Kevin O'Sullivan: A world hungry for growth will have to be fed

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We have all experienced it: paying for our groceries at the supermarket checkout and staring in disbelief at how little change we've received.

While the business sections of the world's media focus on stocks, bonds, precious metals, oil and interest rates, these have a limited impact on most people's lives compared with food commodity prices.

If the price of gold rose 10-fold overnight the immediate impact would be felt by no more than 5 per cent of the world's population, but if wheat was to increase by the same margin, everyone would be affected.

Various commentators have blamed a whole range of factors for the recent surge in commodity prices: evil speculators, greedy producers, shady cartels - the list seems endless. However, let's get back to economics 101: "Demand and Supply will meet at the Equilibrium Price".

If demand outweighs supply, prices will be driven higher, and conversely, if supply outweighs demand, prices will fall - simple, sound, and proven economics.

In 1800, the world's population was 800 million; it now stands at 6.8 billion. The United Nations provides population forecasts at high, medium and low estimates. Their predictions for the year 2040 are as follows:

* High - 10 billion

* Medium - 8.7 billion

* Low - 7.5 billion

Clearly, demand is destined to rise and, unless we discover a way to develop our limited resources, commodity prices will rise with it. Increasing wealth generates increased consumption. The more we have, the more we spend. This is not limited to faster cars and bigger television screens, but includes upgrading the necessities of life: high quality food, for example.

Consumption in Asia has been increasing rapidly. In just a few years, Korea's per capita consumption of oil has grown from 1 to 17 barrels per year, closing in on the US - the world's biggest oil consumer at 22 barrels per capita per year. That fuels a growing economy - and a growing middle class, with a growing appetite for protein.

China and India provide the clearest examples of perhaps the biggest driver of demand: urbanisation. While it is difficult to get official statistics on urbanisation, it is estimated about 150 million people in China have moved from the countryside into the rapidly expanding cities while India could see up to 450 million people urbanised.

And what do all these people need? Food, glorious food.

Urbanisation is a double whammy for commodity prices. People that have been living off the land, often producing more than they need, move to the cities, where they become consumers. Meanwhile, the land they once occupied is often put to a different use.

Climatologists are predicting more wild weather patterns in the coming year, making it likely food producing regions will be negatively affected at some point. The impact of the recent Queensland floods on the price of bananas, or of last year's Russian drought on the supply of wheat are clear illustrations of what that might mean.

We have all heard that nothing is certain in life except death and taxes. I would suggest another certainty: politicians are going to argue with each other, and not a year will go by that we do not have some kind of political unrest in the world. Some of the biggest commodity producing nations in the world happen to be some of the most unstable, and political instability inevitably brings disruptions in production and supply.

War is one cause of famine that cannot be countered by improvements in farming systems or new technologies.

So, what does the future look like: have commodity prices peaked or has the commodity price climb only just begun?

In my view, recent price rises are only the beginning; we will continue to pay more for our commodities in the long run. As with all markets, we will see times when prices plateau or even fall, but in the long term I believe a new base price has been established in many of the key commodities.

For a primary producer like New Zealand, there is of course a silver lining: higher export revenues.

In the meantime, I will look to invest in commodities in order to gain positive exposure to these higher prices (there are many tools available to achieve this), and use the proceeds to offset my ever-increasing supermarket bill.

* Kevin O'Sullivan is head of financial markets at OMFinancial which acts as a broker in the futures, options and foreign exchange market.

- NZ Herald

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