anyway i’ll spare you another enormous post. keep up the good work bloggin!

Your point about pricing derivatives in such a way as to accommodate long-term inflation is a very sensible one and makes a lot of sense to me. To be honest with you - I don’t know the answer and all I’m doing is thinking out loud and speculating wildly. On the other hand, I happen to be meeting someone in a few weeks time who is in the Commodities Trading business, so maybe I’ll get to throw in a question regarding food derivatives and long-term inflation to hear his thoughts. I just hope I’m not going to make an utter fool out of myself… :-S

But to be honest, I somehow like the sound of “December eggs call” - so if we start reading prices for it in the FT in a few year’s time, you know where you read it first!

haha oh yeah sorry for the enormous post. and thank you for the equally grand reply!

You’re right to point out that the subtleties of the relationship between the liquidity/risk crisis and the commodities “supercycle” (as some are calling it) and you’re quite right to mention the whole subsidies point (which I kinda forgot). I agree that much of the rise in commodities is tied to fundamentals. I think the world is changing and we in the West will have to get used to
(i) more competition from BRIC for this world’s resources (and maybe that means we have to accept more expensive food / oil)
(ii) perhaps a change in attitudes to aid/trade, as we see that rising prices for staples (like rice) hit the poorest countries. we might need to overhaul our (arguably pointless) agricultural subsidies to EU farmers and instead focus on how we will maintain living standards for the world’s poor. just because there is a burgeoning middle class of hundreds of millions in BRIC doesn’t release us from the need to help the poor (and that includes not just food importers, like in Haiti, but also the poor of food-exporters like India, where social frictions might pop up and test those societies in the same way that our industrial renaissance tested ours?).

I think the UK food derivatives issue is tricky (and I wonder if anybody who makes derivatives is reading this and can enlighten us…). The thought that came to mind, and perhaps I didn’t elaborate on it well, is that if the institutions creating derivatives (e.g. banks) look ahead (and I think that the trends in recent years of e.g. farmland prices, BRIC development and rising population will be in their minds), they might themselves anticipate that food inflation is long-term. This could lead them to set the food futures prices so high (or the fees) that supermarkets might find them unattractive. After all, if you were a bank creating, let’s say, a Dec 2008 eggs call option (doesn’t that sound odd?), wouldn’t you set the bar pretty high? You’d probably price in so much of an increase that there would be only a small scope for the retailer to profit - in my experience mainstream commercial companies (i.e. companies using derivatives for risk insurance on costs/prices/inflation/fx etc. rather than as a separate trade) can profit from derivatives in fixing short- and mid-term fluctuations but are unlikely to beat long-term price trends unless they achieve the art of managing to forecast better than the bank (and that is why the banks will charge such a premium for longer-term derivatives, especially those like options that offer no downside).

Hmmm and in terms of whether a single retailer would keep prices stable when others inflate… I very much suspect that if any one retailer had hedged their prices in a market where the others hadn’t, they probably would still pass on some of the rise and take the opportunity to just raise their prices slightly slower than their competition - in other words they’d probably take the profit there and then and pass on most of the rise. They are, as you say, an oligopoly! This week’s co-ordinated petrol price cuts are pretty good evidence methinks. Supermarkets may have delivered consumer benefits in recent years, but they also focus on shareholder returns (as they are obliged, of course).

ah ok that’s another hefty post. phew!

@ Jimbo: Many thanks for your - very - long comment. Let me try to respond to every aspect you raised (this might turn into a “slightly” longer comment as well).

I wouldn’t want to go to the extreme and call the commodities boom completely unrelated to the credit crunch or vice versa, but I’m generally not agreeing with people who claim it’s a simple and straight-forward result. I genuinely believe that the increase we’ve seen in the oil price (or generally any other commodity) has a lot to do with fundamentals - i.e. a shift in supply and demand. If you look at the OPEC’s production figures you will notice that they are actually decreasing. All the while China and India experience a major phase of industrialisation that has seen a large increase in energy demand, fuelled even further by substantial government subsidies in those countries… at some point the price just had to shoot up?!

I should certainly think hedging would be feasible for the large grocery stores. If it’s not a product yet, it would certainly be something that could be structured. The banking industry - just like any other - evolves around client’s needs and if they ask for it, they’d get it.

Whether it’s desirable is an interesting question. You’re absolutely right to say that these large buyers have an incredibly price power on their suppliers and operate on very thin profit margins that might be too precious to spend on hedging. With the oligopoly (few large buyers in co-existence) status the large supermarket chains have, it’s easy for them to adjust prices upwards and blaim input prices.

In fact, you could argue that one single retailer couldn’t cope with the demand it would generate by offering lower prices at constant quality compared to the rest of the market… So one thing’s for sure: it’s NOT an easy yes or no question…

What do you think?

However, I don’t think I can agree with the comment that the credit crunch and commodities inflation are unrelated. Don’t you think that the credit crunch has moved commodity prices? (due to both a shift in investors’ cash to more predictable assets and also a devaluation of both the US$ and GBP). It’s not the only reason of course for food price inflation, another of which I think is the social shifts in developing nations. One thing that painfully few people in the West have accepted is that food prices for us are still very low (we spend far less of our money on food than our parents or grandparents did). Real oil prices are also lower than the peak in the 1970s, although that’s little comfort to most people.

The point about retailers hedging is interesting - but is there really scope for e.g. Tesco to hedge against the rise in food price inflation? If this were possible (do banks offer egg derivatives?), then is it really desirable?

We as a society must accept that over the past decade, the supermarkets have delivered incredibly cheap food through sophisticated logistics and very shrewd buying. The supermarkets have thin margins (hence the enormous efforts to push up volumes and cruel treatment of suppliers) and seem unlikely candidates to incur the expense of hedging input costs when the future is so hard to predict. Given the financial markets’ bullish sentiment towards agriculture over recent years, anyone selling call options on food prices would have been setting high prices anyway.

Anyway sorry for rambling and I look forward to reading more posts.
Thanks!

I don’t know how long the trend will last, but on average house prices have been rising at 2% above inflation since the 1970s, and the typical boom-bust cycle lasts 13 years (peak to peak, taking into account inflation). If that’s repeated, any time between in the next 2-7 years would be a good time to buy.