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Why oil prices are falling despite the rise of ISIS

oil

Vivek Kaul

All other things staying the same, oil prices have always been inversely proportional to peace in the Middle East. The moment any tension or war breaks out in the Middle East, oil prices start rising. The logic is pretty straight forward given that the region has some of the biggest oil fields in the world and produces bulk of the oil that the world consumes.
Any tension is seen as a threat to supply of oil in the future, and taking that possibility into account, oil prices start to go up.
But this theory doesn’t seem to be working in the recent past. The Islamic State of Iraq and Syria (ISIS) has been waging a war in the region for a while now, but oil prices instead of going up, have been coming down. The international crude oil price of Indian Basket as on September 30, 2014, stood at $ 95.34 per barrel (bbl). The price must have fallen more since then, but no new data has been released given that the government has been on a five day holiday.
The brent crude oil is currently trading at around $92.8 per barrel. This is a fall of more than 19% since June 2014. The more ISIS has grown stronger in the Middle East, the more oil prices have fallen.
How does one explain this dichotomy? There are multiple reasons behind this. ISIS has managed to capture the largest oilfield in Syria and now controls 60% of the oil production in the country. Nevertheless this has had no impact on the price of oil globally. The reason for this is straightforward. Syria is the 32nd largest producer of oil in the world and in 2013 produced only 0.48% of the oil produced globally.
ISIS has also managed to take over a number of oil fields in Iraq. But they haven’t been able to move into the Southern part of the country where the majority of the oilfields are located. Iraq is the seventh largest producer of oil in the world and in 2013 produced around 3.75% of global oil. Hence, any disruption of oil supply in Iraq will have some impact on global prices. But that hasn’t happened.
As Crisil Research explains in a research report titled Falling crude, LNG, coal prices huge positive for India “This is because the likelihood of Islamic State progressing towards southern Iraq, which has about 65-70% of the country’s oil production and reserves, seems minimal. For one, that part of Iraq is dominated by Shia Muslims who do not support Islamic State.”
Further, ISIS also needs money to keep running their operations. And that means that they need to keep pumping oil out of the oilfields that they have captured. The oil is sold at a discount to the world price of oil, to Turkey, which in turn, resells it in Europe. This is another reason why oil prices haven’t risen. The supply from the captured oilfields is still hitting the world market.
Over and above this, the oil supply from Libya is coming back. A newsreport points out that Libya is pumping close to 925,000 barrels of oil per day. This has been the highest since Muammar Gaddafi was overthrown from power in Libya. Libya in 2013 produced around 0.85% of global oil production. These are the short term reasons as to why the price of oil hasn’t gone up, despite the advance of the ISIS.
There are several long term reasons as well. The United States and Canada are producing much more oil than they were a few years back. Data from the U.S. Energy Information Administration shows that United States in 2013 produced 12.35 million barrels per day. This is a massive increase of 35% since 2009. A recent report in the www.businessinsider.com points out that “In 2010 the [United States] still imported half of the crude it consumed, but the U.S. Energy Information Administration forecasts that will fall to little more than 20 percent next year.”
In case of Canada the production has gone up by 22.8% to 4.07 million barrels per day between 2009 to 2013. This massive increase in oil production has come from a boom in shale oil output. As a recent report in the Financial Times pointed out “Booming shale oil output has pushed US production to a 28-year high at the expense of imports.”
This has led to a situation where the United States has stopped importing oil from countries it was doing earlier. Take the case of Nigeria. The country did not import a single barrel of oil to the United States in July 2014. The country till four years back was one of the top 5 exporters of oil to the United States.
In fact as a October 2 blog on the Financial Times website points out “At its peak in February 2006, the US imported 1.3m b/d from Nigeria – equal to roughly one super-tanker the size of the Exxon Valdez every day. By 2012, Nigeria was already selling just 0.5m b/d, but was still one of the top-5 suppliers to the US, alongside Saudi Arabia, Canada, Mexico and Venezuela.”
Columbian oil exports to the United States have also fallen by a one third up to July this year, in comparison to the same period last year.
All this oil which was going to the United States earlier is now hitting the world market and is a major reason why oil prices have not rallied in the recent past. Interestingly, the US production of oil is now more than one third of the oil being produced in the Middle East. All this has had a huge impact on oil prices given that the United States is the biggest consumer of oil in the world.
