Wheat Crisis: The Next ‘Black Swan’?

by on June 18, 2009 | ETFs Mentioned:

Although it’s doubtful that anyone keeps track of such things, I’d venture to guess that ‘crisis’ has become one of the most popular words in the American lexicon over the last two years. The prevalence of the word in newspaper headlines and everyday conversation is an indication of just how bad the past few years have been. We’ve seen a real estate crisis morph into a global financial crisis, a swine flu crisis, too many industry-specific crises to count, and even a crisis on the high seas. Surely now the worst is behind us, right? Many prominent scientists throughout the U.S. and Europe are afraid not, fearing that the next market-crippling development could come from a most unlikely source: wheat.

Although most outside of Africa are unfamiliar with it, Ug99, a type of fungus commonly called ‘stem rust’ due to its production of reddish-brown flakes on wheat plant stalks, is a serious threat to eliminate 80% of the world’s most widely grown crop. The fungus, which was first discovered in eastern Africa, has now jumped to Iran, with many crop scientists predicting that it is only a matter of time before winds carry the disease to Russia, China, and the U.S. (see this chart from the LA Times depicting the spread of the fungus).

Familiar Foe

Stem rust has hit the U.S. before, destroying 20% of the country’s crop several times in the early 1900s. The last major outbreak was in 1962, when the fungus destroyed 5.2% of the U.S. wheat crop. After farmers successfully introduced stem rust-resistant genes to their crops, the fungus virtually disappeared for several decades, until a new strain was identified in 1999 in Uganda. Ug99 (named for the country and year of its discovery) has since spread to Kenya, Ethiopia, Sudan, and Yemen, becoming increasingly virulent along the way. New variants of the fungus have been discovered that can overcome many of the genes that previously protected the crop. Scientists are now working furiously to develop new strains of wheat that are resistant to the latest incarnation of stem rust, but such innovation is complex, expensive, and time-consuming.

Catastrophic Damage

Although difficult to predict with any degree of certainty, the damage from the spread of Ug99 could be staggering. The International Maize and Wheat Improvement Center estimates that 19% of the world’s wheat, which provides food for 1 billion people in Africa and Asia, is in imminent danger. If the strain spread to the U.S., a significant portion of the crop, including more than 90% of wheat in ten states, could be vulnerable to devastation. By some estimates, up to $10 billion of wheat could be destroyed. If such a scenario played out, the impact of the virus could extend to markets across the globe, pushing up food prices and devastating those regions dependent on wheat for sustenance.

The Next Black Swan?

The Black Swan theory popularized by Nassim Taleb’s book refers to events that were beyond the realm of normal expectations that had a major impact on the global environment. In his 2007 book, Taleb postulates that nearly all major scientific discoveries and major historical events were Black Swan events, including the invention of the computer, the rise of the Internet, and the 9/11 terrorist attacks. The term comes from the 18th century discovery of black swans, which disproved the previously accepted assumption that all swans were white. As such, it refers to a perceived impossibility that becomes a reality. According to Taleb, Black Swan events must (1) be a surprise (2) have a major impact, and (3) be rationalized by hindsight after the fact.

The investment community was introduced to the Black Swan concept in 2008 when the Black Swan Fund, an investment vehicle run by 36 South Investment Managers, posted an annual return of more than 230% as equity markets around the world crumbled. By betting on events that were perceived as impossibilities, such as interest rate cuts in New Zealand and Australia and economic collapses in BRIC countries (the Black Swan Fund purchased put options), the fund capitalized on the crises that devastated most portfolios. 36 South recently launched a similar fund that seeks to capitalize if inflation rates in developed nations jump above 5%.

A devastating wheat fungus outbreak would certainly be a surprise. Even as scientists warn of imminent threats, few Americans have ever heard of Ug99. And it is only beginning to catch the attention of the investment community, as fears of a worst case scenario have begun to affect market prices of various assets. A few ETFs to keep an eye on as the Ug99 saga unfolds:

  • PowerShares DB Agriculture Fund (DBA): This ETF holds a variety of agricultural commoditites, including corn, wheat, soy beans and sugar. Despite pulling back from recent highs, DBA has risen in recent weeks on fears that a wheat shortage could drive global food prices higher.

PowerShares DBA

  • Van Eck Market Vectors Africa Index ETF (AFK): Although African markets have surged so far in 2009, this region could suffer as ground zero of a potential outbreak. Unlike many ETFs that focus solely on the South African market, AFK offers more diversified exposure to the continent’s economies.

Van Eck's AFK