As demand for goods increases, prices of the items climb as well, hence, pushing up prices of commodities used to manufacture these goods.

Within the commodity asset class, crude oil and gold by virtue of their nature as finite resources, usually steal the spotlight as a hedge against inflation.

A glaring example of the correlation was seen in July last year when crude oil rates hit a historical high of US$147.27 (RM515.45) a barrel, sending Malaysia’s inflation to a 26-year high of 8.5%. In fact, during the year, punters had also actively snapped up gold, pushing prices of the precious metal up to a fresh high as well.

However, agricultural or food-based commodities such as palm oil, soybean, and corn are also beginning to capture investors’ attention as a protection against the falling value of money.

Unlike precious metals, the intrinsic worth of agriculture commodities is perceived to be increasing. This is due to demand for crops in the production of energy, besides the fact that land for cultivation of crops are shrinking against a backdrop of a growing world population.

In fact, drought in major soyabean producers such as Argentina has curbed output of the commodity, resulting in the rise in palm oil prices as both crops are substitutes for each other.

“Agriculture commodities could be a hedge against inflation when inflation is rising while interest rates  remain low. The risk (of inflation) is on the upside due to recent developments of rising crude oil prices,” Maybank Investment Bank Bhd chief economist Suhaimi Ilias told The Edge Financial Daily over telephone.

A low interest rate environment against a backdrop of rising inflation, essentially, translates into a negative interest rates for cash deposits.

At the same time, the planned removal of subsidies for essential food items and increase in public transport fares are also anticipated to spur inflation in the country, according to Suhaimi, who predicts Malaysia’s inflation will rise 1% this year before increasing to 1.5% in 2010.

Nomura International (Hong Kong) Ltd head of regional strategy for Asia research division Sean Darby said in general, prices of soft commodites such as palm oil and soybean had been moving upwards. This comes against a landscape of dry weather which had curbed production of food-based commodities globally.

The fact that farmers are facing financing constraints also lends credence to expectations that global crop output will fall, hence, upward pressure on prices.

“In general, soft commodity prices have been doing very well,” said Darby.

Malaysian inflation, measured via the Consumer Price Index (CPI), rose by an annnual pace of 3% in April this year, mainly due to costlier food, and non-alcoholic beverages, besides tobacco and liquor, according  to updates on the Department of Statistics website.

During the first four months of the year, the CPI increased by a yearly rate of 3.5%. Compared to a month earlier, April 2009 consumer prices however fell by 0.2 %, due to cheaper food and transport.

OSK Research head of research Chris Eng offered a second opinion on the country’s inflation.

In a note, Eng said the rise in consumer prices was deemed unsustainable in the long run given that the current dry weather globally is expected normalise next year. This essentially mitigates the possibility of lower output of commodities such as rice which form the staple diet for a large fraction of the global population.

“Apart from that, the price pressure in the transportation category is unlikely to inch up given the  possible switch to lower and fixed-price RON95 petrol with effect from Sept 1,” said Eng who has priced in an average crude oil prices of between US$60 and US$70 a barrel this year, and a US$70 a barrel average for the following year.

This article appeared in The Edge Financial Daily, June 8, 2009.