Greetings from Cronulla, where the cool change has blown in over night and apparently cooled off gold, oil, platinum, palladium, wheat, cobalt, and the animal spirits of resource bulls.
The Reuters CRB/Jeffries commodity index fell 8.4% on the week, its biggest weekly decline since way back in 1956. Now that is a proper correction.
Nothing has been moderate about the commodities boom. You’ve had booming demand in China, soaring prices on the resource markets, and vast new fortunes in Australia. Add to the list a bitter little one-week correction.
The ASX/200 again fell by three percent in thankfully short Thursday trading. The big losers were the miners. BHP Billiton fell 8%. Rio fell 7.7%. Gold futures are at US$920 while oil futures are around US$101. The Dow, on the other hand, rose 200 points in New York.
The headlines will not help you make sense of things today. “Global growth fears hit commodities,” reports the Canadian Press. “FTSE down early, growth fears weigh on commodities,” says Reuters. “Cum hoc ergo propter hoc!” says Dr. Zapatka, our freshman year university professor of classical rhetoric. “With this, therefore because of this,” is how that translates in Latin.
The lower-growth explanation for falling commodity prices is the easy one. And it could be right. Yet we are pretty sure it is absolutley wrong. Let’s take the simplest explanation for falling commodity prices: selling!
As we mentioned early this week, the move to cash brought about by deleveraging means large investors are selling even profitable positions. Some of the MOST profitable positions of the last six months are commodity positions. The motives are in dispute. Not the facts.
“People are cashing in profits in the only markets that have been going up in order to pay for losses in other markets,” said Stephen Briggs, a metals analyst at Societe Generale in London tells marketwatch.com. Yes, that sounds right to us. It could be wrong. But what is the alternative explanation? Is there some other motive that explains why sane people woud sell gold during the greatest bear market in credit ever?
“This is the time to go back into the equity markets, particularly the U.S. market,” says Komal Sri-Kumar, the chief global strategist of TCW Group. “The U.S. equity market will outperform the rest of the world.”
But really, that is the other explanation being offered to retail investors. Richard Bove of Punk Ziegel and Co. was even more succinct. “The financial crisis is over,” he wrote to clients. This is a, “once in a generation opportunity to buy.”
Also insane. But let’s go with it. Is it time to buy?
We seriously doubt it. This is a once-in-a-generation opportunity to realise we are still confronted with a once-in-a-generation cyclical change. Seriously, how bad is it when securities firms (investment banks they call themselves) line up to borrow about US$30 billion from the Fed in a matter of a few days? And what are they doing with that money anyway? Buying S&P futures? Shorting gold with taxpayer money?
The Fed’s new “Primary Dealer Credit Facility,” where it lends overnight money to investment banks at 2.5% interest, was more popular than the one remaining adult book store on Fitzroy Street on a Saturday night in St. Kilda. We walk by that store often on our way to the grocery store. You’ll typically see two types of men enter it: the drunk and the sober.
The drunk are brazen. They don’t care who sees them because they feel no shame (and no pain.) They usually come out of the store with large brown paper bags, or inflatable sheep. The sober ones usually have hats pulled low over their faces and dark sunglasses, which is an interesting choice at 10pm.
Anyway, let’s not be under any illusions over what happened at the tail end of this week. Leveraged players sitting on profits sold gold, oil, and commodities. Cash-strapped investment banks that have balance sheets bulging with assets they can neither price nor sell went to the new free candy window at the Fed. Is it any surprise stocks rallied?
What now? “The potential for further speculative liquidation across the commodities complex remains high in the near term,” says Goldman Sachs energy analyst David Greely. Yes it does. We note this morning, however, that the gold price closed above its inter-day lows in future trading
We wish we could tell you the future this morning. But we can only summarise for you how we think things are playing out. We summarise that expanded Fed lending facilities won’t improve deterioating bank asset quality. The financial crash precedes the economic crash. If you believe in a stock market rally from here, you believe the global economy is about to grow again, in which case resource prices would go up, not down.
It’s a boring word, but stagflation is the perfect description of what we think is ahead: rising prices and no growth. It is true that commodity prices will fall some with deleveraging. How far is anyone’s guess. But you can be sure that there are more losses to come in the financial stocks. And more layoffs. All those losses and layoffs will prompt more explicitly inflationary policies from the Fed and the U.S. Treasury.
