Could raw material prices be heading for a perfect storm?

Could raw material prices be heading for a perfect storm?

We are only one poor harvest away from chaos, a leading food analyst has predicted this week. Coming in the same week as the floods in Australia, which, aside from awful social affects, will devastate the region's wheat harvest, this has thrown the spotlight squarely onto the rising prices of raw materials once again.

Meanwhile, the CEO of Carlsberg used an interview in the British media yesterday to attack the hedge funds for artificially increasing the cost of raw materials. The practice of short-selling in particular, he argued, is making an inflationary situation worse.

Presently, agricultural commodity prices are almost 50% higher than they were this time last year. A series of weather disasters have grabbed the headlines: There has been a severe drought in major wheat-producing countries such as Russia and Ukraine, whilst floods in Colombia, Brazil and Vietnam have affected the production of coffee and sugar. But, food supplies still remain at historically high levels. The reality is that demand is at the heart of the long-term trend, with a booming middle class in India and China eating more meat, leading to a hike in demand for grain for animal feed.

Financial speculators have latched on to this and the attractiveness of commodities as an investment vehicle, in otherwise uncertain times, has boomed.

All combined, we are looking at a crisis of potentially epic levels. Stable rice supplies and prices have shielded the world's poorest so far. But, it's what happens should there be an even more serious failure in the world's harvests that worries watchers. Robert Zoellick, president of the World Bank, has warned that the rising prices are "a threat to global growth and social stability".

In this environment, it is intriguing to hear corporate CEO's and poverty campaigners both play the blame game with regards to financial speculation in the market.

The role of the hedge funds in exacerbating food prices has been criticised before. But the comments from the likes of Zoellick and the very real possibility that we'll see social unrest and food shortages for some of the world's most vulnerable will place the practice under scrutiny like never before.

Looking at the UN figures, there is a clear rise in the price index in July last year when money flooded into the commodity market.

"The real reason for the large and rapid increase in wheat price lay in banks trading in exchanges in Chicago, US," an article on the website Share the World's Resources recently argued. "Away from the wildfires of Russia, hot money flooded into the wheat markets in July 2010, betting on an increase in prices."

It continued: "The ugly face of banks and hedge funds speculating on the price of food had raised its head once again."

Ultimately, the money being piled into commodity trading remains a symptom of the underlining trend rather than a de facto cause. But, it's hard not to believe that short-selling on agricultural commodities does not exacerbate the problem. The very real prospect of the terrible social consequences of spiralling costs gives the calls to rein in these trades a moral legitimacy, regardless of whether it will curb the long-term issues.