Higher supplies from Iran are also expected to hit the market. Currently the country is facing international sanctions and is not allowed to sell a major portion of the oil that it produces. In 2013, Iran produced 4.77% of the total global oil production and was the fourth largest producer of oil in the world. As Crisil Research points out “In case of Iran, production is expected to return to the pre-sanctions levels of 4.4 mbpd from current levels of 3.1 mbpd as Iran is expected to co-operate with the international community after the change of regime post-elections.”
This is expected to happen because over the last two years international sanctions have had a severe impact on Iran. “In 2012 and 2013, Iran’s GDP registered a negative growth, inflation rose more than 60% cumulatively, and Iranian Rial depreciated by more than 85% cumulatively. Since Iran’s economy is oil-dependent, with oil exports contributing to ~85% of total exports, it will have to increase its oil exports to repair its economy,” Crisil research points out.
All these reasons, along with the fact that China’s economic growth is slowing down have ensured that oil prices haven’t gone up in the recent past. China is the second largest consumer of oil in the world after the United States.
In the recent past several analysts have suggested that Saudi Arabia and United States are working together to drive down the price of oil. This is being done to cut off the funding of ISIS. As oil prices fall, the price at which ISIS will have to sell oil will fall further. And that way, they amount of money they earn will come down. The question that needs to be answered is that how much truth does this theory have. I will try and answer that in the next piece. Watch this space.
The article originally appeared on www.FirstBiz.com on Oct 7, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

US shutdown no big deal, expect bigger crisis on 17 October

platinum_coinVivek Kaul
 Starting today nearly 800,000 of the 2.1 million people that work directly for the government of the United States of America, have been asked to go on an unpaid leave, leading to non essential services from national parks to museums to libraries being shut down temporarily. The call centres of the Internal Revenue Service(IRS or the equivalent of the income tax department in India) won’t work and nearly 90% of the workers of the Environmental Protection Agency, won’t be at work either. NASA or the National Aeronautics and Space Administration has also more or less been shut down, except its mission control centre at Houston, Texas. Services like rubbish collection and street cleaning stand suspended as well.
Nearly a million workers have been asked to work without pay. This will ensure the continuation of essential services like military, postal service and police. Airport security and air traffic control will also carry on their work as usual.
So what is happening here? The US budget year ends on September 30 every year. A ‘shutdown’ comes into the picture when the American Congress (the equivalent of what we call the Parliament in India) does not pass appropriation bills to fund the ‘discretionary’ spending programmes. The discretionary spending programmes need to be funded every year.
As Matthew Yglesias writes on www.slate.com “Discretionary spending…is money that Congress appropriates on what’s traditionally been an annual cycle. A law is passed saying that such-and-such agency has X amount of money to spend over such-and-such amount of time on this or that.” What is not categorised as discretionary spending is ‘mandatory’ spending. This includes social security, medicare (a form of medical insurance) and some farm subsidies. This spending continues as usual.
The two houses of the American Congress are currently in a logjam. The House of Representatives is dominated by the Republican Party and the Senate is dominated by the Democratic Party. The Republicans want the Affordable Care Act (better known as Obamacare, and an Act which aims to improve the quality of health insurance, at the same time making it more affordable ) to be pushed forward by a period of one year. They have made this a condition for passing a temporary budget to fund the ‘discretionary’ spending of government.
The Democrats on the other hand are in no mood to relent given that the Affordable Care Act is something that President Barack Obama has been closely associated with. Hence, the two political parties have been at loggerheads. As Yglesias writes “When the parties in Congress can’t come together on appropriations bills, they often pass what’s known as a continuing resolution that essentially instructs the government to extend the last appropriations bill forward in time…House Republicans keep writing new continuing resolutions that fund the government while simultaneously delaying or repealing key elements of the Affordable Care Act. Senate Democrats keep taking those provisions out and sending the “clean” continuing resolution back to the House. Absent a continuing resolution, the discretionary portions of the federal government lack funding to continue their work and the government goes into “shutdown.””
With no money coming in the non-essential services are being shutdown. As The New York Times reports “The Office of Management and Budget issued orders that “agencies should now execute plans for an orderly shutdown due to the absence of appropriations” because Congress had failed to act to keep the federal government financed.”
