Inflation Trend and the Weather

With current food prices rising and the possibility of the return of El Nino looming, MoneyShow's Jim Jubak weighs the possible repercussions, and who's likely to feel the impact the worst.

Food commodity prices are soaring. The Federal Reserve may not care since the core inflation number it watches takes food and energy prices out of the calculation. But commodity traders do. And so does your wallet, I'll bet.

Ahead of today's meeting of the Federal Reserve's interest-rate-setting Open Market Committee, the Bureau of Labor Statistics yesterday, March 18, reported a miniscule 0.1% increase in the core inflation rate in February. On an annual basis, core inflation is up just 1.6%. That's well short of the Fed's 2.5% target. The very low rate of inflation is one more reason to think that the Fed will hold its course at today's meeting with another $10 billion reduction in what was once a program to buy $85 billion a month in Treasuries and mortgage-backed securities and a pledge to keep short-term rates at their current low 0%-0.25% range deep into 2015.

But for those of us who live in the real world—as opposed to the Fed's world, where energy and food prices don't count in calculating inflation—the inflation trend is a little ominous. Food prices climbed 0.5% in February, the fastest monthly increase since September 2011. Prices for meat, poultry, eggs, and fish climbed 1.2% in the month.

The price increases don't stop with those food items. Coffee prices are up 70% thanks to unseasonably dry weather in Brazil. An epidemic of pig virus has sent pork prices up 40%. Wheat is up on the crisis in the Ukraine and on extreme cold in the United States. Dairy prices are up on rising demand from China.

And current weather may not be the end of the problem. Last week, Australia's Bureau of Meteorology became the third major national weather forecaster to issue an alert for El Nino. This cyclical weather pattern results from a warming of ocean surface temperatures in the Pacific that triggers drought and floods in areas that can include the wheat growing regions of Australia, Canada, the United States, India, and Argentina. El Nino last developed in 2009 and the last strong pattern—in 1997-1998—caused billions of damage to US crops. A strong El Nino pattern could produce drought in 2015 that would drive down production of cocoa and palm oil in West Africa, Indonesia, and Malaysia, and reduce harvests of wheat, sugar, cotton, and rubber.

It's too early to be certain that the El Nino pattern will arrive this year and next or that it will be strong enough to have a major effect on the prices of food commodities.

But the current increases in food commodity prices have been enough to push net long positions among commodity traders to the highest level in four and a half years.

If those traders are right, and food commodity prices are headed much higher, it would be bad news for consumers and for consumer companies such as McDonald's (MCD) and PepsiCo (PEP) that have to pay higher prices.

And it would be good news for food commodity producers such as the Fonterra Dairy Cooperative Group ((AU:FSF) (NZ:FSF) in Sydney and Auckland, respectively), and for companies, such as Deere (DE), that sell equipment to farmers.

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did own shares of Fonterra as of the end of December. For a full list of the stocks in the fund see the fund's portfolio here.