Looking back at the last bull market could offer invaluable advice for the next few years.
Coinciding with the start of harvest 2011, the grain markets staged a welcome surge. These spikes have become more common in recent years as the European market has become less managed and more open to global volatility.
It is perhaps worth looking back a few years at the last bull market, and seeing what lessons might be drawn. What led to the grain price spike in 2007 and 2008? It was not simply down to unregulated market forces at work, allowing grain stocks to fall which then led to massive price hikes. It was rather more complex. We outline the individual elements to better understand the whole.
In the 1990s, grain reserves were gradually building up across the world. Central governments, for either strategic or price management reasons, wished to hold significant stocks.
Around 2000, strategic security started to be seen as less necessary. Government policies globally switched to gradually releasing stocks and discouraging wheat production. For example, in China various incentives to produce wheat were dismantled and fresh produce was encouraged. Throughout this period, the EU intervention stockpile was gradually liquidated, and commercial holders of grain steadily reduced their held quantities.
This gradual release added to harvest volumes generating ample grain for consumers' demand, and thereby depressing prices. This low price discouraged grain production.
When the stock liquidation ended, the availability of grains fell as farming had adjusted its production to meet demand (less stock liquidation). This was suddenly insufficient, pushing prices up fast. At the same time demand was rising strongly due to economic growth and the biofuels industry.
It only takes a small shortage to create a large price rise as consumption of staples is inelastic to price (people eat bread whether they are rich or poor – they eat bread whether cheap or dear). The only scenario more costly for processors than expensive raw materials is no raw materials. In order to ensure continued supply, consumers bought heavily. The level of speculation in grain markets was also increasing exponentially.
There is nothing more 'bearish' than a high price. It encourages the consumer to use less and the producer to produce more. For harvest 2008 record grain yields were documented throughout the world, not because weather conditions were good, but because farmers were using more inputs to ensure high yields. Consumers that season also became more careful with the use of grain. For example, many biofuel plants were idled or closed.
Since then, food security policies have changed again. Some countries have reintroduced grain storage programmes, others have policies to manage the availability of inputs such as fertilisers and so on, and others have been taking long-term leases of land in other countries (the so called 'land grabs').
The volatility we saw between 2007 and 2009 was as a response to the specific factors discussed above (and some others too). It implies that this level of price volatility, i.e. a doubling of prices in a matter of months, is not likely to happen again in the short term. As we have seen in the past few weeks, volatility has not gone away, but the events of two or three years ago may well not be repeated until a similar number of factors come together again.
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