Saturday, March 22, 2008

Alert: Commodities are Dead

.... or so you'd believe if you listened to the financial news media this weekend. Wow, I have never seen such an about face based on 2-3 days of trading action. No wait. I have seen such about faces - every other month. It is simply amazing to watch these people abandon this trade in such force; many of whom were touting it up to.... last week.

I still cannot get over the defense of the dollar due to the Fed (a) "only" cutting 75 basis points instead of 100 basis points and (b) putting more language about inflation into it's statement. So the fact the Fed took a massive slash to interest rates (75) instead of a historic cut (100) indicates they are now defenders of the dollar and not inflating the currency into a hand basket? Got it. And now that they put words into their statement saying they are watching inflation (similar words to what they had all last spring, and summer) now means they are at the ready to fight inflation? By what means? Raising interest rates? Hold on why I laugh over that. So the theory is the Fed is now suddenly going to fight inflation or will in 3-6 months, correct? So they will be raising rates to offset global inflation in the teeth of a US recession. Ok, I get it now. But this is the "thinking".

Now the dollar has other reasons to rise - namely one I have been posing which is Western Europe is posed for a slowdown (along with Japan), so the dollar could rally not on the "upcoming strength and inflation fighting by the Fed" but on a RELATIVE basis to other countries which will be entering recessions (or at least slowdowns). That theory at least I can understand. I call it the 'race to the bottom' theory - i.e. who is in the worst economic shape and hence should have an even weaker currency than the other. But a 2-3 day countertrend move, or even 2-3 week countertrend move does not make a sea change - despite the claims to the contrary. And once again, if European banks need to cut rates and inject liquidity it simply creates more paper money circling the world, which is still positive for commodities... but since we only think in "dollar" terms, that's the focus. Nothing goes straight down - but I expect to the dollar to continue to be weak over decade(s) (?) until we begin addressing the structural deficits in this country. But that doesn't mean it cannot rally for 3 months at a time. And keep in mind, we will have another fiscal emergency in about 2012-2013 time frame? Why? Because we are recreating conditions for it by following the exact same policy that got us here in 2001-2002. So we'll once again be bailing out something and flooding the system with liquidity in half a decade. Those who do not learn from history....

Now a much darker view for the downturn in commodities? Worldwide serious recession, combined with deflation. That is still an outlier view and not something I am ready to get behind - but if we reach that stage your stock investments or the price of gold will be the last thing you'll have to worry about. But that's another "theory" I am starting to see inklings of...

I don't know where commodities will be in a week or two, but I've been touting my "World of Shortages" theme and have my theories on where they will be in 3 year, 5 years, 10 years - this could be thought along the lines of Malthusian economics

Malthusian catastrophe, sometimes known as a Malthusian check, Malthusian crisis, Malthusian dilemma, Malthusian disaster, Malthusian trap, Malthusian controls or Malthusian limit is a return to subsistence-level conditions as a result of agricultural (or, in later formulations, economic) production being eventually outstripped by growth in population.

This is a long, long, long term view. And it relies on world population trends, along with the thirst for many of the world's poor (which is still the vast majority of this globe) to enter the bottom of middle class.

In February 2008, the world's population is believed to have reached over 6.60 billion.[1][2] In line with population projections, this figure continues to grow at rates that were unprecedented before the 20th century, although the rate of increase has almost halved since its peak, which was reached in 1963, of 2.2 percent per year. The world's population, on its current growth trajectory, is expected to reach nearly 9 billion by the year 2050.

So we have to feed another 2.5 billion or so within 40 years. (2.5 Billion would be equivalent to a new China, and a new India born in the next 40 years). And even if you think those numbers are baloney (myself, I think limitations on water supply will be restricting growth perhaps by famine or wars), if even 300 million people a decade move from "3rd world" to "2nd world/1st world" you have to feed (and provide energy) for a "poor man's United States" population every decade. (why do I say poor man? Well no one can consume like the good ole American - but even if they consume like the good ole Swede or South Korean, it's going to be a unheralded strain - if these people want to consume like Americans we can just forget any chance of planetary survival - thankfully there are only 300M of us). That's without any new population entering the world. Granted, Wall Street's view of long term is "next week", but without significant technological breakthroughs we have some major issues. We are well on the way to cleaning out our seas of foodstuffs. So more and more reliant on land foodstuffs. Or perhaps some sort of medical plague will wipe out a few hundred million (or more) as Mother Nature accomplished 700 years ago as a way to cull the human herd.

Now, did the hedge funds go overboard? You bet. Are we done going down? No idea, most likely not because everything overshoots. But a solid 15-20%+ correction in a long term uptrend is reasonable. Granted we already have 10%+ in 3 days - hence how horrific the fall has felt. People have been piling in these trades as "weak dollar" plays; I've been pursuing them as "World of Shortages" plays, with the weak dollar as an added bonus. Further, taking into consideration potential worldwide slowdown (even the best Asian economies slowing by 4-6% GDP points) I have been avoiding for the most part oil, and base metals such as copper. Those should be the most economically sensitive. I do have iron ore for a specific reason - fixed negotiated prices (+65%) that last a year (I love future visibility). But right now in this homogeneous hedge fund view where oil = corn = dairy = gold = copper = wheat = copper = palladium, any nuance is lost. I've been focusing on agriculture as my #1 long term bull market. People will eat no matter the economic outcome on the globe; and the fortunes of many in the developing world will still be on an upward slope as those in developed world suffer (remember where all the cash in the world is going to = petrodollars and countries with huge trade inflows). But right now a bushel of corn might as well be a barrel of oil to the unregulated pools of money running the world's investing. And when they move like a horde of locusts you get burnt in the short run.

Thinking back to last week, I have had very little oil exposure because frankly the stocks were not confirming the great strength in crude oil pricing. I had about a 2.5% precious metal stake. I did have a large agricultural stake but always will for the foreseeable future because that to me is the true commodity trade. I have begun some mining exposure in the past few weeks on weakness, mostly with iron ore exposure. I have had for a long time had coal exposure because I don't think the energy crisis is going to change anytime soon and relative to crude, coal is a steal. Speaking of... I've mostly avoided steel despite it's great strength. So that's how I entered the weak, and I simply added (mostly) to the agriculture exposure because even though I have a large exposure it is far below what it's been in the past as I've been waiting for a pullback. I've also doubled the precious metal exposure to about 5%. And with the pullback in some of the iron ore names, I've added there as well. Coal I've already had a large stake.

So again, would a 20% pullback signal the end of days for commodities. If you listen to the financial media this weekend, yes, and everything is heading back to 2002 levels. But then again these were the same folks who missed the whole housing bubble, missed the credit implosion, denied recession as even a possibility until December 2007/January 2008, and missed the first 80% of the move up in commodities (most jumped on the bandwagon right around February 08). So I have about as much confidence in the pundits accuracy as I do in Standard & Poors (who is out Friday warning about investment banks - GEE THANKS)

Can I be wrong? Always. But running independent to Wall Street herd usually works out very good in the long run, even if it provides pain at times in the near term, when the herd turns against you. Maybe another week or two of weakness for commodities in my book but nothing the US is doing is showing me they care one iota about the dollar or inflation. And with a slowdown in other world economies, and potential for 75% of world GDP (W. Europe, US, Japan) I see a lot of money creation by central banks still to come as we no longer allow the business cycle to work in this world...

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