But don’t expect it all to happen in a week. That was the point we tried to make with yesterday’s charts of the Dow from 1929 to 1932. The deleveraging is also an unwinding in expectations, and this is done grudgingly and only in the face of undeniable evidence that something isn’t worth what you’d like to believe it’s worth. Investors give groud emotionally very slowly. Often, bulls are willing to fight to the last vanishing dollar.
Here’s some reader mail on inflation and gold.
Although I have complained about it being too long on one occasion, I make a habit of reading your commentary top to bottom (it is quite amusing and sometimes outlandish) but agree with most of your analysis, however (you guessed it I am about to diverge here) some of the assumptions are just too hard to agree with. Such as your long-time bullishness about gold reminds me of an investor who married to his stocks through bull and bear cycles. As they say, your stocks never love you back, so he lost the last 10 years of gains in one fell swoop (yes I am over 50 and vividly remember such mistakes).
On the constantly drumming about the coming inflation (near you) subject, how could it be if the US wages have been static for quite sometime and the unemployment there is now rising (remember 70-80% of core inflation comes from wages whilst the commodities inflation is only one-off, which means it is washed off the CPI come the next quarter. Plus low-capacity utilization means higher PPI is most likely to be absorbed rather than passed on to consumers).
Gold is a poor conversationalist. But it is excellent at doing nothing! That is why we like it. It has no intrinsic value. You can’t eat it, or grow it, or burn it. But that is precisely gold’s value as an historical medium of exchange: it is always the same everywhere. Money is a commodity. And gold has always been popular as money.
The main reason is that all paper currencies are eventually debased by corrupt government leaders. It is simply too tempting to cheat the system and print more money to buy more votes or fight more wars. Name us one paper currency that has outlasted the mismanagement of its stewards and we will buy you lunch with it.
The current empire of the Greenback has purchased the world a huge amount of interconnectivity and made it easier to trade, travel, and speculate. You only get that kind of expansion in real economic activity with an artificial expansion in the money supply. And oh how artrificial it’s been. Oh how real will the contraction be.
That may be one reason why some readers are emotionally hostile to gold as money: it means a contraction in global economy, plain and simple. Gold-backed money prevents governments from running large debts. That is why we like gold so much, it is a natural check on the lust for power and glory that all politicians share.
In any event, the other point about inflation confirms what we’ve been saying. U.S. wages have been static (in real terms) for years thanks to globalisation (which has unleashed deflation in global wages. But while Americans make less, Asians make more per capita than ever before, increasing the marginal demand for the same quantity of scarce resources.
In the great Army of Inflation, wages are the turncoat, secretly fighting for the other side. But we don’t reckon they will turn the tide. Americans have a not-so-secret weapon which has not-so-secretely been weaking their battle readiness for the world in which we now live.
Faced with falling real wages, zero savings, falling asset prices, and rising food and petrol prices, Americans (like Australians and Brits) have used consumer credit or home equity lines of credit to make up the difference. Massive debts have ensued at the personal and public level.
The easiest most convenient way for a government to ease the burden of massive debts is inflation. And this is precisely what Ben Bernanke has chosen. You do not make the dollar stronger by lowering interest rates. But Bernanke has no interest in protecting the capital value of foreign investors who own large amounts of U.S. Treasuries. He answers to the White House, which answers, sometimes, to the American people. Inflating away the debt is what governments always do.
This is why we are confident you can have wage deflation and consumer price inflation at the same time. Australia may be a bit different, where the labour force is smaller and where many of the jobs (like digging up ore in the Pilbara) can’t be outsourced. But the fudnamental forces are the same: rising levels of personal and public debt coupled with rising global demand for food and fuel.
Did any of that change this week? Sadly, we think not. Demand for some things like computer mouses, digital televisions, and new vaccuum cleaners may fall when belts get tight. But the demand for basic stuff has never been higher. We believe that’s what puts a firmer floor under commodity prices (as opposed to financial stocks).
But then again, what do we know? The future is never entirely like the past. So this time, whatever it brings, will be different than 1929. But like then, we continue to recommend the virtues of cash and low debt. It will help you sleep at night.
And on that note, we wish you a great, relaxing, happy, and safe Easter Weekend. It’s a pleasure to write the Markets and Money every day knowing there are so many interesting, thoughtful, intelligent readers. We promise to make better jokes next week. Hopefully, the world will be a funnier place. Until then…
Markets and Money