Commodity trends: ag vs. oil

As I mentioned in my previous post, Michael Roberts at Greed, Green and Grains had a thought-provoking post on commodity trends. His mini-thesis is that, over the last few years, "Price fluctuations have become much more a demand-related phenomenon than a supply-related phenomenon."

He summarizes how for the last few decades, oil prices were driven mostly by supply shocks (embargoes, wars, etc.), whereas (falling) agricultural prices were driven mainly by "remarkable yield growth." But today...

But today it's all about demand. Demand for all kinds of commodities from oil to food grains came from tremendous growth in China and India. Supply growth couldn't keep up. Agricultural commodities got an additional demand boost from ethanol, which also linked agricultural prices more closely to energy prices. Then, when the global economy tanked, so did commodity prices. And today speculation, instead of being about possible supply disruptions, is all about when demand growth will resume.

I agree with him on oil - demand certainly has tanked due to the recession. I am not so sure on ag. First, the 2007/8 run-up in world cereal prices was caused by a complex set of factors including some on the supply side, like droughts in Australia and rice export bans in Vietnam, India and Egypt. Second, food demand is not as elastic as oil demand - people for the most part keep eating in a recession (not to insensitively downplay unfortunate exceptions), and the RFS mandates which drive the majority of corn ethanol and biodiesel demand remained in place. Third, unlike oil (where supply proved fairly inelastic in the face of record prices), high food prices provoked an impressive supply response - according to The Economist, "farmers harvested 2.3 billion tonnes of cereals in 2008/09, the biggest crop ever seen."

In conclusion, while in oil a peak supply/Peak Oil dynamic may be in play, I don't think we are at Peak Ag yet (although the more one looks at water, soil degradation and climate change, the more one worries it may be closer than most people think). In the medium term, both supply and demand in ag are flexible and speculation will continue to be about both, and at what price they'll meet to clear the world market.