Commodity boom – why we should be vigilant

With all the hype about the increasing price of commodities and our reliance on this sector to boost the NZ economy, we shouldn’t get too carried away. Fonterra Cooperative Group lifted its forecast 2011 pay-out to farmers to a range of $8 to $8.10 per kilogram of milksolids. Historically the NZ economy has relied on commodities such as wool, timber and more recently meat and dairy. However, the May “National Farming Review” publication came up with four areas of concern:

1. Commodities are volatile:
Prices are at the mercy of supply and demand and events like the global financial crisis can have a significant impacts on demand and ultimately price. Furthermore, the weather can cause supply shocks and volatility – see previous post Demand↑ and Supply↓ = Food Prices↑. As noted by the Reserve Bank – “it is fiendishly difficult to predict the future path of commodity prices”.

2. Exchange rate impact: The NZ$ is driven largely by the value of commodities so the recent rise in commodity prices had the effect increasing the value of the NZ$. This smooths the volatility of commodity prices, but can cause problems at the farm-gate. In 2007/08 when dairy prices were high and the NZ$ was also strong, world meat prices were rock-bottom. With the low prices and the high exchange rate meat famers had a bad year whilst their dairy farming counterparts were buying new tractors.

3. Induced supply: When you have high prices for commodities it starts to induce new supply from other countries in that they are trying to take some of the ‘pie’- but ultimately this reduces the price as markets become flooded with excess stock. The US has seen a big increase in dairy exports. It is predicted that increased food production will come from low cost food producers in the developing world who will become serious competition to the NZ farming industry.

4. Deleveraging: there is a widesptread belief that when there is a big payout to dairy farmers people are of the understanding that they are quite well off. However, what they fail to comprehend is that there have been many years of hardship and significant debt – NZ$48bn has beeen accumulated in the 2000’s. Ultimately they have to payoff this debt and only a small part of this income will find its way into the general economy, although services and products associated with primary sector will benefit from a cash injection.

The commodity boom is good for NZ farmers and the economy but there is no room for complacency or becoming a high cost producer.

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