The shutdown will impact the American economy depending on how long it continues. Estimates made Goldman Sachs suggest that a two day shutdown could slowdown the economic growth rate during the period October-December 2013 by 0.1%. A longer shutdown of a week could shave of 0.3% from the economic growth.
Nevertheless, the American government partially shutting down should not be seen as a big worry. The bigger worry is set to come on October 17, later this month. On that day the American government is expected to hit its debt ceiling. The American government spends more than what it earns. In order to make up for the difference it sells bonds and takes on debt. There is a maximum amount of debt that it is allowed to take on, and which currently stands at $16.69 trillion. This limit is likely to be exhausted by October 17, 2013.
If the debt ceiling is not raised the American government will have to stop borrowing and start cutting its expenditure. AsEric Posner writes on Slate.com “If the debt ceiling is not raised, and the executive branch stops borrowing, the government will need to cut spending by about 15 to 20 percent—or almost 40 percent of spending on everything (yes, Medicare and defense) other than the interest on the debt.”
The impact of the cut in expenditure will be immediate. As Henry J Aaron writes in The New York Times “A decision to cut spending enough to avoid borrowing would instantaneously slash outlays by approximately $600 billion a year. Cutting payments to veterans, Social Security benefits and interest on the national debt by half would just about do the job. But such cuts would not only illegally betray promises to veterans, the elderly and disabled and bondholders.”
Also, the American government has reached a stage where it pays the interest on past debt by selling new bonds and taking on more debt. Any decision to stop paying interest on bonds will lead to a global financial crisis. As Posner writes “ If he(i.e Obama) stops interest payments, the United States will default. This will not only raise interest payments—costing taxpayers hundreds of billions of dollars—but could spark a financial panic like the meltdown of 2008.”
If this situation arises, there is not much that President Obama will be able to do. He will basically have three options. “One is President Obama could decide that the government’s legal obligation to spend (and certain elements of the 14thAmendment) trump the statutory debt ceiling, and just order the Treasury to sell more bonds. The second option is Obama could instruct the Treasury to pay some of the government’s bills and just not pay the rest. The third option is to pay nobody. All three of these options face the same basic problem of seeming to be illegal. (The second one also faces the problem that Treasury says it lacks the logistical capacity to do it),” writes Yglesias.
Also, there are no legal provisions to decide which expenditure should be cut first. “There is no clear legal basis for deciding what programs to cut. Defense contractors, or Medicare payments to doctors? Education grants, or the F.B.I.? Endless litigation would follow. No matter how the cuts might be distributed, they would, if sustained for more than a very brief period, kill the economic recovery and cause unemployment to return quickly to double digits,” Aaron points out.
Given this, the Republicans and the Democrats need to start talking pretty soon, or we will have another crisis on our hands pretty soon.
The article originally appeared on www.firstpost.com on October 1, 2013
 (Vivek Kaul is a writer. He tweets @kaul_vivek)
 

Why Moily’s idea of buying oil from Iran won’t work

M-Veerappa-Moily_0Vivek Kaul
India is thinking of importing more oil from Iran than it currently does. In a letter to the Prime Minister Manmohan Singh, oil minister Veerapa Moily, suggested that “An additional import of 11 million tonnes during 2013/14 would result in reduction in forex outflow by $8.47 billion (considering the international price of crude oil at $105 per barrel).” (As reported by Reuters).
This is because Iran accepts payments in rupees and not dollars as is the case with most of the other oil exporters. This will help India save precious foreign exchange.
While theoretically this idea makes immense sense, it is not really a solution that India will be able to execute. The United States and the European Union have placed sanctions on Iran over its nuclear programme. As Reuters reports “U.S. and EU sanctions placed on Iran over its nuclear programme have reduced its oil exports more than half from pre-sanction levels of about 2.2 million barrels per day (bpd). In the first half of 2013, imports of Iranian oil from its four biggest buyers – China, India, Japan and South Korea – fell more than a fifth from a year ago to around 960,000 bpd.”
India’s oil imports from Iran have declined by 46% to 185,700 barrels per day during the first seven months of the year, in comparison to the same period last year. And this is because of the sanctions.
Oil is bought and sold internationally in dollars. This started sometime after the Second World War. President Franklin D Roosevelt realised that a regular supply of oil was very important for the well being of America or what came to be known as the great “American dream”.
