The information coming back from the front in the war between inflation and deflation is a bit confusing today. Let’s review the dispatches and see if we can make sense of what happened and where we’re headed.
First, commodities gave ground. Crude oil, copper, coffee, wheat and nearly ever major commodity benchmark fell. The Reuters/Jefferies CRB Index fell about 5%, for example. That was its biggest fall in 40 years.
It’s hard to say for sure, but we reckon this is evidence of speculative traders and hedge funds reducing their long positions in the commodities markets. In the retreat to a larger cash position, even profitable trades in commodities must be sold (especially if you’re facing a margin call or simply winding down the amount of leverage you have).
So, as we mentioned yesterday, you can still have falling commodity prices AND a weaker U.S. dollar. That’s what we see today. We don’t buy the argument, though, that the move in commodities is related to the U.S. recession. It IS true, and makes logical sense, that if consumer spending in the U.S. slows (tighter credit, fewer home equity lines of credit, abject fear of the future) then this slow down in final demand would work its way back the chain to resources. Slower retail demand equals slower resource demand.
All that said, we still reckon what changed yesterday was not the economic demand for commodities but the investment demand. “I think a move toward liquidity, aside from the longer-term fundamentals, is driving this,” said Bart Melek, Global Commodity Strategist at Toronto’s BMO Nesbitt Burns in today’s Age. “Credit is difficult to get and if you have an asset that has made money, and commodities certainly have, you sell what you need to sell to get liquidity.”
You should be prepared for more of that. As capital flees the battlefield for higher ground, resource stocks and commodities will take some fire. We reckon, tangible assets that they are, they are sounder than financial stocks. And there is always the matter of the weaker U.S. dollar driving things priced in dollars ever higher.
Gold, for its part, kept its head about US$1,000. It too gave some ground, but grudgingly.
Gold is strange. It plays no real role in the industrial economy. There’s no economic demand for it. There’s only investment demand, and, increasingly, monetary demand.
What about the Aussie dollar? It swung wildy yesterday against everything, falling against the yen, the U.S. dollar, and even the Kiwi dollar. What gives? We asked our currency trader Gabriel to give us a report. See below for his rather thorough analysis.
The Fed’s liquidity efforts will become truly inflationary when it runs out of Treasury bonds to exchange for dodgy mortgage collateral, we said yesterday. There is an interesting argument to be had over whether the new dodgy collateral becomes the backing for the U.S. dollar. But we will leave that aside. We wonder today how many bullets the Fed has left in its monetary policy gun.
“The Fed has committed as much as 60 percent of the $709 billion in Treasury securities on its balance sheet to providing liquidity and opened the door to more with yesterday’s decision to become a lender of last resort for the biggest Wall Street dealers,” reports Scott Lanman at Bloomberg.
It also cut the discount rate this weekend, he ads. “The action comes on top of Chairman Ben S. Bernanke’s other balance-sheet commitments totaling as much as $430 billion through other auctions, repurchase agreements and $30 billion in financing to help JPMorgan Chase & Co. purchase Bear Stearns Cos.”
The Fed can throw another grenade into markets when it meets on Tuesday in the U.S. If it acts true to its recent form, you can expect to see the Fed funds rate slashed by a full one percent. Pretty soon Bernanke is going to run out of bullets. He’ll have to throw the gun!
Here’s the question though, how does any of these help Americans pay their mortgage? Does it? Making inter-bank credit cheaper isn’t even encouraging banks to lend to one another. The Fed has had to step in and become a direct lender to prime brokers.
Air Marshall Bernanke is in trouble. As soon as he runs out of his stock of Treasury bonds to lend to distressed banks, he’s going to have to buy more. He’ll have to create new money to do it. And if he somehow escapes that necessity, he may have to purchase outright the collateral held by Fannie Mae and Freddie Mac. That will take new money too.
It is probably Henry Paulson’s turn to do something to save the system, although we are not sure what. Paulson opposes a bailout of investment banks. But maybe he won’t be as opposed to the creation of a new authority set up to purchase the assets of Fannie Mae and Freddie Mac and hold them in trust. Then, millions of Americans will have Uncle Sam as their land lord (over lord).
A coda to the Bear Stearns story. JP Morgan did not buy it for US$4 billion as we reported yesterday. Morgan paid US$236 million or about US$2 per share-one tenth of Bear’s market value at the close of trading on Friday. Bear’s selling price is actually less than an apartment which sold in London this week. Either Bear was absurdly cheap or property in London is absurdly high.
According to the Times of London, “The flat in St James’s Square, equidistant from 10 Downing Street and Buckingham Palace, was granted planning permission last week…It is to be carved out of a seven-storey 1930s office block, which will be used to create a total of six extravagant apartments.”
Markets and Money