Water Wars Everywhere

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“Water water every where, nor any drop to drink”
(Samuel Taylor Coleridge, “The Rime of the Ancient Mariner”, 1798)

The world is awash in water. 70% of the planet’s surface is covered by water, and significant water is contained in frozen and gaseous forms as well.   Further, the volume of water on planet Earth has remained roughly constant for more than 1 billion years at ~344 million cubic miles. By almost any account, water is quite literally everywhere. Yet we constantly hear of impending shortages. Why? To begin, 97.5% of the water on Earth is in oceans and unfit for human consumption. This means that if all of the planet’s water filled a typical one-gallon milk container, less than a teaspoon of it would be freshwater.

The real problem is a shortage of freshwater consumable by plants, animals, and humans. By changing historical rainfall patterns and increasing the severity of storms, climate change is exacerbating the already tenuous balance of water supply and water demand. Agriculture is a primary culprit – accounting for more than 90% of freshwater use each year. The same forces driving demand for food—namely a global population boom and increasing preferences within that population for animal protein—are placing unsustainable pressure on water supplies (see my “King Morocco” piece HERE).

So what? Climate change and food-driven water demand are creating a toxic cocktail that will meaningfully shock global stability. Consider that 1 in 4 large cities are “water stressed,” according to the Nature Conservancy (see HERE). A recent Bloomberg story highlighted rising tensions between Brazilian cities jockeying over water resources (see HERE). Or let’s not forget that Barcelona actually came within days of running out of water in 2008 and actually imported a tanker of drinking water (see HERE).

Water wars are coming. The US National Intelligence Strategy (see HERE), released in September of this year highlighted the potential for water scarcity to generate instability. Further, a US intelligence community report on Global Water Security (see HERE) released in 2012 clearly warned that “During the next 10 years, many countries important to the United States will experience water problems—shortages, poor water quality, or floods – that will risk instability and state failure, increase regional tensions, and distract them from working with the United States on important US policy objectives.”

Sadly, it appears we may soon have to update Coleridge to “Water wars every where, nor any drop for peace.”

 

Falling Food, Riot Risk, & Protein Preferences

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Given the very strong relationship between food prices and food riots, the UN Food Price Index is an excellent early warning sign for forthcoming food riots. It measures the monthly change in international prices of a diversified basket of various food commodities. The following graphic illustrates the trend in index levels by year. Note the line for 2010. Now recall that the Arab Spring effectively began on December 18, 2010. Coincidence? I don’t think so.

FAO.Food.Price.Seasonal
(Source: FAO)

It appears that a level of around 210 on the food price index for any sustained period of time generates riots. Although the index averaged a problematic 209.9 in the year 2013, the index currently reads 192.3 (Click HERE for latest level). While I believe that lower food prices will in fact help food vulnerable countries like Indonesia remain (relatively) stable, there is a disturbing undercurrent we must consider.

Pardon the pun, but let’s peel the proverbial onion. The food price index is actually composed of five indices representing the prices of dairy, cereal, meat, vegetable oils, and sugar. Each of these is down on a year over year basis, with the exception of one:  meat prices.  Let’s continue peeling. The inputs into the meat price index are poultry, bovine, pig, and ovine meat product prices, implying a bigger phenomenon than dwindling US cattle stocks.

FAO.components
(Source: FAO)

The real story is one of protein preferences, and falling food prices are masking meat demand. The world is at the early stages of a forthcoming boom in animal protein consumption (See King Morocco and Protein Production Powerhouse) with wide-ranging implications. Livestock consume grains, so more demand for meat is effectively more demand for grains. Grains consume fertilizers, so more demand for grain is effectively more demand for fertilizer.

Falling food prices should buy us some time and a period of reduced riot risk; but let’s not bank on the calm lasting indefinitely; demand for protein is rising rapidly and will soon bring food prices and riot risks along with it.

 

A Wild Ride!

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What a wild ride we've had since my last update a mere six weeks ago.  My last note commented on the seemingly large disconnect between the rampant geopolitical chaos and the shockingly low volatility in asset markets.  Well, things changed in October.  The yield on the US 10-year plunged to under 2% and then rebounded.  The S&P 500 saw multiple days of 2%+ drops, and volatility spiked (the VIX skyrocketed into the 20s). But by month end, things had rebounded and since then markets have raced onward to new highs.

I recently had a chance to speak with Jeremy Grantham about his presidential cycle hypothesis.  He firmly believes that markets will race to even higher highs between now and early Spring. For sure the oil price plunge is an effective tax cut and should support discretionary consumer spending this holiday season.  While I hope he's right, I fear deflationary pressures are building rapidly in Europe and China's slowdown can't be helping. 

This mid-quarter update contains links to several comments I've made over the past six weeks.  Of particular note is a piece I wrote about Ghana (below) in which I explore a potential solution to the current crisis of confidence.

Best wishes for the remainder of 2014!
 


 

Watches, Flags, & Confidence...

My latest comment was about art markets and how the $2 billion of sales during the last two weeks have telegraphed a rapidly rising confidence.  I suggest we connect the dots between art markets, M&A activity, and global confidence.  Read more HERE.