After the end of the Second World War Roosevelt travelled quietly to USS Quincy, a ship anchored in the Red Sea. Here he was met by King Ibn Sa’ud of Saudi Arabia, a country, which was by then home to the biggest oil reserves in the world.
The obsession of the Untied States with the automobile had led to a swift decline in domestic reserves, even though America was the biggest producer of oil in the world at that point of time. The country needed to secure another source of assured supply of oil. So in return for access to oil reserves of Saudi Arabia, King Ibn Sa’ud was promised full American military support to the ruling clan of Sa’ud. This oil was sold in dollars.
This was one of the major reasons behind the dollar becoming the international reserve currency. Every country in the world needed oil. And for countries that did not produce enough of their own oil they needed dollars they could use to buy oil from other countries.
This continued till the 1970s. In the seventies, after the end of the gold standard, the dollar started to lose value rapidly against other currencies and against gold. This meant that the purchasing power of the OPEC countries which sold oil in dollars and then used those dollars to import goods they did not produce, came down dramatically.
As William Greider writes in Secrets of the Temple: How the Federal Reserve Runs the Country “The dollar had already lost one-third of its value in only half a dozen years and seemed headed toward even steeper decline… Oil trades worldwide in dollars and if the U.S. was going to permit a free fall in the dollar’s value, that meant the oil-producing nations would received less and less real value for their commodity.”
One impact of this was OPEC countries raising the price of oil. Another impact was that some of the OPEC countries wanted to price oil in several currencies rather than just the American dollar. Jahangir Amuzegar, who was an economist by training, and had been a minister in the government of Iran, as well as a negotiator for OPEC, outlined some of these proposals in a 1978 article. In this article he outlined several currency combinations that could be used to price oil. Iraq, Qatar, United Arab Emirates and Venezuela were in support of this plan.
The idea was not to be dependent on one currency, but a number of currencies and hence iron out any fluctuations in the value of one currency. Moving to a basket of currencies at that point of time clearly made sense for OPEC as far as future revenues were concerned.
As per estimates of the US department of treasury, Saudi Arabia, the largest member of OPEC, would have been better off if it had priced oil in a basket of currencies instead of the dollar, in all but 18 months since 1973.
So what was stopping Saudi Arabia and OPEC from moving to pricing oil in a basket of currencies rather than the dollar? As David E Spiro writes in The Hidden Hand of American Hegemony: Petrodollar Recycling and International Markets: “The Saudis, however, had the greatest proportion of dollar-denominated reserves in OPEC. This means that their reserves were diminished by the depreciation of the dollar (compared to the basket of their imports). But it also meant that they had the most to lose if a shift by OPEC to a basket of currencies threatened international confidence in the dollar. Having agreed to invest so much in dollars, the Saudis now shared a stake in maintaining the dollar as an international reserve currency. On the one hand dollars constituted 90% of Saudi government revenues in 1979, and those revenues were subject to the same fluctuations as the dollar. On the other hand, the Saudi investments were, roughly at same time 83% dollar denominated. The choice was whether to stabilise current revenues threatening the worth of all the past revenues (since invested in dollar assets).”
Also, as mentioned earlier, Roosevelt had stuck a deal with the ruling clan of Al Sa’uds. It is important to remember that the American security guarantee made by President Roosevelt after the Second World War was extended not to the people of Saudia Arabia nor to the government of Saudi Arabia but to the ruling clan of Al Sa’uds. So they had an intrest in selling oil in dollars and keeping the dollar going as an international reserve currency.
Also other than being the largest producer of oil Saudi Arabia also had the largest reserves among all OPEC countries. It had 39% of the proven OPEC reserves. Within OPEC it had the almost unquestioned support of what were known as the sheikhdom states of Bahrain, Kuwait, United Arab Emirates and Qatar. These countries faced threats from other OPEC members like Iraq and Iran. For many years, Iraq had been eyeing Kuwait. It had tried to annex Kuwait in 1961 (and then again in the early 1990s).
Hence, the support of Saudi Arabia, the largest nation in the region, was important for them. If we added the reserves and production of the sheikdom countries which supported Saudi Arabia, they were together responsible for 50% of OPEC’s production and owned nearly 61% of its proven reserves. So, when Saudi Arabia made the decision that OPEC oil would be continued to be priced in dollars, there wasn’t much option for the other OPEC members but to follow what the largest member had decided.
