Daily Bread, from Andrew Moe

September 22, 2007 |

Can the global macro boys explain to me how wheat is up 60% for the year but i can get a loaf of bread or a box of Wheaties at the same price as 2006? Would seem the producers of food hedge their costs so as to control both the cost to consumer and their profits from the best recurring biz in the world — food.

But if they hedge then of course the must hedge at certain levels and if it keeps going they must keep hedging until the reflexive traders are satisfied and in the end it seems only the consumer gets the bill, so there must be inflation upon us as a result not only of the quants but also of the global macro reflexive crowd.

Jason Thompson replies:

First, I'd very much question the observation that you are paying the same price YoY. This is certainly not the case here in Chicago as Wheaties, along with Raisin Bran, Cheerios and Cornflakes are measured as part of a basket in a private inflation survey. They are up roughly 9% 3rd Quarter to 3rd Quarter and will experience price increases (already announced by manufacturers) of 10-12% to be seen within the next six months. It's very likely what you are missing is the reduction of discounts. By this I mean there are fewer promotions, coupons to the consumer, or rebates being offered to the grocery store. The price quoted on the rack may not have changed, but the average price paid by the consumer has increased.

I'm much more perplexed by your observations on bread, as that has seen the one of the largest increases in our basket of food, outside of milk and cheese, and some fruits and vegetables. Bread here in Chicago is up 18% YoY.

David Lamb extends:

Wife I've got to be luckiest husband on Daily Spec. My wife makes our bread and she orders hard wheat for $6-$7 per 25 lb. bag. It takes 12-13 cups to produce five pounds of wheat flour, which is needed to make five loaves. We go through five loaves every week (she gives away half of it). Therefore, she spends $6-$7 per month on our breadstuffs (rolls, loaves of bread, etc).

Compared to store bought bread — well, there is no comparison, at least in taste. However, if we bought the same number of loaves at a store it would cost us, for the cheapest bread at WalMart, almost $2 a loaf. That would be $40 a month. Yes, I have seen an increase in wheat prices but the greatest wife in the world can handle it!

Riz Din replies:

The cheapest bread in the UK is less than 50p a loaf. Currently, £1 (or two UK cheap loaves) buys two dollars (or 1 US cheap loaf). Perhaps the international cheap bread arbitargeurs have helped to lower the USD/£.

Eli Zabethan explains:

Most food producers hedge out several years, but now there is little carryout as supplies are being used for alternative energy projects.

Kurt Specht replies:

It's true that most food producers (and processors) hedge out several years, but the levels of hedging and the duration can vary widely by company and by item. Several companies have cited various raw materials increases in their quarterly earnings reports this year as a cause of diminished earnings per share, but as the prices of commodities rise and more time passes, more and more of these companies will have to raise prices to keep up.

Comments

2 Comments so far

Cole Walton on September 21, 2007 3:07 pm
Perhaps you are looking at this issue from the wrong angle. Contrary to popular belief, the main profit lever for most food producers is not the cost of the raw ingredients or the price of the finished goods, but the cost of the packaging materials. The following excerpt is from the most recent General Mills press release:

“Cereal sales rose 5 percent after General Mills increased prices by reducing the size of boxes, generating higher revenue per ounce.”

As food is a rather inelastic good, I believe you are correct in asserting that food producers have a significant amount of pricing power. However, they do have to deal with market forces - mainly competition from substitutes. However, I would posit that none of these factors affect the bottom line as much as the size, shape, and materials used to package the food.
Adam Nelson on September 24, 2007 11:30 am
The answer is looking at the comment from Mr. Lamb in a different way. $6-7 (up from $4-5 a year ago–some of the bag of wheat price is distribution costs) wheat becomes approximately 20 loaves of bread (or a similar ratio of cereal). So in a $2 loaf of bread only less than $0.32 is for wheat (the distribution amount is likely to be in the loaf of bread price rather than at the wheat level). Most of the price of a loaf of bread covers machinery to make the bread, energy to cook and move the bread, rent for the store that’s convienient to your home and people to accomplish all those tasks.
A 10-15% increase in most final good prices would more than cover the increase in raw agricultural good prices to date.

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