GMO’s 2Q
2012 Letter comes in two parts. Part I, “Welcome to Dystopia” is Jeremy
Grantham’s update to “Time to Wake Up” and “Resource Limitations 2.”In this
piece, Jeremy focuses on the continuing global food crisis and what we might,
and can, do to avert it. Ben Inker follows with “When Bad Things Happen to
Cheap Assets,” looking into the question of how concerned investors should be
about the potential damage that could be done if already cheap assets were to
suffer further declines.
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Excerpt:
Summary of the Summary
We
are five years into a severe global food crisis that is very unlikely to go
away. It will threaten poor countries with increased malnutrition and starvation
and even collapse. Resource squabbles and waves of food-induced migration will
threaten global stability and global growth. This threat is badly
underestimated by almost everybody and all institutions with the possible
exception of some military establishments.
Summary
1. Last
year we reported the data that showed that we are 10 years into a paradigm
shift or phase change from falling resource prices into quite rapidly rising
real prices.
2. It
now appears that we are also about five years into a chronic global food crisis
that is unlikely to fade for many decades, at least until the global population
has considerably declined from its likely peak of over nine billion in 2050.
3. The
general assumption is that we need to increase food production by 60% to 100%
by 2050 to feed at least a modest sufficiency of calories to all 9 billion+
people plus to deliver much more meat to the rapidly increasing middle classes
of the developing world.
4. It
is also widely assumed that at least the lower end of this target will be
achieved. I believe that this is substantially optimistic. At very best,
if we reach that level we will not be able to hold it. Much more likely, we
will not come close because there are too many factors that will make growth in
food output increasingly difficult where it used to be easy:
• Grain productivity has fallen decade
by decade since 1970 from 3.5% to 1.5%. Quite probably, the most efficient
grain producers are approaching a “glass ceiling” where further increases in
productivity per acre approach zero at the grain species’ limit (just as race
horses do not run materially faster now than in the 1920s). Remarkably,
investment in agricultural research has steadily fallen globally, as a percent
of GDP.
• Water problems will increase to a
point where gains from increased irrigation will be offset by the loss of underground
water and the salination of the soil.
• Persistent bad farming practices
perpetuate land degradation, which will continue to undermine our long-term sustainable
productive capacity.
• Incremental returns from increasing
fertilizer use will steadily decline on the margin for fertilizer use has increased
five-fold in the last 50 years and the easy pickings are behind us.
• There will be increased weather
instability, notably floods and droughts, but also steadily increasing heat. The
last three years of global weather were so bad that to draw three such years
randomly would have been a remote possibility. The climate is changing.
• The costs of fertilizer and fuel will rise rapidly.
5. Even
if we could produce enough food globally to feed everyone satisfactorily, the continued
steady rise in the cost of inputs will mean increasing numbers will not be able
to afford the food we produce. This is a key point that is often missed.
6. On
the positive side, scientists are now very optimistic that they will be able to
engineer more efficient photosynthesizing “C4” genes (corn belongs to that
family) into relatively inefficient but vital “C3” plants such as rice and
wheat, in 20 to 30 years. If successful this would increase output up to 50%
and would buy time for a less painful transition to a sustainable population.
7. Many
of these increasing difficulties were reflected in the original 2008 food
crisis and the 2011 rebound. The last six weeks’ price rise is more threatening
because it occurred despite very much larger plantings than were available
in 2008. Global demand is now so high and rising so fast and reserves are
so low that price sensitivity to weather setbacks has become extreme.
8. It
seems likely that several countries dependent on foreign grain imports have in
fact never recovered from the 2008 shock. Countries like Egypt saw the percent
of their consumer budget for food rise to 40%. At this level, social pressures
may be at an extreme and probably have already contributed to the Arab Spring. Any
price increases from here may cause social collapse and a wave of immigration
on a scale never before experienced in peacetime. Another doubling in grain
prices would be catastrophic.
9. Strong
countermeasures to prevent a food crisis would be effective in curtailing the
current crisis and preventing the development of a much greater crisis, but these
measures will likely not be taken. This is because the price signals for
the rich countries are too weak – they can afford the higher price – and there
is inertia in all parts of the system. Also, the problems of malnutrition in
distant countries are not generally felt as high-order priorities in the richer
countries.
10. If
food pressures recur and are reinforced by fuel price increases, the
risks of social collapse and global instability increase to a point where they
probably become the major source of international confrontations. China is
particularly concerned (even slightly desperate) about resource scarcity,
especially food.
11. The
general public, the media, the financial markets, and governments badly
underestimate these risks. Only the military of some countries, including the
U.S. and the U.K., seem to appreciate them appropriately.
12. Natural
gas supply increases buy some time, mainly for the U.S., but seem more likely
to create complacency and continued dependence on hydrocarbons. The energy
situation is less pressing globally in the short term than is the food problem.
Supplies are sufficient to cause merely a slow and erratic price increase. The main
problem with oil is in its contribution to the food problem through higher
farming costs and generally increasing cost pressures on poorer countries.
13. In
the longer term, in contrast, energy costs and absolute shortage in the case of
oil form a serious problem second only to food shortages and will result in
prices so high that they will impact global growth and even the viability of
modern, rather fragile, economies.
14. On
paper, though, the energy problem can be relatively easily addressed through
very large investments in renewables and smart grids. Those countries that do
this will, in several decades, eventually emerge with large advantages in lower
marginal costs and in energy security. Most countries including the U.S. will
not muster the political will to overcome inertia, wishful thinking, and the
enormous political power of the energy interests to embark on these expensive
programs. They risk being left behind in competiveness.
15. Availability
of metals is, in contrast, a minor problem in the next few decades. The prices
will steadily rise but the consequences will be less. In the long run though, metals
are the most intractable problem. There is no brain-intensive solution as
there is for agriculture (i.e., organic farming), nor is there any
capital-intensive or technology-intensive solution as there is for energy. We
will just slowly run out and prices will rise.
16. The
results of these problems will be felt mainly as price pressure in rich
countries. The need to obtain adequate resources will squeeze national budgets,
profit margins, and economic growth. For poor countries, though, it is
literally a matter of survival.
17. We
are badly designed to deal with this problem: regrettably we are not the
efficient species of investment theory, but ill-informed, manipulated, full of
inertia, and corruptible. Only once in a blue moon – like World War II – do we
perform anywhere near our theoretical capabilities and this time the enemy is
amorphous and delivers its attack very, very slowly. But the stakes globally
are very high indeed. We must try harder.
18. The
following comments on this topic are mine personally and reflect my
Foundation’s portfolio (and a total lack of career risk!). These comments are
based on a time horizon of 10 years and beyond. The portfolio investment
implications are that investors should expect resource stocks – those with
resources in the ground – to outperform over the next several decades as real
prices of the resources rise. Farming and forestry, though, are at the top of
the list. Serious long-term investors should have a very substantial
overweighting in a resource package. I suggest for long-term investors a
resource position of at least 30%. Another relative beneficiary
of resource pressure is the quality group of equities. Resources are a smaller
fraction of final sales than average and higher profit margins make them more
resilient to margin pressures.
19. Perhaps
more importantly, the resource squeeze, coupled with other growth-reducing
factors (to be discussed next quarter), is likely to reduce the return from
the balance of the portfolio.