Category: Articles

I have been getting a bunch of email lately about commodities. This was emailed to me today..

From Roubini’s RGE Monitor

Today we turn our attention to commodities, which have been badly battered by the global financial crisis, deleveraging and a worsening economic outlook, with commodity indices having lost 50% of their value since the July peak. With the G10 in recession and many emerging economies slowing sharply, further demand destruction is likely, and it may continue to outpace production cuts. Once the price adjustment filters through to producers, they may account for another source of slower aggregate output.

Despite the steep price declines so far, commodities as a group have only fallen halfway to their 2001-02 trough, meaning they may have farther to fall. Among individual commodities, those that grew the most expensive in the shortest period of time have suffered the sharpest and fastest price drops. In fact, some investors are pricing in a temporary drop in the price of oil below $30 per barrel, far below marginal production costs.

Metals and energy led recent declines, after breaching nominal and inflation-adjusted highs earlier this year. Agricultural commodities took smaller hits as their price climbs were not as excessive – their peak prices this year remained 2-3x below their inflation-adjusted highs in the 1970s. Only newsprint has yielded positive returns this year as of November but its resilience seems unsustainable in the medium-term. Across the commodities group, inventory buildup and falling demand creates conditions ripe for a continuing current bear market despite the fact that some commodities, such as oil, seem to have fallen below production costs.

WTI crude oil futures have fallen from a peak of $147/barrel in mid July to around $55/barrel, well below the 2007 average price. U.S. government data suggest that demand for oil products is about 6-7% lower than last year, with the sharpest declines in jet fuel. Despite the fact that gas prices are now hovering at $2 a gallon and energy costs fell 18% nationwide in October, demand continues to fall. Forecasts from the EIA and OPEC suggest that 2009 might mark make the largest contraction in oil demand in decades, despite the recent price correction. EM oil demand will be insufficient to offset growing declines in the OECD countries. For now, financial market trends and macro fundamentals might point in the same direction, towards weaker energy prices.

Yet, output cuts are reducing supply, removing the surplus reached earlier this year, even as OPEC’s surplus capacity increases. Non-OPEC supplies continue to disappoint. Oil production has declined in Russia, the North Sea and Mexico while new production in Kazakhstan and Brazil has yet to come on stream. In the short-term, it might take a major supply shock – say one that cuts off Iran’s oil supply or major output from the GCC – to really boost prices. The Somali pirate hijacking of a Saudi tanker might raise transport costs as insurance premiums rise and routings increase, and reminds observers of the energy supply chain’s vulnerabilities, but it may not have a major affect on oil market fundamentals. OPEC’s willingness to comply with current (and future?) production cuts may be the most significant supply side factor. Yet the elevated cost of new oil supplies may lead to future supply crunches. Canada’s oil sands are woefully expensive at today’s prices and projects are being deferred if not canceled.

Lower global energy demand, in the face of increasing supply, is also affecting current and expected natural gas prices. EIA has noted that the Henry Hub natural gas spot price projection for 2009 has fallen from $8.17 per Mcf to $6.82. The front month contract price of natural gas on NYMEX has steadily declined and the futures curve has sloped downward. Demand for alternative energy tends to move inversely to fossil fuel prices, so the deep cuts in oil and coal prices could pose a headwind for alternative energy, unless counteracted by climate change mandates. Fortunately for producers, falling grain prices will help relieve the profit margin squeeze, even if the credit crunch impairs borrowing for expansion.

Oil (USO) was insane at $147 and may fall to equally insane levels on the lower end. Long term, the trend is definitely higher, but when it happens is another story. I think the food commodities will rally first as the demand for them will not fall nearly as much due to a global recession. Wheat, corn, soy beans should all continue to rise as demand does. Folks do not stop eating in a recession.

My feeling is the way to play this is the DBC (DBC). The DBC seeks to reflect the performance of the Deutsche Bank Liquid Commodity index. The fund will pursue its investment objective by investing in a portfolio of exchange-traded futures on the commodities comprising the index, or the index commodities. The index commodities are light, sweet crude oil, heating oil, aluminum, gold, corn and wheat.

I like it because all the components of the index are high demand items. I do not see how demand for any of them drops significantly for a prolonged time. That being said, supply of all is somewhat limited. There is only so much oil and land to grow corn and wheat. That bodes well for the fundamentals of it going forward.

Would I buy it now? Not yet. I think early next year might be the time to do it. There is a glut of items now and it will take time for production cuts to take the slack out of the system. That means short term price decreases..

Long terms the story stands….short term…not so much..

Disclosure (“none” means no position):none
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Back in October I wrote about what I thought was a positives of a deflationary period. Here is an article that does a nice job on it.

First, my post

Doug French Writes:

There is now world-wide worrying about price deflation again. After all, real estate prices have sunk, stock prices have hit the ditch, the price of oil has the sheiks concerned, and even Las Vegas hotel room rates have plunged. Sounds like all good news for those of us who buy things, at the same time being a bit of a bummer for heavily indebted sellers.

But Ex-Federal Reserve governor Rick Mishkin told an early morning CNBC audience that “inflation could be too low.” On the same program, James K. Galbraith, who teaches economics at the Lyndon Baines Johnson School at the University of Texas at Austin, chimed in that there has been “a huge deflationary shock” to the economy, and of course the government needs to step in and stabilize the markets and bail out businesses.

“The Fed did not allow the money base to expand, and we had a panic in the liquid markets,” supply-side guru Arthur Laffer told a Las Vegas audience last week, “which caused this financial panic, pure and simple.”

