Commentary: High prices cure high prices, mostly

by Ron Sterk
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The market adage "The best cure for high prices is high prices," appears to be working for many commodity markets with the exception of crude oil, although that too shows signs of coming around.

The adage has to do with basic supply and demand, although those aren’t the only factors affecting commodity prices, considering the impact of weather, commodity funds, a weak dollar and other economic factors.

But it’s still generally true. High prices, for many commodities record high prices in the past few weeks to a year, impact supply and demand in two ways. First, for agricultural commodities high prices encourage production. Second, they may discourage demand.

Corn prices hit record highs only within the past couple of weeks, well past the time that would have prompted farmers to increase plantings. That happened a year ago when corn acreage was the largest since 1944 and prices were soaring because of increased demand from the ethanol, export and feed sectors.

Although wheat prices hit record highs in late February, prompting increases in spring wheat and durum seedings in North America, they were high enough last fall to prompt large increases in winter wheat seedings. The result, a record large world wheat crop is forecast for 2008-09. Wheat prices, meanwhile, have plunged by a third in Chicago and Kansas City and by nearly 50% in Minneapolis, on a continuous futures basis.

A similar scenario has played out in dairy products. Increasing prices in 2007, resulting in record highs for several dry dairy products around midyear 2007 and for milk late last year, encouraged producers to increase herd sizes. The resulting 2% increase projected in 2008 milk production, a whopping 3.9 billion lbs, along with resistance to high product prices, have pushed prices for dry whey down 64% from a year ago, 34% whey protein concentrate down 55%, low- and medium heat nonfat dry milk down about 30% and buttermilk powder down 40%.

Then there is crude oil. Prices recently hit record highs near $150 a barrel, but high prices appear to have neither spurred production nor reduced demand, except maybe in the U.S. Clearly the oil market plays by different rules, with supply largely controlled largely by a few nations and limited refining capacity controlled by a few companies. But crude oil prices have dipped more than $10 a barrel this week, which offers a glimmer of hope that even in that market, high prices could eventually cure themselves.

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