 

Japan's Latest Export: Deflation

Japan's unprecedented economic stimulus has one very obvious impact for the rest of the world: it pushes deflation from Japan towards the rest of us.  Read my comment HERE.


 

Saudi Sows Budget Busts

Why the heck is Saudi Arabia, the traditional arbiter of world oil production, pumping more oil in the face of an oversupplied world?  Read my thoughts HERE.


 

One Child Ripples...

What are the global implications of China's one child policy?  In this brief comment, I consider some ramifications--including the ongoing economic slowdown in China.  My comment is available HERE.


 

King Morocco

The true beneficiary of the ongoing and structural boom in animal protein consumption may be Morocco, a desert nation in Northwest Africa.  Read my comment HERE to understand my thesis.


 

Hong Kong Gong

The unrest in Hong Kong may be pointing at a larger problem: a world with Chinese characteristics.  Read my comment HERE


 

Gloomy Ghana

My thoughts on a country that went from the world's fastest growing economy to one fighting a crisis of confidence.  Read my comment HERE

Wonderful Watch, Fabulous Flag, and Corporate Confidence

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Recent art market activity has been spectacular. Record prices have been set in numerous categories ranging from watches to paintings. Contemporary art has been catching the attention of many, and bidding activity has been frenetic with many lots selling in excess of estimated prices.

Consider the fact that the Henry Graves “Supercomplication” timepiece sold last week at Sotheby’s for more than $24 million, setting a new world record price for a watch. The prior record was $11 million (See WSJ article here). Another noteworthy sale was a placemat-size Jasper Johns painting of an American flag. It was estimated to sell between $15 and $20 million, against a prior record of ~$29 million for a Johns painting. When the gavel fell, the winning price was $36 million.

The geographic breadth of art buyers participating in art auctions has been rapidly rising. Sotheby’s noted that yesterday’s contemporary art sale at which the Johns painting sold had bidders participating from 38 countries. (See Sotheby's release here).

So What? Art markets tend to be a good indicator of global confidence. Why’s that? Although art prices tend to appreciate over time, art markets tend to be based on expectations—the expectations of sellers, of buyers, of appraisers, etc.  Art markets are therefore cyclical.  Remember also that many buyers of high-priced art are themselves corporate and economic leaders.  As such, their personal bidding behavior provides an insightful glimpse into their confidence as business leaders. Corporate confidence is clearly rebounding.  It's not surprising to me that corporate mergers are also booming.  Art markets, merger activity, and corporate confidence are dots worth connecting.

Because rapidly rising confidence can quickly turn into overconfidence, art markets can telegraph bubbles before they burst. (See “The Art of Spotting Bubbles” and “Sotheby’s: The World’s Best Overconfidence Indicator”). While these markets are obviously heating up, they are not pointing to any specific bubble dynamic yet.  However, they're definitely not flashing "all clear" either.   There is insight in art…even if you’re not an art enthusiast or collector. Recent activity serves as a useful reminder to watch watches and pay attention when flags rise to new records…

 

Japan’s Latest Export: Deflation

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The Bank of Japan's announcement last Friday of additional "quantitative and qualitative easing" to stimulate its economy sent many equity markets racing towards multi-year highs.  The enormous monetary stimulus (~16% of GDP/year) was also accompanied by news that the country's pension assets would be more equities-oriented.  The primary objective: shake the  deflationary pressures that are returning after the consumption tax increase and help cement inflation expectations.  One of the most noteworthy impacts of this policy announcement was the chaos it produced in currency markets.  The Yen plunged against the dollar.  A mere two years ago, it only took 80 Yen to buy one dollar.  Today it will cost you ~114 Yen.

So What?  In addition to impacting export competitiveness, currency moves also reallocate inflation and deflation pressures.  The Yen is no exception, and the recent depreciation will have meaningful implications for Europe, the United States, and the entire world economy.  To illustrate the dynamics, let's use a simple example.  Suppose that imported beef costs $5/pound and the price has remained constant over the past two years.  Two years ago, the cost was 400 Yen/pound.  Today, that same beef costs 670 yen/pound...meaning that a weaker currency translated into higher import costs.  Further suppose that Japanese yellowtail costs 800 Yen/pound and has remained so for the last two years.  This means that foreigners buying this fish will now pay ~US$7/pound versus the prior US$10/pound.  Because of the falling Yen, Japan is now importing inflation and exporting deflation.

This has big ramifications for Europe, which is already suffering from falling prices and is trying to generate inflation.  Japan exporting deflation to Europe does not help.  Might the ECB have to amplify its already loud efforts?  It also has major implications for the United States, where imported deflation may allow the Fed to be looser for longer, possibly even driving US asset markets towards bubbly levels. Lastly, consider the fact that 13 OECD countries have negative CPI readings and that another 8 are below 1%.  Add to these deflationary pressures recent advances in robotics, the North American energy revolution, excess capacity in China, and demographic headwinds in most large economies.  Now sprinkle a healthy serving of debt across most economies.  Might this toxic cocktail be foreshadowing toxic wealth-destroying debt-deflation dynamics?

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