Gold Will Get a Rise if It Goes With the Grain

August 3, 2012 at 08:02

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Gold is poised to get a boost from surging corn and soybean prices, as investors look to the metal as a hedge against the growing risk of global inflation.

Should an increase in global inflation raise the appeal of traditional stores of value, gold’s fortunes could change.

“Rising food prices are relevant for gold to the extent that it feeds into [the Consumer Price Index], particularly in countries that have an affiliation with gold,” like China and India, UBS analyst Edel Tully said.

Gold, which tends to maintain its value better than other assets at times of market volatility, is often sought as a store of value in inflationary environments.

“Should food inflation lead to physical gold purchases in emerging markets [that] would give investors in the West much more comfort to step back into gold again,” Ms. Tully said.

The risk of a wave of global food price inflation is growing fast, as U.S. grain and soybean prices trade close to all-time highs amid the worst drought in more than half a century.

Chicago Board of Trade soybeans for August delivery settled at $16.53 a bushel Thursday, down 1.7%, but up 3.5% from the beginning of the year. September corn futures settled at $7.94 a bushel, down 0.8% on the day but up 2.9% year to date. On July 20, soybean and corn futures hit record highs of $17.77 a bushel and $8.28¾ a bushel, respectively.

The Food and Agriculture Organization, the United Nations’ food relief agency, warns that its food-price index for July, which is scheduled to be released next Thursday, is likely to show a rebound from three consecutive months of declines.

The agency said commodity prices have started rising again, mainly because of weaker crop prospects for corn and soybeans in the U.S. Midwest. It has even decided to publish its food-price index in August, when traditionally there is an annual break, because of sharp price increases in grain and oilseed. Once this data is released, the effect of rallying corn and soybean prices will be more clear.

Food inflation is particularly acute in emerging economies, where consumers spend a significantly higher percentage of their incomes on food than in developed nations.

According to UBS, food represents 30% of China’s CPI reading and 50% of India’s. Those countries are the world’s top gold consumers, accounting for 42% of global demand in 2011, the World Gold Council says.

“In 2009 and 2010, both China and India suffered from this kind of high inflation, and it did feed into higher demand for gold in both cases,” notes BNP Paribas analyst Anne-Laure Tremblay.

High food prices can also lead to social unrest, heightening gold’s appeal as a hedge against instability, HSBC analyst James Steel said. “Sharp increases in food prices have historically introduced elements of geopolitical risks, which have been positive for gold.” He said that prices of commodities such as corn and soybeans recently topped levels seen during global food riots in 2007-2008 and the Tunisia riots in early 2011.

In China, jitters over rising food prices are evident. Producers of cooking oil, a bellwether of food prices, said last week the government advised them to avoid raising prices “unless absolutely necessary.” The move suggests that the government is wary of surging prices after a rally in U.S. grain drove up the price of Chinese soybeans. Last year, 42% of China’s soybean imports came from the U.S. and this year that figure is up to 58%, UBS said.

Determining the impact of food-price inflation on Indian gold demand poses problems, since rural India, with two-thirds of the country’s gold jewelry purchases, is facing a slow-starting monsoon season.

“A disappointing monsoon season, coupled with rising food prices, would weigh on farmers’ incomes and in turn dent gold purchases from rural areas,” said Ms. Tully. “At the same time, higher inflation could encourage buying in nonrural areas or by the more well-off segments of the rural community. The net impact is therefore less straightforward in India than in China.”