An Aggravating Factor

by Addison Wiggin – February 16, 2011

• World Bank warns of “dangerous” food prices… Chris Mayer with two investment take-aways

• Inflation red flag: Producer prices up 3% in four months

• Investors dump gold ETF… but not necessarily gold itself

• Ray Blanco on how a Big Pharma takeover is a sign of the times… and how to play it to your advantage

• Readers weigh in on Monopoly money, Chinese inflation, piracy

“Global food prices are rising to dangerous levels and threaten tens of millions of poor people,” World Bank chief Robert Zoellick just declared.

The World Bank’s latest data on food prices reveal an overall 15% increase from October through January. Its index now sits just 3% below the 2008 record. (A separate index maintained by the U.N.’s Food and Agriculture Organization has already surpassed 2008 levels.)

Zoellick acknowledges rising food prices were "an aggravating factor" behind the downfall of dictators in Egypt and Tunisia.

“Last August, I was a guest on Russian TV, warning of another food crisis,” recalls Chris Mayer. “Asked by the host which countries were most at risk, I gave him two: Egypt and Pakistan.

“Getting Egypt right was easy. It was and remains the world’s largest buyer of wheat. Pakistan has a big import bill, too. Over the summer, massive floods destroyed many crops, quadrupling prices for staples like potatoes, onions, squash and tomatoes.”

Sure enough, the World Bank report forecasts rising food prices will drive Pakistan’s poverty rate up another 1.9%.

“There are two investment conclusions I draw” from these trends, Chris says.

“The first is that many emerging markets are on borrowed time. Egypt, for instance, grew 4-6% per year over the last several years, even through the financial crisis. It’s hard to imagine anything like that continuing when food prices are where they are.

“All of the emerging markets deal with suddenly surging prices for many commodities. As they are still in the commodity-intensive phase of their growth curves, this means, at the very least, the arc of their economic growth rates ought to flatten out for a time. At worst, they are vulnerable to social unrest, as most also have large poor populations.”

“The second conclusion is about the unfolding food crisis in the context of the broader sweep of rising commodity prices. Everything from oil to corn seems to be making new highs.

“The danger is that we have another 2008 situation. Prices got so high that demand dropped. Oil, for instance, hit an all-time high of $147 per barrel in July. Not too many industries can shrug that off.”

Still, not every commodity is topping 2008 levels. Chris points to this chart from UBS — which suggests that prices reached in the second half of 2008 may represent some kind of upper limit, after which demand falls:

“This table might suggest where commodity prices may still have room and where they may not,” Chris says. “All the agricultural commodities, along with copper, seem in danger of running against some kind of wall akin to 2008.

“Oil and natural gas, on the other hand, still look reasonable compared to the run-up in 2008. Food and energy share a link in that we burn energy to make food. But food prices have made their highs this time without new highs in the price of oil (or fertilizers, for that matter).

“So while food riots may continue, some commodity prices may well be nearing a short-term peak. Oil and gas, though, seem to have lots of room on the upside yet.”

Chris is especially enthusiastic about an oil play in the Zagros oil basin — a region well insulated from the tumult and protests sweeping much of the Middle East. The guy who runs it turned a minuscule $500 into $1 billion with his last venture. To learn about the potential behind this find, give Chris’ latest presentation a look.

As we write, the major U.S. stock indexes have recovered yesterday’s modest losses. Traders cheered the news that housing starts rose 15% from December to January, more than expected. Likewise, they shrugged off news that industrial production fell 0.1%.

And they’re blithely ignoring this truly ugly data point.

Wholesale prices jumped 0.8% in January, according to the Bureau of Labor Statistics. The producer price index has now jumped 3% over the last four months. And no, that’s not an annualized figure.

Note that the PPI headline number is for “finished goods” — stuff that’s ready to be sold direct to consumers. In the category of “crude goods,” the figures are far worse — up 3.3% in January, and up a staggering 15.8% over the last four months.

Crude oil has firmed up another 81 cents, to $102.46. That’s Brent Crude, which is quickly becoming the new world benchmark.

It doesn’t help that protests are entering a third day in Bahrain — smack in the middle of the Gulf oil patch, and home to the U.S. Fifth Fleet.

We wrote about the trouble in Bahrain nearly six months ago, when the government started rounding up opposition leaders. Bahrain has a Shia Muslim majority, ruled by a Sunni Muslim minority. We’ll stick to our outlook that Bahrain might well become a fourth flash point in Byron King’s “New War” scenario that could drive oil to $220 a barrel.

To learn about the other three — and to snag a subscription to Outstanding Investments — check out this presentation. There’s no better time… Outstanding Investments was just named the No. 1 performing newsletter over a 10-year period by the independent Hulbert Financial Digest.

Gold is holding onto yesterday’s gains, the spot price currently $1,372.

Holdings in GLD, the biggest of the gold ETFs, now sit at a nine-month low. From a record of 1,320 metric tons last June, holdings have fallen to 1,224 as of yesterday.