What this brief history of oil tells us is that for dollar to continue being an international reserve currency, it is very important that oil continues to be sold in dollars. Other countries need to earn these dollars whereas the United States has the exorbitant privelege of simply printing them and spending them.
Iran has been trying to challenge this hegemoney of the dollar for a while now. It has been trying to move the buying and selling of oil away from the US dollar. In late 2007, Iran claimed to have moved all of its oil sales to non dollar currencies, with most of it being sold in euros and a small part in yen. There were no independent reports confirming the same.
The United States and Iran have been at each other’s throats since the 1979 revolution in Iran which overthrew the King. Lately there has been tension because of Iran’s nuclear programme.
Mahmoud Ahmadinejad, who was the President of Iran till around a month back, has called the dollar “a worthless piece of paper”. News reports suggest that Iran has started accepting renminbi from China and rubles from Russia in lieu of the oil that it exports to these countries.
In fact in a November 2007, summit of OPEC, Iran had suggested that OPEC oil should be sold in a basket of currencies rather than the American dollar. But it did not get the support of other members except Venezuela. Hugo Chavez, the late President of Venezuela, was known to be a vocal critic of the United States. 
On February 17,2008, Iran set up the Iranian Oil Bourse, for the trading of petroleum, petrochemicals and natural gas, in currencies other than dollar, primarily the euro and the Iranian rial. But the exchange since inception has not traded in oil but products made out of oil which are used as a feedstock in pharmaceutical and plastic industries.
Reports in the Iranian press suggested that the bourse started trading oil in non dollar currencies from March 20,2012. India wanted to pay for Iranian oil, either in gold or in rupees. If India paid in rupees, Iran could use those rupees to import goods from India.
This move to pay for oil in rupees or gold was a clear attempt to undermine the dollar in the buying and selling of oil, something that keeps the dollar at the heart of the international financial system. Hence, great pressure was applied by America on India to stop its oil imports from Iran and source its needs from some other producer.
India’s oil imports from Iran in April 2012 fell by 34.2% to 269,000 barrels per day from 409,000 barrels per day in March 2012. The government of India asked the Indian oil refiners to cut Iranian oil imports and they obliged.
What this tells us in a very clear way is that even though the US dollar may not be in the best of shape, but any attempts to mess around with its international ‘currency’ status will not be taken lying down. And for dollar to maintain its international currency status it is important that oil continues to be bought and sold in dollars.
So if the United States could pressurise India into cutting down its oil purchases from Iran in March 2012, it can do the same in September 2013. Any move away from dollar , which in turn will undermine access to “easy money” which has been so important to what is now called the American way of life.
Also it is best to remember that financially America might be in a mess, but by and large it still remains the only superpower in the world. In 2010, the United States spent $698billion on defence. This was 43% of the global total.
The article originally appeared on www.firstpost.com on September 2, 2013 
(Vivek Kaul is a writer. He tweets @kaul_vivek) 
 

Why you should be nice to your mom – and buy some gold

 

Vivek Kaul
So let me start this piece by admitting Ben Bernanke, the Chairman of the Federal Reserve of United States (the American central bank) has proven me wrong.
I was wrong when I recently said that the Federal Reserve would not initiate a third round of quantitative easing (QE), before the November 6 presidential elections in the United States. (you can read about it here).
Bernanke announced late last night that the Federal Reserve would buy mortgage backed securities worth $40billion every month. This will continue till the job scenario in the United States improves substantially. The Federal Reserve will print money to buy the mortgage back securities.
I concluded that the Federal Reserve wouldn’t announce any QE till November 6, primarily on account of the fact that Mitt Romney, the Republican nominee for the Presidential elections, has been against any sort of QE to revive the economy.
“I don’t think QE-II was terribly effective. I think a QE-III and other Fed stimulus is not going to help this economy…I think that is the wrong way to go. I think it also seeds the kind of potential for inflation down the road that would be harmful to the value of the dollar and harmful to the stability of our nation’s needs,” Romney told Fox News on 23 August. This had held back the Federal Reserve from initiating QE III.
