Russia’s ban on wheat exports sets the commodity markets on fire

On August 5, Russia banned grain exports for the rest of the year. Drought has destroyed about 20% of the wheat crop of one of the world’s top wheat exporters. The ban will run from August 15 until December 31. At a minimum.

Wheat prices, already up 70% this summer, climbed again. Wheat was “up” another 8.3% on the Chicago Broad of trade that day.

The ban on Russian exports (Russia exported 21.4 million metric tons of wheat in 2009.) comes on top of prior forecasts for a smaller than expected U.S. corn harvest, and smaller than expected plantings of wheat in Canada due to a wet spring.

Wheat farmers in the United States, Argentina, and Australia will pick up part of the slack—as well as the benefit of higher prices. The wheat harvests in Canada and the European Union are not forecast to be particularly abundant this year.

But the ban on Russian exports isn’t the end of the story. On August 6 Russian Prime Minister Vladimir Putin fueled the speculation that other countries would also end exports when he said that Kazakhstan and Belarus should join Russia’s ban. Kazakhstan exported 7.5 million tons in the 12 months that ended on June 30 and Belarus shipped 400,000 tons, according to the U.S. Department of Agriculture. Another wheat exporter in the area, Ukraine, could well refuse to follow Russia’s lead because of political tensions between the two countries. But formal ban or not, the drought and wildfires that have devastated Russia’s grain crop are likely to reduce supplies from the Ukraine too. That country exported 9.2 million tons of wheat in the 12 months that ended in June.

Global wheat stockpiles aren’t anywhere near danger levels. The forecast now is for the bad weather and the export bans to cut world wheat stockpiles by 2.5% to 192 million tons, according to the International Grains Council.

 But the bans on exports by individual countries have more to do with internal domestic politics than any fear that the world is running out of wheat. Individual countries are trying to head off a surge in food prices that would create a wave of domestic political protest. Peak wheat prices of 13.50 a bushel in February 2008 set off food riots in Egypt, for example. Domestic wheat prices in Russia climbed 19% in the week before the country imposed its export ban.

And the bans have set off a scramble for supply and that has led to the wild surge in wheat and other grain prices on commodity exchanges. For example, Indonesia and Japan, Asia’s two biggest wheat buyers, have started to scour the markets for alternative supplies from the United States, Australia, and Argentina

That has created a psychology of shortage among global commodity traders who are now seeing commodity disasters everywhere. For example on Wednesday August 4 agricultural stocks led the Shanghai Composite Index to a 0.4% gain on speculation that recent floods will lead to a decline in the rice harvest—and higher rice prices. Chinese vice premier Hui Liangyu called on local authorities to increase rice planting after foods damaged more than 7 million hectares of farmland, according to the Xinhua News Agency on August 4.

It’s important to recognize two things about a commodity price surge like this.

India lags China and Brazil in fighting inflation

Spahn and Sain and pray for rain was the battle plan for the 1948 Boston Braves. It worked as the Braves won the National League title that year with two dominant pitchers.

It leaves something to be desired as central bank policy, however. Do nothing and hope that the monsoon rains will stop inflation, isn’t much of a way to run an economy. (It’s not very catchy either.) But that seems to be the stance that the Reserve Bank of India has adopted in its fight against inflation.

 Consumer prices are rising faster in India than in Brazil or China, countries where banking authorities are waging conspicuous fights to keep inflation from running out of control. Inflation in India rose at an annual rate of 14% in May. The Indian economy grew at an 8.6% annual rate in the first quarter of 2010.

After doing nothing as inflation built up momentum in early 2010, the Indian central bank has raised interest rates three times since March. But the increases have been just 0.25 percentage points each and haven’t done the job: the economy has reacted as if it knows that the bank is half-heartedly playing catch-up. That’s allowed inflationary expectations to build up in the economy.

The bank is widely expected to raise interest rates again at its July 27 meeting—but also widely expected not to take dramatic action.

Inflation is breaking loose in China and India

The inflation news from the United States was absolutely benign yesterday, March 18.

Can’t say the same for a big piece of the developing world. Inflation is on the loose from China to India.

 The only question is Will somebody important to the global economy wreck the recovery in an effort to fight inflation that threatens to run out of control?

For the moment at least, inflation in the U.S. looks like it’s under control. In February the CPI (Consumer Price Index), once seasonally adjusted, was flat. That puts this headline number at a 2.1% increase for the 12-month period. Core inflation, which takes volatile energy and food costs out of the number (and is useful, I assume, mostly to economists who don’t eat or drive) is now running at an annual rate of 1.34%.

The Federal Reserve doesn’t use CPI as its inflation benchmark (It prefers a measure called Personal Consumer Expenditure or PCE.) but translating from the Fed’s calculation suggests a core CPI target of 2% to 2.5%. At an annual rate of 1.34%, the core CPI isn’t even close to the Fed’s inflation limit.

The inflation picture couldn’t be more different in China, India, Vietnam, the Philippines, and other countries in the developing world.

Update HDFC Bank (HDB)

At the end of January the Reserve Bank of India, the country’s central bank, held a conference call for analysts and investors.

The message: The bank is worried about continued growth in government borrowing and strong demand for loans from the commercial sector. And that the bank will move to reduce excess liquidity in the banking sector before it leads to rising expectations for higher inflation.

Look out Indian banks, higher interest rates ahead.

I’d be surprised if Indian bank stocks didn’t retreat as the Reserve Bank of India moves from rhetoric to action.

Shares of Indian banks such as Jubak Picks 50 member HDFC Bank (HDB) are already down 20% since January 19 as part of the global correction in emerging markets. Any further decline would give long-term investors who are impressed, as I am, by the results out of Indian retail banks a chance to get into (or add to positions in) the sector at a reasonable price.  (For more on building a global portfolio see my post http://jubakpicks.com/2010/02/05/how-to-build-a-global-portfolio-what-countries-do-you-want-to-own/ )

How to buy into emerging market stocks now

Here’s the dilemma.

Long-term emerging market stocks are going to beat stocks from the world’s developed economies like a drum.

Everything right now points in that direction.

• Growth rates: For example, the United States looks likely to grow by 2% to 3% annually over the next decade (if it’s lucky) and China, India, and Brazil are projected to grow at twice to four times that speed.
• Debts: Developed economies such as Japan, the United States, and the United Kingdom will spend the next decade trying to dig their way out from under a mountain of growth-crippling debt while China and the rest of the world’s developing economies have emerged from the global financial crisis with comparatively undamaged balance sheets.
• Demographics: The developed world has to find a way to finance the “golden years” of rapidly aging populations. For the next decade, at least (and longer in the case of India), the economies of the developing world will be decisively younger. And growth, the historical pattern shows, goes to the young.

But in the short-term emerging stock markets look risky.

• Everybody suddenly loves them. And every guru is saying, You’ve got to be in emerging market stocks.
• Emerging market stocks are expensive. The companies in the MSCI Emerging Markets now trade at 24 times earnings. The last time the price to earnings ratio on this index was this high was in April 2000. Remember April 2000? Not the greatest of times to enter any market.
• The Chinese government and central bank keep signaling that they’re going to start slowing bank lending—and every time they do the market jumps like a cat landing on a hot tin roof.
• In the short-term emerging stock markets will take a licking if the developed world slides into another financial crisis. And that seems like a very real possibility somewhere in the belt that stretches from Athens west to Tokyo.

So is there a solution to this dilemma? A strategy that promises a way to navigate the short-term potholes while keeping your portfolio vehicle intact until the long-term arrives?

Sure. There are plenty of them. Let me lay out your choices and suggest those that make the most sense to me.