A Melman Minute — January 9, 2008

The new year is only into its sixth trading day and already the changes in various markets have been enormous. Gold has soared by over $60 (all prices US$), silver is nearing $16.00, Crude Oil touched $100 and the Dow Jones Industrials have plunged by eight hundred points! In past times, those could be monthly or even yearly changes, but they have taken place in barely one week and, therefore, it would not be unusual if the markets decide to take a breather for the time being - and that is what we are seeing so far this morning. Gold is holding near $880 spot after rising to near $892 overnight, other metals markets are seeing only modest changes, oil is slightly lower and the financial markets are slightly higher.

So, rather than dwell on the short run outlook, we will take a moment to look at the longer term, and what we see is not at all encouraging in one particular area, that of worldwide food prices. They have begun to rise, in some cases spectacularly, and the fundamentals appear to be changing in the direction of tightening supplies accompanied by higher prices.

One look at grain prices over the past year tells us that something unusual is going on. During 2007, corn went from about $3.20 per bushel up to the $4.75 area, soybeans rose from $6.50 per bushel to over $12.00 and wheat more than doubled in price from $4.40 to over $9.00. The price increases in these grains is now being reflected in additional costs to cattle raisers, bakeries, food processors, grocery stores, restaurants, etc.

If the extreme rise in these prices was the result of a single event, such as Hurricane Katrina affecting American Gulf Coast petroleum operations, we would expect a relatively quick retreat from excessively high price levels, such as we in fact did see in the period following Katrina. But that is not the case. The rise in grain prices this time around appears to be due to a combination of factors which we believe are likely to grow in impact, not diminish.

First, the world’s population continues to explode upward. According to figures published by the International Programs Center of the U.S. Census Bureau, it took from the beginning of time until 1950 for the world’s population to reach 2.5 billion persons. During the next fifty years, the world showed a net GAIN of over 3.5 billion people, bringing the total population to 6.1 billion and the Bureau now estimates that by 2025 - just 17 years away, this globe will be supporting - and feeding - eight billion people.

This fact alone has staggering implications. The same farmlands, fields, pastures, orchards and seas that just a half-century ago supported 2.5 billions must soon be made to produce sufficient food for three times the population! But there is more. The eating habits of most of those projected eight billions are undergoing a serious transformation. As levels of worldwide prosperity have improved, so have the eating habits of many in previously-impoverished nations. Foods such as meats and dairy products are in rapidly rising demand patterns and such foods require the consumption of enormous quantities of grain stuffs to feed the cattle required to produce those products.

So, we have the dynamic of a long term trend toward rising population combined with important alterations in eating habits uniting to create a relentless rise in the demand for grain production on Earth. But there are now several important factors which are working against our planet’s capacity to provide these items. Three in particular stand out in this time frame.

First, the land available for agriculture is vanishing in the face of ever-expanding demands for land for housing, commercial and industrial requirements. Agricultural land is being plowed under in order to be transformed into sites for housing, highways, shopping malls and industrial facilities.

Second, the great seas and oceans are failing to keep up with the ever-rising consumption of various sea-food items. Stocks of important fish foods such as cod and salmon, for example, are diminishing and simply cannot be replaced in any short time frame.

Third, new demands for alternative fuels are now consuming huge quantities of grain for conversion into ethanol, thereby diminishing the supply of grain-for-food, and by American law, those demands will be rising sharply, not abating, during coming years.

The crisis has reached the point where special reports are being issued warming the public of this emerging crisis. For example, Donald Coxe, global portfolio strategist at BMO Securities, noted in a recent article published in Canada’s Financial Post relating to food prices, “…The credit crunch and the reverberations of soaring oil prices around the world will pale in comparison to what is about to transpire.” He then added, “It’s going to hit this year hard.” His study also provided information that the amount of grain in storage for the following seasons was now at the lowest level in history relative to consumption, indicating that, like we have noted earlier regarding petroleum supply/demand fundamentals, there is virtually no supply cushion throughout the food distribution systems.

By coincidence, a report was just issued in Britain that the grocery store chains in the British Isles have reached the point where they could no longer absorb raw material price increases and would be forced to now pass those along to consumers.

One other topic is worth mentioning this morning, particularly as gold continues its upward trend. The U.S. banking industry, the largest and most important on earth, has entered a period of difficulty that has few parallels in history. In just the past few months, more than one-third of the value has been erased from the market capitalization of major financial institution as measured by the “Kbw Bank Index” (see chart) and, unlike previous sharp declines (notably 1998), this selling appears to be more pervasive and sustained.

The year 2008 appears indeed to be shaping up as one of potential turmoil and difficulties.

DISCLAIMER

The information presented above is based on data which we believe to be from reliable sources, but the accuracy of which cannot be guaranteed. Any opinions or predictions contained herein are those of the editor and are likewise offered also for information purposes only.

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