But from the looks of it Bernanke doesn’t feel that Romney has a chance at winning and that he is more likely than not going to continue working with Barack Obama, the current American President.
This round of quantitative easing is going to help Obama and hurt Romney. Let me explain. The theory behind quantitative easing is that when the Federal Reserve buys mortgage backed securities (in this case) by printing dollars, it pumps in more money into the economy. With more money in the economy, banks and financial institutions it is felt will lend that money and businesses and consumers will borrow. This will mean that spending by both businesses and consumers will start to up. Once that happens the economic scenario will start improving, which will lead to more jobs being created.
But as I said this is the theoretical part. And theory and practice do not always go together. Both American businesses and consumers have been shying away from borrowing. Hence, all this money floating around has found its way into stock and commodity markets around the world.
As more money enters the stock market, stock prices go up and this creates the “wealth effect”. People who invest money in the market feel richer and then they tend to spend part of the accumulated wealth. This, in turn, helps economic growth.
As Gary Dorsch, an investment newsletter writer, said in a recent column, “Historical observation reveals that the direction of the stock market has a notable influence over consumer confidence and spending levels. In particular, the top 20% of wealthiest Americans account for 40% of the spending in the US economy, so the Fed hopes that by inflating the value of the stock market, wealthier Americans would decide to spend more. It’s the Fed’s version of “trickle down” economics, otherwise known as the “wealth effect.””
When this happens, the economy is likely to grow faster and hence, people are more likely to vote for the incumbent President. As Dorsch explains “Incumbent presidents are always hard to beat. The powers of the presidency go a long way…In the 1972 election year, when Nixon pressured Arthur Burns, then the Fed chairman, to expand the money supply with the aim of reducing unemployment, and boosting the economy in order to insure Nixon’s re-election.”
Bernanke is looking to do the same, even though he has denied it completely. “We have tried very, very hard, and I think we’ve been successful, at the Federal Reserve to be non-partisan and apolitical…We make our decisions based entirely on the state of the economy,” the Financial Times quoted Bernanke as saying. Given this, Romney has been a vocal critic of quantitative easing knowing that another round of money printing will clearly benefit Obama.
Other than Obama and the stock markets, the other big beneficiary of QE III will be gold. The yellow metal has gone up by around 2.2% to $1768 per ounce, since the announcement for QE III was made. In fact the expectation of QE III has been on since the beginning of September after Ben Bernanke dropped hints in a speech. Gold has risen by 7.3% since the beginning of this month.
This is primarily because any round of quantitative easing ensures that there are more dollars in the financial system than before. The threat is that the greater number of dollars will chase the same number of goods and services. This will lead to an increase in their prices. But this hasn’t happened till now. Nevertheless that hasn’t stopped investors from buying gold to protect themselves from this debasement of money. Gold cannot be debased. Unlike paper money it cannot be created out of thin air.
During earlier days, paper money was backed by gold or silver. When governments printed more paper money than the precious metals backing it, people simply turned up with their paper at the central bank and government mints, and demanded that paper money be converted into gold or silver. Now, whenever people see more and more of paper money being printed, the smarter ones simply go out and buy that gold. Hence, bad money (that is, paper money) is driving out good money (that is, gold) away from the market.
But that’s just one part of the story. The governments and central banks around the world, led by the Federal Reserve of United States and the European Central Bank, are likely to continue printing more money, in the hope that people spend this money and this revives economic growth. This in turn increases the threat of inflation which would mean that the price of gold is likely to keep going up. “Gold tends to benefit from easy-money policies as investors utilize the precious metal as a hedge against potential inflation that could ultimately result from the Fed’s policies,” Steven Russolillo, wrote on WSJ Blogs.
Market watchers have also started to believe that the Federal Reserve is now only bothered about economic growth and has abandoned the goal of keeping inflation under control. Growth and inflation control are typically the twin goals of any central bank.
“They are emphasizing the growth mandate, and that means they don’t care about inflation other than giving lip service to it,” Axel Merk, chief investment officer at Merk Funds, told Reuters. “The price of gold will do very well in the years to come,”he added.
Something that Jeffrey Sherman, commodities portfolio manager of DoubleLine Capital, agrees with. “The Fed’s inflationary behavior should be bearish for the dollar in the long run and drive investors to seek protection via the gold market,” he told Reuters.
