Grains Oilseeds

[Tackler]

Optimistic "Malthus-iasm"

Saturday, January 19, 2008; Posted: 07:30 AM

Jan 19, 2008 (Zacks Investment Research via COMTEX) -- With the U.S. headed into a recession of unknown depth and duration (much will depend on how fast we get fiscal stimulus and how effectively designed it is) one of the most important questions is to what extent will the U.S. drag the rest of the world down with it. Historically, when the U.S. gets a cold, the rest of the world get pneumonia. However, for some time now, the U.S. has not been the locomotive of the world economy, rather the biggest boxcar on the train. The real engine for world economic growth has come from China, with quite a bit of help from India, Brazil, Russia and the rest of the emerging economies. This is particularly true of production, or the supply side, of the equation. The U.S. has continued to be the biggest player on the consumption, or demand side of the equation. So what happens when the U.S. consumer slows down or goes into reverse? How much does that cause China to slow, and could we see a Chinese recession? Well, there is no law that says that the only people who can consume the goods being produced in China are Americans. Indeed, China does more trade with Europe than it does with the U.S. Also, China has built up truly massive foreign exchange reserves, reserves which have been growing by hundreds of billions each year. China could spend some of these reserves to keep things going over there. Remember that China still has hundreds of millions of people who literally dont have a pot to, well, you know. Perhaps the Chinese could start consuming some of their own production. With very high savings rates there, it certainly seems possible. While it is popularly perceived that Chinese growth is entirely driven by exports, particularly exports to the U.S., this is not the case. China has been investing very heavily in its infrastructure, as well. Still, given the relative sizes to Chinese consumption and U.S. consumption, it takes some very heroic growth rates by the Chinese to make up for a slowdown here.This question has enormous implications, particularly for the commodities markets. Over the last few years, commodities have been on a tear, and it has not just been one or two commodities either. Oil has been the most prominent, but gold, industrial metals and grains have all doubled or tripled. Some have wondered if just as the housing bubble replaced the dot.com bubble if we are now seeing a commodities bubble replace the housing bubble. The liquidity being pumped into the system has to go somewhere. Oil, given the potential that we are near world-wide peak production is probably a special case, but what about the others? Lets consider grains for a bit. One of the founders of Economics, and the reason it is called the dismal science, was Thomas Malthus. He argued in the early 19th century that since land under cultivation is limited and can only grow arithmetically, while population grows geometrically, that the world would always tend towards starvation, and keep grain prices high. Fortunately a series of events, such as the opening of the U.S. West to large scale cultivation, the introduction of tractors and combines, the green revolution, etc. have proved Malthus wrong. Today, there are two huge factors which are pushing up grain prices. First we are burning rather than consuming a large portion of our crops in the form of ethanol. Given government mandates, this process will continue. Second is the emergence of a large number of Chinese (and Indians) into something resembling a middle class -- for the first time in history. This is an epic change and one of the greatest economic developments of all time; in many ways it is more significant than the Renaissance or the Industrial Revolution. However, it takes several pounds of grain to produce one pound of pork. As the Chinese move toward having a first world economy, its citizens are demanding first world diets. This is good news for the entire agricultural complex. Some of the more prominent beneficiaries of this are Monsanto (MON), Deere (DE) and Potash (POT). However, in grains, the cure for high prices is high prices. It will cause farmers to plant more acres (both here and abroad) and eventually bring prices down. If the slowdown by the U.S. consumer causes Chinese economic growth to slow significantly, the shift in their diets would also slow and cause a sharp decline in prices.A similar process has been place for the metals, both precious and base. For gold, it is simply the case that historically Chinese and Indians have a much higher propensity to hold their wealth in the form of gold and silver than Westerners do. As they have gotten wealthier, demand has gone up (a very weak dollar has also helped). For the base metals, think of the amount of copper it takes to wire hundreds of millions of houses for the first time. Think of the amount of steel that has gone into projects like the Three River Gorges, and building all the skyscrapers of Shanghai and Beijing. These trends have been extremely beneficial to base metal companies such as Freeport McMoran (FCX), Southern Copper (PCU), Vale De Companhia Rio (RIO), not to mention the gold miners like Newmont Mining (NEM) and American Barrack (ABX). A Chinese slowdown would certainly take the wind out of their sails (and sales).In short, I expect that there will be a slowdown in China, but not a full fledged recession. Short-term, many of the commodities seem over-extended and are likely to pull back, perhaps significantly. However, consider it a major correction in a long-term up-trend, not the popping of a bubble. The underlying trends are real. Ironically, Malthus might be the most compelling reason to be optimistic about the world economy over the long term. Read the full analyst report on POT.