Wheat and the price of gold in Asia

While it might be considered a bit of a stretch to tie possible higher movements in the wheat price to the price of gold, I want to pose a scenario that I believe could at least have some connection, specifically across the Asian region and particularly in China.

Wheat prices have embarked on another tear higher fueled by a combination of several factors: surging demand for the real stuff, insufficient supply and speculative demand tied to hedge funds and managed money looking to purchase tangibles as a hedge against unlimited money creation by the Western Central Banks.

It was a mere month ago when wheat prices were trading closer to $7.72/bushel. Today, they are at $8.74 for that same bushel of wheat. That is an increase of 13% in 30 day’s time. The catalyst today was a report out of the UN group that as much as 37% of China’s total wheat crop might be affected by drought. In a market in which there is already a rather tight stocks situation, such news led to another surge higher in price.

Here is how this has the potential to tie into gold.

The Chinese as you know are fighting what appears to be a losing battle with inflation. Since October of last year, they have engaged in a series of rate hikes and bank reserve ratio hikes in an effort to somehow slow down their rapidly growing economy. Thus far it has had little effect particularly on soaring food prices.

In their efforts to ward off the unwelcome intruder, they overnight hiked one year rates to 6.06% and raised one year deposit rates to 3%. Unfortunately for savers, when the official rate of inflation in China is running closer to 5% with the government attempting to bring it down to a mere 4%, that still leaves Chinese savers in a hole as they are receiving a negative rate of return on their savings.

As I wrote in an earlier post, this is why Chinese gold demand is so strong right now. (Please see the post below for some further details).

That brings us back to wheat. One of the idiosyncrasies of the grain complex and to cereals in general, is that one grain or foodstuff generally cannot embark on too high of a price run without affecting its neighbors in the complex. Many are not aware of the fact that wheat is generally divided into two broad categories when it comes to its consumption (there are several types of wheat grown also); wheat intended primarily for Humans and wheat intended primarily for livestock feed. Feed wheat, as the latter is called, is generally lower quality wheat but it is fed to livestock because it is a good source of protein and it requires less bushels to achieve the same weight gains as an equal amount of corn. One can see that if the price of feed wheat becomes too high, even though it is less nutritious, many livestock feeders will shift to corn due to the lower cost. They can simply make up for the lower nutritional quality by feeding more and achieve the same weight gains at a better price.

When feed wheat gets too high, that then pulls up the price of corn as demand shifts to it. It works the same way in reverse. If corn is very cheap, feed wheat prices will have to work lower to entice demand. If corn is too high, and wheat is relatively cheap by comparison, demand will shift away from corn to feed wheat.

What we are seeing now is a situation where supplies of corn are much smaller than the world has hoping for due to a smaller harvest in the old crop corn in the US and drought damage to S. American corn coming mainly out of Argentina. With corn supplies already being constrained, higher wheat prices are not yet shutting off demand for feed wheat because corn is still very expensive compared to historical norms. The two are, to use a pun, “feeding” off of each other’s strength.

Rice has not gotten left out of this picture nor have soybeans, the latter which are currently at 31 month highs in price.

All of these price increases in the basic cereal, grains or whatever you want to term them, are conspiring to keep pushing food prices higher and higher. This of course continues to feed the inflation beast which is raging throughout all of Asia making life incredibly difficult for the average citizen who must be watching in alarm at what is taking place around them when it comes to the essentials of life.

Based on what I can see of the current demand/supply fundamentals in many of the grain markets, I see nothing on the immediate horizon that suggests to me that prices are going to move sharply lower anytime soon. In other words, until we get some sort of take on the new crop this year, these higher food prices are here to stay.

This poses an extreme dilemma for the Chinese leaders – if they attempt to hike rates to the point of slowing their economy enough to tame the beast, they run the very real risk of putting millions of their citizens into the ranks of the unemployed. If there is one thing history has taught those who rule that nation, it is that unemployed millions coupled with soaring food prices is NOT A RECIPE FOR PEACE AND TRANQUILITY, nor it is conducive to keeping oneself in power.

IN other words, the Chinese are attempting to fine tune or tweak a situation that requires a heavy sledge hammer using instead a finely sharpened scalpel. I would also say that as far as it goes, if they had to pick between higher food prices and higher energy prices or vast numbers of unemployed and empty factories, they will choose the former rather than risk the latter.

How does all this tie back to gold – simple – Chinese interest rate hikes are going to have to be much more severe in order to knock the rate of inflation down to a level at which the average saver is going to be able to actually receive a REAL, not nominal, POSITIVE RATE OF RETURN on their savings. They do not seem interested or willing to do that at this point hoping instead that the measures that they have taken will result in inflation moderating.

Given the fact that there is little that they can do in the way of impacting food supplies for the time being, their options appear rather limited. Yes, they can subsidize food for their masses out of their massive foreign reserves (running an enormous trade surplus has its advantages) and that remains a distinct option for them but that only tends to aggravate the supply situation since it shortcircuits the market’s attempt to move prices high enough to begin the rationing process and crimp demand. Nearly everywhere where artificial price subsidies are implemented, shortages inevitably result which just work to further compound the woes.

As long as inflation is a serious problem in China, and in other places in the region, and as long as real yields for savers there are negative, gold demand is going to stay very, very robust.