Also unlike previous two rounds of money printing there are no upper limits on this QE, although at $40billion a month it’s much smaller in size. QE II, the second round of money printing, was $600billion in size.
Something that can bring down the returns on gold in rupee terms is the appreciation of the rupee against the dollar. Yesterday the rupee appreciated against the dollar by nearly 2%. This is happening primarily because the UPA government has suddenly turned reformist.  (To understand the complete relationship between rupee, dollar and gold, read this).
In the end let me quote William Bonner & Addison Wiggin, the authors of Empire of Debt — The Rise of an Epic Financial Crisis. As they say “There is never a good time to die. Nor is there a good time for a crash or a slump. Still, death happens. Be prepared. Say something nice to your mother. Offer a bum a drink. And buy gold.”
So be nice to your mother and buy gold.
Disclosure: This writer has investments in gold through the mutual fund route.
(The article originally appeared on www.firstpost.com on September 15,2012. http://www.firstpost.com/investing/why-you-should-be-nice-to-your-mom-and-buy-some-gold-456915.html)
(Vivek Kaul is a writer. He can be reached at [email protected])

Why food prices will continue to remain high in the coming years

Vivek Kaul

Buried somewhere in the Reserve Bank of India‘s first quarter review of monetary policy released yesterday is the following paragraph:
The stickiness in inflation, despite the significant growth slowdown, was largely on account of high primary food inflation, which was in double-digits during Q1 of 2012-13 due to an unusual spike in vegetable prices and sustained high inflation in protein items.
In simple English what this means is that despite economic growth slowing down inflation continued to remain high because of high food inflation. The Reserve Bank of India (RBI) has not seen the last of food inflation and there are several reasons why food inflation will continue to remain high in the days to come.
Below average rainfall: The immediate reason for the food prices continuing to remain is the below average rainfall this monsoon season. As the RBI said in the first quarter review of monetary policy:
During the ongoing monsoon season, rainfall up to July 25, 2012 was 22 per cent below its long period average (LPA). The Reserve Bank’s production weighted rainfall index (PWRI) showed an even higher deficit of 24 per cent. Further, the distribution of rainfall was very uneven, with the North-West region registering the highest deficit of about 39 per cent of LPA. If the rainfall deficiency persists, agricultural production could be adversely impacted.
The availability of water can make a huge difference to the agricultural output in India. Areas fed by canals form only around 40% of the total arable land in India. The remaining 60% are dependent on rains. With deficient rains this year the current khareef crop is likely to be impacted with production not being enough to meet demand. This will lead to food prices going up in the days to come.
Rural India is eating better: The various social schemes being run by the current United Progressive Alliance (UPA) government have put more money into the hands of rural India. The income of rural India has more than doubled in the last five years. One thing that seems to have happened because of this is that people are eating better than before. Economists are of the opinion that as income of people rises above the subsistence level of $1000 per year, a substantial portion of the new money is spent on food. People eat more and better quality food. At the same time they also move from cereal based diets to more protein based diets. In major parts of the world this means that people start consuming more meat. But India has a lot of vegetarians and hence consumption of other high protein food items like dal, milk and other dairy based products has gone up, pushing their prices up. This is likely to continue in the months and years to come given the social commitment of the current UPA government. If the proposed Right to Food Act goes through you could see a further increase in food prices.
The Japan syndrome: As a densely populated country industrialises, the area under agriculture tends to go down. This phenomenon was first observed in Japan, and has since then been observed in South Korea, Taiwan, and very recently China. As Lester R Brown points out in Outgrowing the Earth: The Food Security Challenge in an Age of Falling Water Tables and Rising Temperatures “First, as a country industrialises and modernises cropland is used for industrial and residential development. As automobile ownership spreads, the construction of roads, highways, and parking lots…takes valuable land away from agriculture…. Secondly as rapid industrialisation pulls labour out of the countryside, it often leads to less double cropping, a practice that depends on quickly harvesting one grain crop once its ripe and immediately preparing the seedbed for the next crop…Third, as incomes rise, diets diversify, generating demand for more fruits and vegetables. This in turn leads farmers to shift land from grain to these more profitable high-value crops.”