But don’t get the idea investors are abandoning gold. Edel Tully, the veteran precious metals analyst at UBS, doesn’t believe this represents “absolute selling.” Rather, she suspects institutional investors are switching their gold exposure from ETFs to the real thing — numbered bars, held in allocated accounts, deep inside bank vaults.

“The picture painted by recent persistent ETF outflows is not wholly accurate,” she says.

Silver has retreated from its run toward $31, now sitting at $30.41.

Sales of U.S. Silver Eagles have pulled back from January’s record. So far in February, the U.S. Mint has sold just over 1.7 million ounces to its authorized purchasers.

Assuming that tempo keeps up for the rest of the month, that would be a total of 3.4 million ounces — very respectable, but well off the pace of January’s record 6.4 million.

The French pharmaceutical giant Sanofi-Aventis just announced a buyout of the U.S. biotech firm Genzyme for $20.1 billion.

For Sanofi, it’s a matter of survival: Patents on several of its best-selling drugs are on the verge of expiration, if they haven’t expired already.

“The large players are all succumbing to a similar disease: patent expirations,” observes Ray Blanco of our tech team.

“At the same time, shrinking in-house pipelines mean that the Big Pharmas are without sufficient new products to replace the ones they will lose to generics. It is notable that only a fraction of FDA decisions for 2011 will go to the behemoths.

“Too big to be nimble, too bureaucratic to coordinate effectively, large pharmaceutical companies are slashing their lifeline to future profits: research and development.” True to form, Sanofi revealed in its earnings report last week that it’s cutting R&D spending.

“Needless to say, slashing R&D is no way to grow a business based on drug discovery. Biotech discoveries are not slowing down; they are actually accelerating. Pharmaceutical innovation has not died — it is just coming from a different place.”

That place is the smaller, more innovative biotechnology companies like the ones Ray and Patrick Cox follow in Technology Profits Confidential. “These — and others — are sitting on the intellectual property estates that will mint the millionaires of the coming years.

“A rational market would recognize this. We can, however, exploit nearsightedness for long-term gains. The fact that the sector as a whole is beaten down by the big players' lackluster performance actually creates golden opportunities for long-term investors to pick up gems on the cheap.” To learn about Ray and Patrick’s six favorite ideas right now, check this out.

“Business — at least in our experience of it — is much different from what most people think,” writes Bill Bonner, weighing in on our ongoing theme about the challenges of entrepreneurship.

“Businessmen are not cold and calculating. They are not trying to maximize profits at all costs. They are not necessarily rational. Not necessarily sensible. Often not very reasonable. And frequently driven more by vanity and sentimentality than the search for return on investment.”

Bill’s full comments are below, in a special Overtime Briefing.

“I've also been playing Monopoly with my kids,” says a reader who saw yesterday’s issue, “and one thing you notice is how cut-throat and unrealistic it is.

“It's close to a zero-sum game with no wealth-creation expansion factor, and it has to be in order to end with a clear winner in under 12 hours. But I can't help but to think that the socialist policies of the last 100 years arose in response to Monopoly economics.

“But maybe it's more true to life than I suggest. State-sponsored cartel banking is a problem in real life also, but nobody seems to learn the right lessons here either.”

“I came to a similar revelation playing Monopoly with my kids a year ago. If you keep loading up Free Parking with jackpot money (which is not an official rule, but the way everyone I know plays), just as with real bailouts, liquidity floods the game and secondary-market prices for properties go sky-high.

“Nobody goes bankrupt, and the game goes on forever.”

“China has been taking notes after watching how I.O.U.S.A. handles things,” writes another. “The drop in inflation from 5.1% to 4.9% comes totally from recent changes in accounting methods.

“Apparently, the Chinese don't eat or drive either.”

“Maybe I'm late to the table on the piracy discussion… One just needs to follow the money.

“International shipping is governed through IMO policies, banking and insurance in ‘the City.’ Someone is making a few pounds (or dollars) every time a ship sails through the Gulf of Aden.

“For every ship that is hijacked, there are 250-plus that are not. Two hundred and fifty ships each paying a piracy insurance premium of, say, $50,000 means that somebody is raking in $12.5 million per day. If the international maritime community wanted piracy in the Gulf of Aden to stop, it surely would.”

The 5: You remind us about one of the ways Hank Greenberg built AIG into an insurance behemoth. Back in the ’70s, when it was de rigueur for terrorists and other malefactors to kidnap high-profile business executives, AIG started offering kidnapping insurance.

The demand was steep. The premiums were staggering. The likelihood of payout was minuscule. AIG had a virtual license to print money.

Cheers,

Addison Wiggin

The 5 Min. Forecast

P.S.: Next week, we’ll do something we haven’t done for four years: We’ll make it possible for you to claim lifetime membership in all our resource services — Outstanding Investments for blue chips, Byron King’s Energy & Scarcity Investor for high-potential juniors and Alan Knuckman’s Resource Trader Alert for fast-paced commodity options.

