Are higher commodity prices here to stay?

Will commodity prices stay on this lofty plateau for the long term?

Higher commodity prices might be the rule rather than the exception in the coming years, a Purdue University agricultural economist says.

While prices regularly rise and fall, they have trended upward in a way that suggests they’ve reached a plateau, said Mike Boehlje. He attributed much of the price movement to bullish export markets, weather-shortened supplies and the effect monetary policies have had on interest rates and investors.

“This higher level may be the new normal,” Boehlje said. “But volatility has increased significantly for agricultural prices, as well as for agricultural inputs. In terms of corn, for example, it’s not unusual in the futures markets to see prices moving 30 cents or more on a daily basis. And although prices may be higher, so are costs to producers. So margins are not likely to stay unusually high.”

Corn and wheat in recent weeks have been trading in the range of $6-$7 per bushel and soybeans above $13 a bushel, about double the prices five years ago.

The strong prices are not driven just by weather and shortage of crops. A major cause of surging prices is global demand for food. While agricultural exports always have been a mainstay of the U.S. economy, they have taken on even greater prominence as personal incomes grow in developing nations, Boehlje said. Along with having more money to spend, people in those nations are demanding more and better food.

“There’s been a very rapid growth of income in Asia and, particularly, China,” Boehlje said. “They’ve been very aggressive in buying food and trying to improve their diets. That was a big part of why agriculture in the United States didn’t have the same level of pain from the recession as most of the rest of the U.S. economy.”

China is a major purchaser of U.S. grains, especially soybeans. While many nations were still reeling from the global recession, China recovered quickly and continued to import agricultural products. Concerns about inflation have since cooled China’s economic expansion, Boehlje said.

Less obvious, but significant, influences on agricultural prices are actions the Federal Reserve has taken to strengthen the U.S. economy, Boehlje said. The Fed’s moves to both keep a lid on interest rates and provide U.S. capital markets with dollars have made agriculture an attractive option for those with cash to invest.

Chairman Ben Bernanke on June 22 announced that the Fed would end its second round of Treasury bond purchases later in June. The $600 billion program, known as “quantitative easing,” contributed to a loss in dollar value. The weaker dollar further boosted U.S. exports to those nations whose currency is worth more, Boehlje said.

Bernanke also said the Fed would leave the federal funds rate – a key interest rate used as a benchmark for business and consumer borrowing – near zero percent. The fed rate has been unchanged since December 2008.

The additional liquidity in capital markets from both rounds of quantitative easing means there is more money for investors to deploy. That creates complications, however, when interest rates are at or near zero percent, Boehlje said.

Investors “need to find some place to put those funds,” he said. “And when you’ve got very low interest rates it’s not particularly attractive to put those funds into financial instruments that have low rates of return. So you start looking at other places to invest those funds.”

One attractive investment option for investors worried about possible inflation from an increased money supply and low interest rates is real goods, Boehlje said. Commodities, farmland and other real assets often are better hedges against inflation than financial assets, he said.

Although signs point to continued high commodity prices, Boehlje noted that markets can retreat at any time. He urged farmers to carefully consider any additional risk they might take in their operations and be prepared for market corrections.

“When you’re on a higher plateau you also have the potential to fall a lot further when things don’t go well,” Boehlje said. “We need to acknowledge that we do have a lot more downside potential than we might have had otherwise.”

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