This is a long term phenomenon which is clearly playing out in India right now. Just drive around towards the outer limits of the city you live in and you will realize that what was once agricultural land has been taken over to build malls, apartments, offices etc. This leaves less area to grow vegetables, cereals and other crops, pushing up their prices in turn. Depleting aquifers: A huge amount of increase in the irrigation of crops across the gangetic plane, India’s agricultural heartland have substantially depleted the aquifers or the underground water tables. As a report by DWS Investments points out “Dramatic increases in the irrigation of crops across northern India have substantially depleted the region’s groundwater. Between April 2002 and August 2008, aquifers lost a total of more than 54 cubic kilometers per year. That decrease in groundwater is even more than double the capacity of India’s largest reservoir.”
While this data is around four years old there is no reason to believe that the situation could have improved in the last four years. It could only have got worse. This is something that Brown agrees with in his book Outgrowing the Earth. He writes “the extensive overpumping of aquifers in India will deprive farmers of irrigation water and will also reduce grain production”.
Climate change also threatens food security: As the following table points out Indian agriculture has very low productivity when it comes to other parts of the world. Even Bangladesh does better than us when it comes to producing rice.
Comparing productivity of Indian agriculture with the world (kg/ha)
Country Paddy Country Wheat Country Maize
World 4,223 World 2,829 World 5,010
Bangladesh 4,012 China 4,608 Agentina 7,666
Brazil 3,826 Egypt 6,478 Canada 8,511
China 6,422 France 6,256 China 5,151
India 3,303 India 2,704 India 2,440
Indonesia 4,705 Italy 3,568 Italy 9,144
Japan 6,511 Spain 3,470 Turkey 6,838
USA 8,092 United Kingdom0 7,225 USA 9,458
Source: Agriculture Statistics at a Glance /Kotak GameChanger Report
Even this production is threatened now because of rising global temperature which beyond a certain point tends to reduce the amount of crop produced. As Lester Brown told me in an interview I did for the Daily News and Analysis (DNA) a few years back “For each degree celsius rise in temperature above the norm during the growing season, farmers can expect a 10% decline in wheat, rice, and corn yields. Since 1970, the earth’s average surface temperature has increased by 0.6 degrees Celsius, or roughly 1 degree Fahrenheit.”
As the earth’s temperature rises it has led to glaciers melting. “Nowhere is this of more concern than in Asia. It is the ice melt from glaciers in the Himalayas and on the Tibetan plateau that sustain the major rivers of India and China, and the irrigation systems that depend on them, during the dry season. In Asia, both wheat and rice fields depend on this water. China is the world’s leading wheat producer. India is No 2 (The US is third.) These two countries also dominate the world rice harvest. Whatever happens to the wheat and rice harvests in these two population giants will affect food prices everywhere. Indeed, the projected melting of the glaciers on which these two countries depend presents the most massive threat to food security humanity has ever faced,” said Brown.
Cars and people are competing for grains: As the price of oil keeps going up, the world has started to look for alternate sources of fuel to run cars and other forms of transport around the world. One such fuel is ethanol which is made from corn and sugarcane in different parts of the world. In Brazil, a lot of cars run on ethanol, which is produced using sugarcane. So if oil prices go up, ethanol becomes more viable as an alternate fuel. And this pushes up the price of ethanol input, i.e. sugarcane. With lesser sugarcane available to produce sugar, the price of sugar also goes up. The United States uses corn to make ethanol. So oil prices going up leads to corn prices going up as well. As Brown put it “If the fuel value of grain exceeds its food value, the market will simply move the commodity into the energy economy. If the price of oil jumps to $100 a barrel, the price of grain will follow it upward. If oil goes to $200, grain will follow. From an agricultural vantage point, the world’s appetite for crop-based fuels is insatiable. The grain required to fill an SUV’s 25-gallon tank with ethanol just once will feed one person for a whole year. If the entire US grain harvest were to be converted to ethanol, it would satisfy at most 18% of US auto fuel needs.”
Given these reasons the food prices are likely to remain high in the months and years to come. And the Reserve Bank of India can fiddle around with the interest rates as much as it wants to, but there is no way it can control food prices.
(The article originally appeared on www.firstpost.com on August 2,2012. http://www.firstpost.com/economy/why-food-prices-will-continue-to-rise-in-the-coming-years-400532.html)
(Vivek Kaul is a writer and can be reached at [email protected])