Commodities

To review.

Long-time listeners to our podcast will appreciate that our call for negative growth in the second half of 2011 was made in the first days of 2011, not at the end of Q3. Now, just as last month the turning in the sky was from recovery to no recovery, it is now from recovery to recession. This was epitomized by Laksman Achutan of Economic Cycle Research Institute when he rushed to press in the last days of September to announce, yes, recession, either now or in the 4th quarter. But Demand Side listeners had the same information back when it would have made a difference to planning. That was a forecast. Saying it is happening now is not a forecast.

And we can’t go very far without a comment on Europe. As the same January forecast made clear, and even into last year, we said – following Nouriel Roubini and others – that there was no option but default for Greece. We added that this was essentially a cost of the financial crisis and would not be a problem except that it exposed the banks. That is, policy makers would be willing for Greece to undergo whatever austerity they could impose, but asking the banks to take a hit on the other side of the contract for bonds? There would be hysteria. Now there is hysteria.

We are in 1932, 2008 was 1929. Now as then, we didn’t fix the problem but kicked the can down the road. Now we’ve run out of road. The kicking of the can has let us imagine we are going somewhere. But we needed to fix the road and the bridge, not comfort ourselves or our elites.

Forecast: Commodities

This week is forecast lite.

Commodities

Demand Side is an economic forecaster, not a market predictor. In terms of investment advice, we don’t. The markets are a herd or behavioral field. They react to what they perceive the economy to be doing. That perception today is the perception of a herd of cattle in a lightning storm.

And today we are forecasting markets. We are not forecasting demand and supply for individual commodities based on global production. Because all that is washed out by the market dynamics. Commodities are trading in close correlation with other financial assets. Financial assets? Commodities are goods, right? Not when the traders need a profit. Your food and fuel is their bread and butter.

The market is being driven not by demand for the product, but by demand for financial returns. Speculation. There is immense liquidity sloshing around in the system. There is massive paper wealth looking for a place to be. This is part of the dynamics of commodities. As the real economy failed over the past dozen years, that money has moved more and more into liquid financial assets and away from real productive assets. No real investment in the private economy, particularly with the housing crash. There is a glut of productive capacity (see Forecast: Capacity Utilization) brought on by focus on the private consumer economy at the expense of the public goods economy.

In any event, this massive amount of capital needs a home. It can go into cash. But at its base cash is just a government bond with no interest on it. “Federal Reserve Note.” It has gone into stocks, bonds and commodities and derivatives of these. Commodities are perceived to be a liquid asset that will maintain its value. This is in spite of all evidence to the contrary.

The commodities bubble of 2011, which is now collapsing, was a core predictor of the new leg down in the economy. We used it in January, saying it would be the trigger. And so it has proven out. So far, 2011 is a repeat of 2008, only on a weaker economy, with far less appetite for the stimulus of 2008-09, and thus much more likelihood of serious further suffering. We didn’t fix the banks the first time. All the old troubles are still with us. We kicked the can down the road instead of fixing the bridge.

L. Randall Wray at Economonitor has this discussion of the coming commodities nuclear winter. His blog continues in three parts. Including analysis of how index trading has contributed.

Shall we do Copper?

Shall we do Gold?

Gold is interesting as a commodity, because it has no real industrial use. Other precious metals do. Gold is simply a bet. Some see it as inflation hedge. Some see it as a hedge against instability. But it is a bet that people will continue to buy gold. The new ETF’s for gold have undoubtedly raised the price by allowing purchase of gold without holding it in your house. If you have one, look closely, it may be a virtual fund which operates on the “value” of gold, rather than actually owning gold.

So recently when commodity prices went south, gold should have gone north. it didn’t. We have a very loose understanding, but it came a little tighter when someone revealed that traders take positions in gold as a liquid value that can be tapped to cover other positions. This is what we think happened to gold. As stocks and bond yields came down, investors covered their losses by liquidating gold. Much to the consternation of the world. Or at least to the financial speculators. We understand the buying of gold to hold in India and China dried up when the price went over $1,700. They may be coming back now.

What about oil?

Here is the poster child for all commodities. You can see the up-to-the minute action on the right side panel on the transcript. The bubble is bursting, hopping down now to under $79 a barrel West Texas and under $103 in the much more relevant Brent Crude.

Oil and commodities are bouncing around in complete correlation with the rest of the markets. A correlation incidentally that is closer than at any time since the maps of correlation became detailed.

But speculation as the cause. Senator Bernie Sanders let the cat out of the bag in August by leaking data from the CFTC, Commodities Futures Trading Commission, which clearly shows that financial traders have positions in oil futures which dwarf those of any legitimate hedger. And as we showed last year, it is the futures market – not the spot market – where real oil prices are set. Apologies to Paul Krugman.

We’ve been 9-12 months ahead of consensus forecasters on the commodities bubble. Our surprise this time is the trend down is in bunny hops, clearly visible in the charts but which have yet to be explained in any terms that make sense. Our view is again, a trading strategy designed to limit losses in the Big Houses.