Absorbing the Food Shock of 2011

The agricultural price spike of 2008 unleashed riots in more than 30 countries and forced companies into bankruptcy. It lasted five months. The latest rise in commodity prices, which has already helped topple regimes in Tunisia and Egypt, may last many more months, if not years. "If you are not scared, you are not paying attention," says David Nelson, a global strategist in the food and agribusiness research advisory unit of Rabobank in Chicago. "There is no margin for error with these agricultural markets." That prospect has governments and companies around the world searching for ways to profit or insulate themselves from price shocks.

A growing, more prosperous global population is draining stores of grain and meat. Corn inventories—used in food, feed, and fuel—will fall to just 53 days, a 37-year low, before harvest in the northern hemisphere begins, according to the U.S. Agriculture Dept. Soybean stockpiles worldwide may be the lowest in almost 18 years. Tight inventories and a recovering global economy set this rally apart from the abrupt rise and fall in 2008. That's when crude oil led commodities higher in February, and a plunge in food demand amid the recession pulled prices down in July. "This one is different," says Dennis Gartman, an economist and editor of The Gartman Letter, a market tracker. "This is sustainable. We're coming out of global recession, and we're going into global strength."

Deere & Co. (DE), the world's largest farm-equipment maker, is building factories in emerging markets to capitalize on this growing appetite. The Moline (Ill.)-based company in January announced a $100 million investment in India, where Deere will also court small-scale farmers both with a cheaper tractor one-tenth the power of U.S. models and a program that enables them to share equipment. "A farmer on one hectare of land could never afford that tractor," says Chief Executive Officer Samuel Allen. Yet "if you help them mechanize, that helps them go from using an ox to a tractor."

Other companies are lobbying Washington to boost the number of U.S. acres that can be farmed. The Andersons (ANDE), a Maumee (Ohio) grain merchandiser and elevator operator, is calling for the temporary removal of some of the 31.2 million acres set aside by the federal Conservation Reserve Program. The CRP pays farmers to leave land idle as a way of preventing soil erosion and other environmental damage. "We need to have large enough crops where we can stop the decline and start to replenish," says Hal Reed, president of Andersons' grain and ethanol group and chairman of the Washington-based National Grain and Feed Assn. "To do that, there aren't enough acres to be planted."

Once farmers harvest the grain, governments are finding new ways to secure supplies and temper prices. South Korea, where inflation of food and nonalcoholic drinks reached at least a 10-year high of 14.1 percent in October, is setting up a trading firm in Chicago to buy grain. It's one of the steps the country, which will soon be importing nearly all of its corn, is taking to secure food at a reasonable price. The state-run Korea Agro-Fisheries Trade Corp. will team up with private companies to establish the firm. The goal is to handle about 30 percent of South Korea's annual imports by 2020.

To tame food prices after drought damaged crops last year, Ukraine has started to work with Leo Melamed, the chairman emeritus of Chicago-based CME Group (CME), to develop its own wheat futures market. A futures exchange would dampen price surges, since farmers could use it as a hedge to reduce losses when crops fail, giving them confidence to plant more in seasons to come. "Over the long run it smoothes out peaks and valleys," says Melamed, who introduced currency futures in 1972.

Companies that buy grains are also preparing themselves for higher, more volatile prices. Sanderson Farms, the fourth-largest U.S. chicken producer, in February said it would delay plans to build a new processing plant in North Carolina until there is "some visibility" regarding crop prices in 2011. In Sanderson's first fiscal quarter, feed, made up of corn and soybean meal, accounted for 52 percent of the cost of producing chickens. Meat processors want to avoid the fate of Pilgrim's Pride, which was pushed into bankruptcy protection in 2008, partly by high feed costs. Corn and soybean futures traded in Chicago rose 52 percent and 34 percent, respectively, in 2010. "There may be gyrations, wild gyrations, this spring and summer during the planting season, if it's wet or dry," says Sanderson CEO Joe F. Sanderson Jr. "It could just be explosive."

The bottom line: Governments and companies must act aggressively to contain the risk from what is expected to be a long-term rise in food prices.

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