This extraordinary package of services saves you $17,000 in membership fees in the first five years alone. It also gives you admission each year to the Agora Financial Investment Symposium in Vancouver…, where you can meet in person with legendary resource investors like Rick Rule and Eric Sprott.

Because we have only so much space in Vancouver, we must keep this offer strictly limited. When we throw open the doors next week, we’ll let only 200 people in.

If you don’t want to be shut out, you can sign up right now for our priority list — guaranteeing you’ll have the chance to review this opportunity before anyone else. There’s absolutely no obligation that comes with signing up today… so if you even think you’d be interested… let us know right here.

P.P.S.: We spent the first day of the “Chill Weekend” down here in Nicaragua, doing just that: chilling in the colonial city of Granada. The city is hosting the National Poetry Festival. The town square is rife with poets, local vendors, wandering hippies and gringos trying to enjoy their retirement funds.

More to come. We’re on our way down to the ranch, and we’ll have more time to write tomorrow. Thanks to Dave Gonigam back in Baltimore for holding down the fort.

Reserve members are advised we still have slots open for the next Chill Weekend in June. Click here for the dates and other essential info.

More on the Nicaragua project from Bill below.

Starting a business isn’t always what you expect it to be. It’s even more complicated in a postwar emerging market… as our founder Bill Bonner explores…

Business — at least in our experience of it — is much different from most people think. Businessmen are not cold and calculating. They are not trying to maximize profits at all costs. They are not necessarily rational. Not necessarily sensible. Often not very reasonable. And frequently driven more by vanity and sentimentality than the search for return on investment.

We were down in Nicaragua with a group of investors and businessmen. But they were not very businesslike at all. Our group included an Irish poet, pretending to be a tough-talking entrepreneur, a charming Palladio manque disguised as a Jewish accountant, an Italian Jesuit trying to pass himself off as a WASPy Maryland lawyer and a delightful modern Democritus impersonating an investment banker.

At issue was what to do with an investment that had gone in a very different direction than we had planned:

“Look, we came down here because we thought we could make some money,” said one of our partners. Hard on the outside, but a mushy dreamer inside, he was instrumental in laying out the original development and designing some of its most important features.

“Not just that, it looked like such a nice place. Admit it, we wanted to have fun building roads and restaurants… and riding stables. Now, we even have bulldozers and backhoes. It’s as if we were kids… playing in a sandbox.”

“Yes, but we’re a business,” said our numbers guy. “If we want to have fun, we should do it on our own… with our own money. It doesn’t make sense to involve the business in this if we’re not going to treat it in a businesslike way. You want to build a clubhouse? Go ahead. Raise the money and build it. You want to build a hospital? Great. But don’t pretend that you’re doing it for business reasons.

“Of course… I know. I’m tight. And I want a good deal for the investors. And we’re now millions in the hole. That’s a lot of money. It’s not right for us to now take the position that money doesn’t matter.”

“No, we’re not saying that,” said our lawyer. “All we’re saying, or all I’m saying, is that this is more than just an investment. It’s a community. We have legal obligations to the people in it, of course. And we have moral obligations. And we have an obligation to ourselves. This place will be here long after we are gone. We want to make it as nice as we can.”

“Well, then… let’s admit it’s not an investment,” countered the accountant. “We’ll write off the money. Take the loss. And be done with it…”

“But we’re not finished,” countered the lawyer. “We can’t walk away. And besides, we have our own houses here too… we need it to work.”

“Well, we certainly can’t continue investing money like this forever.”

The men around the table scratched their heads. They studied the numbers. They looked at plans for a new conference center. A new inn. A new entryway.

“This is just crazy… now I see how this works,” your editor interjected. “We buy land for $500 an acre. We sell it for $500,000 an acre. And we lose money over a 10-year period. Not just a few bucks. Millions.

“Who do we think we are? The U.S. government? The Fed? It is fundamentally wrong to operate this way. Because it is phony. We’re doing something that isn’t economically sound. We’re living a lie. It’s like living at a level of luxury you can’t really afford. We’ve got to find a way to make the community self-sustaining… so that we’re happy with it… and so that it can stand on its own two feet.”

“It can stand on its own two feet now,” replied the accountant. “It’s just that we keep investing to make it nicer.”

“Well, that’s got to stop… we have to be more hard-nosed about this… more like businessmen and investors…”

We all agreed.

“Hey, let’s go look at the wood shop…” said one partner

“We should build a machine shop too. I like fooling around in a machine shop,” said another.

“When are we going to put up that shopping area,” asked a third.

“You know what we should do?” your editor began. “We should build a little square… like a town square in a medieval European town. With a church. The church bell should sound every hour. And toll, of course, all day when one of us dies.”

“You guys are hopeless,” said the accountant.