Nomura Research cautions about El Nino, food price surge

Steep rise in food prices can affect the global economy, with particularly devastating effects on poor countries that import most of their food and spend a large share of personal incomes on food.

KUALA LUMPUR: Nomura Research cautions about a possible price surge in food prices due to weather effects while powerful structural supply and demand forces that could drive food prices higher over the next decade.

It said on Tuesday, it may not take much disruption in global food supply to trigger another price surge which, as in 2007-08, could be compounded by feedback loops such as increased hoarding, financial speculation and trade protectionism. 

Nomura highlighted that Chinese renminbi depreciation and concerns over emerging markets growth have contributed to a renewed plunge in global commodity prices, and many soft commodities have not been spared. 

“Yet, some meteorological experts believe that the current El Niño could be among the strongest since records began in 1950, unleashing droughts and floods across the globe,” it cautioned. 

It believed most models underestimated future food demand as they fail to take into account the wide income inequality in the world’s most rapidly developing (and most populated) economies. 

The supply side of the food equation is being constrained by lower agricultural productivity gains and competition for finite available land. 

In its report, it assessed how a steep rise in food prices can affect the global economy, with particularly devastating effects on poor countries that import most of their food and spend a large share of personal incomes on food. 

It warned that such countries may experience a sharp fall in GDP growth, a surge in CPI inflation, worsening fiscal and trade positions, higher interest rates, currency depreciation and widening credit spreads. 

On the other hand, rich countries that are large net exporters of food could benefit. To gauge overall impacts, we have updated the Nomura Food Vulnerability Index (NFVI), first published in 2010, ranking of each of the world’s 80 largest economies in terms of macro exposure. 

In terms of relatively large economies (2014 nominal GDP of at least US$150bil), the 30 most vulnerable include Bangladesh, Algeria, Egypt, Nigeria, Pakistan, Philippines, Kazakhstan, Hong Kong, Saudi Arabia, Russia, Indonesia, China, India, Mexico and Portugal. Unsurprisingly, the vast majority are developing economies. 

At the other extreme possible beneficiaries include New Zealand, Uruguay, the Netherlands, Argentina and Norway. 

Equity strategy

Fortunately for equity investors, the most vulnerable world markets to a food inflation shock lay largely outside the asset class’ mainstream benchmarks and are concentrated mostly in the more exotic “Frontier Market” equity category. 

That said, food price risks are material for emerging markets (EM) investors (especially in EEMEA); plus, even in markets more insulated overall, sector-level exposure – positive and negative – may still be material and actionable. 

At the country level and below, two principal considerations dictate our assessment of food price-related equity-market risks and opportunities: 1) top-down market-wide risk premia, and 2) bottom-up corporate earnings impacts (direct and indirect). 

Market-wide equity risk premia appear most vulnerable to a food price shock in the more richly valued equity markets of India, the Philippines, South Africa, Egypt and Mexico; and overall Consumer Discretionary-sector earnings vulnerabilities appear most glaring in (again) India, Indonesia, Malaysia, the Mediterranean (including EMs Greece and Turkey), (again) South Africa, (again) Mexico, as well as Chile and Brazil. 

“On the positive side, we identify 70 global stocks that should benefit from higher food prices, including: upstream plantation/production names, midstream operators and trader-intermediaries, purveyors of agricultural inputs/supplements, farm equipment producers, and grocery/retail operators. 

“These include 17 Nomura Buy-rated stocks or Neutral stocks with double-digit potential upside – In Asia ex-Japan: First Tractor, First Resources, London Sumatera and Mahindra & Mahindra; in Japan: Mitsubishi, Mitsui, Sumitomo, Itochu, Marubeni, Kumiai Chemical and Kubota; and in EMEA: Yara, WM Morrison, Metro Ag, Tesco, Delhaize and Distribuidora,” it said.

FX strategy

Nomura Research found that risks are greatest in Latin America (Venezuela, Argentina), where food inflation is already elevated amid political uncertainty and capital outflows have become the norm. 

In Eastern Europe and Africa (EEA), the South African rand appears particularly vulnerable due to drought and an increasing reliance on imports, while CEE3 countries are at less risk. 

As a result of Turkey’s uncertain politics and increasing inflation expectations, a food price shock could accelerate outflows, while the asymmetric impact on Russia’s poor, while the economy faces stagflation, poses a potential political risk for the region. 

“In Asia, capital outflows and currency weakness are most likely in IDR, MYR and THB,” it said.

CDS market

In the credit default swap (CDS) market, it recommended buying sovereign CDS protection for Egypt, Morocco and the Philippines, and selling CDS protection for Australia, Chile, Thailand and Brazil, in anticipation of a surge in food prices.