounce to near $1,000 an ounce in this rising inflationary environment. While you might be paying more at the gas pump or supermarket, the profits you would have made would have offset the higher prices. The same could not be said if you held your money in cash over the last several years.

The other reason why gold makes sense in this type of "food-crisis" environment is it becomes even more powerful and relevant in times of war, economic instability, and political instability. During these times, you can be assured that gold not only protects your wealth (in terms of purchasing power), but it also provides you a globally-recognized medium of exchange recognized that has withstood countless alternate forms of money.

Consider the following excerpt from my book:

"The word "money" is defined as a medium of exchange that is able to preserve wealth. A "medium of exchange" is simply something that is widely accepted to have a certain value and that can be exchanged for goods or services. The U.S. dollar, for example, is a medium of exchange. You can easily transfer the dollar to other individuals because it represents a certain value that will allow you to purchase food, clothing, or a variety of goods and services. The same is true about gold. While you cannot use gold to purchase some of these goods and services directly, you still can use it to purchase dollars or any other currency. Then you can use the dollars to purchase your goods.

"Consider, for instance, this scenario. Every month I get paid. In return for my time and labor, I receive U.S. dollars, which provide me with the value necessary to pay my bills and any other expenses. Once I receive the money, instead of putting it in the bank, I decide to go to the local coin shop and purchase some gold coins. Now let's assume that a year later, I decide to purchase a new car. I will then take the gold coins to the local dealer, convert them to U.S. dollars, and take the dollars to the dealership where I can purchase my vehicle. In this case, did gold serve as a medium of exchange? Of course it did.

"Now, if gold was not widely accepted and I had the difficulty converting it into a local currency, things might be different. However, this is not the case. If I were to purchase gold in Newport Beach, California, get on an airplane, and fly almost anywhere in the world, I would most likely be able to find a jewelry store, a bank, a coin shop, or even a local resident that would be able to easily convert the gold into the local currency. Why would they do this? Well, because they understand that gold is money and it represents wealth. More important than the fact that gold represents wealth is the fact that gold preserves wealth. This is the second part of the definition of money. If you recollect the brief history on gold, the price associated with an ounce of gold has changed considerably over the last several hundred years. In 1837, one ounce of gold was priced at $20.67; in 1934, it was priced at $35; in 1973 it was priced at $42.22; and in 2006 it hit a high of $720. The general trend has been higher gold prices over a prolonged period of time.

"This point might not seem extremely relevant when you look at things from a short-term perspective, but it is extremely relevant if you are concerned with preserving wealth. Consider, for instance, the option to purchase an ounce of gold in 1973. The amount that you had to pay was $42.22. At that time, you could spend the $42.22 and purchase an ounce of gold, or you could simply hold on to the money. The difference between the two options is pretty substantial. In 1973 $42.22 could buy a lot more than it could buy today. Today it might be able to purchase a dinner for two at a local restaurant. In contrast, you would have been able to convert an ounce of gold to $720. This amount would be equivalent to 16 dinner-for-two meals or enough money to buy some higher-priced items. Even more significant is that this amount would more clearly represent the wealth that you had accumulated in 1973. By holding on to an ounce of gold, you were able to preserve the value of your wealth. Unfortunately, the same could not be said had you simply kept the $42.22."

Excerpted with permission of the publisher John Wiley & Sons, Inc. from Commodities for Every Portfolio: How You Can Profit From the Long-Term Commodity Boom. Copyright ©2007 by Emanuel Balarie. This book is available at all bookstores, online booksellers, and from the Wiley website.

Thus, while I echo the sentiments of the FAO - that we are in the midst of a global food crisis - I also believe that there are ways to protect oneself from this type of food-led instability. This is a just another reason why I believe that gold is still a long-term buy and that it's unique investment qualities continue to make it an irreplaceable part of any portfolio.

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Emanuel Balarie is President and CEO of Jabez Capital Management. In addition, he is also editor of www.commoditynewscenter.com and the author of Commodities For Every Portfolio: How To Profit From The Long-Term Commodity Boom. Mr. Balarie's industry experience ranges from commodity stocks to futures to alternative investments. He is a highly regarded advisor to clients and institutions on the commodity markets, and has had his research published all over the world. In addition to being a regular guest on CNBC, Balarie is frequently quoted in financial publications such as, The Wall Street Journal, Reuters, Marketwatch from Dow Jones, and Barron's. Mr. Balarie is a graduate of UC Berkeley.

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