“Watch out below for yet another reversal of commodity froth,” says Morgan Stanley’s chief economist Stephen Roach. He is not alone. Goldman Sachs analyst James Gutman says, “There is a risk of longer-term demand destruction,” as a result of high metals prices. And John Berthgeil of J.P. Morgan says metals prices are “unsustainable.”
Why are these three men so nervous? Roach is a perma-bear, driving through the markets using his rearview mirror as a guide. We like reading him because he correctly points out that the big boom of the last few years has been driven by U.S. debt. Roach says the global economy is badly in need of “rebalancing.”
Economists treat the economy as if it were a tiresome three-year old that just won’t sit still long enough to be weighed and measured. But growing things don’t sit still. They surge and retreat, boom and bust, and are never really in a state of equilibrium. That is a phrase reserved for textbooks.
So are metals prices climbing their own slag-heap of worry on the way to steadily higher highs? Or will high metals prices be the cure for high metals prices? Will the high price of copper, nickel, and lead discourage Chinese demand and lead to a correction/crash in metals and metals shares?
The answer to all those questions depends on how much of current demand for metals is driven by funds, and how much is driven by real economic demand. There is surely some froth in the metals markets. There is a froth in all the world’s financials markets. Froth is the new dew! We see it each morning we wake up to check prices on Bloomberg.
But let us remember commodity prices are coming off 200-year lows. It seems far more likely to us that they are climbing a slag-heap of worry than that they have reached a golden ceiling beyond which they cannot rise. And that’s more than just a hunch. It’s based on supply bottlenecks and sustainable rates of demand for the developing world. But we will spare you the details (for those you can subscribe to Outstanding Investments.)
Henry Liu at the Asia Times reckons we are due for the kind of crash that comes every ten years. It happened in 1987 on the Dow. It happened in 1997 in Asia. And Liu says the same factors that caused the previous global corrections have lined up again. He says the crisis is “looming.”
In the last two cycles, Liu writes, “Highly leveraged short-term borrowing of low-interest currencies was used to finance high-return long-term investments in high-interest currencies through ‘carry trade’ and currency arbitrage, with projected future cash flow booked as current profit to push up share prices.”
Translating, this means hedge funds and private equity have borrowed in Japan and America to buy in Australia and Brazil. He continues, “In all these cases, a point was reached where the scale tipped to reverse the irrational rise in asset prices beyond market fundamentals. Market analysts call such reversals ‘paradigm shifts’. One such shift was a steady fall in the exchange value of the US dollar, the main reserve currency in international trade and finance, to cause a sudden market meltdown that quickly spread across national borders through contagion with selling in strong markets to try to save hopeless positions in distressed markets.”
Economists also make the mistake of believing, despite all the evidence to the contrary that markets are rational. They are not. Markets are made up of people taking action. And human beings ARE rational, at least sometimes. Human beings are also greedy, fearful, stupid, uniformed, impulsive, murderous, lecherous, and ridiculous. It’s pretty hard, and ultimately futile, trying to make the market conform to your expectations.
We have no idea whether tomorrow will be more like yesterday or more like 1929. But evolution loves a survivor. And he who adapts survives. More on this, and the admirable qualities of cockroaches, tomorrow.
Markets and Money