Across the pond, Ambrose Evans-Pritchard, writing for the Telegraph, warns “Abandon all hope once you enter deflation.” Fine wines and white truffles have dropped in price and these price drops could “spread through the broader economy, lodging like a virus in the British and global monetary systems.”

“The curse of deflation is that it increases the burden of debts,” frets Evans-Pritchard, who goes on to contend: “Deflation has other insidious traits. It causes shoppers to hold back. They wait for lower prices. Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop.”

Yes, the current economics brain trust is worried that consumers will collectively show the good sense to delay purchases, pay down debt and increase their savings. After all, this liquidation of malinvestments will likely take awhile. The prudent thing to do in times of uncertainty is not to ramp up debt and spend money you don’t have.

But now all of a sudden saving is a dirty word. According to Evans-Pritchard, “It [savings] also redistributes wealth – the wrong way. Savings appreciate, which is nice for the ‘rentiers’ with capital. The effect is a large transfer of income from working people with mortgages to bondholders.”

Of course sounder thinking economists don’t see deflation as evil, as Jörg Guido Hülsmann points out in his just published Deflation & Liberty, “it fulfills the very important social function of cleansing the economy and the body politic from all sorts of parasites that have thrived on the previous inflation.”

And although Hülsmann’s definition of deflation is the proper one: a reduction in the quantity of base money, while what the main-stream blathers on about is a drop in prices, the point remains: “There is absolutely no reason to be concerned about the economic effects of deflation – unless one equates the welfare of the nation with the welfare of its false elites,” explains Hülsmann.

But to say governments and their friends are concerned about deflation is an understatement. Professor Peter Spencer from York University says the Bank of England has learned many hard lessons since its founding in 1694. And with no gold standard to get in the way, that central bank is “cutting rates very fast, and if necessary they too will to turn to the helicopters,” referring to Milton Friedman’s (or Ben Bernanke’s) idea that governments are capable of dropping bundles of banknotes from helicopters to stop deflation.

This printing of money “will keep the [deflation] wolf from the door,” according to Professor Spencer. But creating more money doesn’t create more goods and services. There is no wolf at society’s door. “From the standpoint of the commonly shared interests of all members of society, the quantity of money is irrelevant,” Hülsmann makes clear. And if the over indebted and the over lent go bankrupt, that’s fine. The fact is, these liquidations have no effect on the real wealth of a nation, and as Hülsmann stresses, “they do not prevent the successful continuation of production.”

Meanwhile the Bernanke Fed has gone on an unprecedented growth spurt, more than doubling its balance sheet – out of thin air – in an attempt to bail out the financial community. Formerly the asset side of the American central bank’s balance sheet was Treasury securities with a dash of gold. Now the Fed, despite being double the size, has fewer Treasury securities, with the rest being the toxic securities that has buckled the big Wall Street banks. It’s as if Bernanke is channeling John Law, the architect of France’s Mississippi Bubble back in 1720. Law couldn’t keep his bubble inflated and neither will Bernanke and his fellow central bankers.

While central bankers furiously try to re-inflate, cheered on by the mainstream financial media, monetary authorities should deflate the money supply, pulling in their horns like consumers are doing. Deflation is a “great liberating force,” writes Hülsmann, “because it destroys the economic basis of the social engineers, spin doctors, and brain washers.”

Original Post

Doug French is executive vice president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine.

Disclosure (“none” means no position):
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I wish Hank had done what John is…

Let’s be upfront. I wish the Treasury in its TARP program had bought loans and not provided liquidity to banks. I said before and still feel that giving them more cash will not increase lending.

Onward:
From the FT:

John Paulson, the hedge fund manager who was called before Congress last week to discuss the big profits he made by foreseeing the collapse of the subprime mortgage market, has started to buy securities backed by residential mortgages.

Mr Paulson’s move marks the latest example of a famously bearish investor shifting gears to profit from depressed prices in the global credit markets.

US residential mortgage securities fell in value last week after Hank Paulson, Treasury secret-ary, said that the federal government had decided against buying toxic assets as part of its $700bn (£466bn) troubled asset relief programme (Tarp).

John Paulson, who is not related to the Treasury secretary, has told his investors that he started buying troubled mortgage-backed securities at the end of last week, hoping to capitalise on price falls that followed the Treasury announcement.

Mr Paulson, who has $36bn under management, was scheduled to hold a dinner and wine-tasting at New York’s Metropolitan Club last night so that he could brief his investors on his plans.

According to Alpha Magazine, Mr Paulson made $3.7bn in 2007, reflecting the success of his strategy – begun in 2006 – of betting on a collapse of the subprime mortgage market. At the end of the third quarter of this year, his funds were up 15-25 per cent. His funds also made profits in October, his investors say.

For several months Mr Paulson has been considering investing in distressed subprime mortgage securities, financial firms and debt used to back private equity deals.

He estimated there are $10,000bn in total in such assets.

This is what the treasury should be doing. The original idea, the buy debt, the one Berkshre’s (BRK.A) offered to participate in was the way to go. Still is.

Until the bad loans are off the banks books, lending will not pick back up.

Disclosure (“none” means no position):None
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Read vs Watch, Dominos, Steelers, Wii

– Happy folks read, unhappy watch tv

– Order from your TV

– Selling the Steelers to do business with degenerates…..sad

– Got mine for the kids

Disclosure (“none” means no position):
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If this is true, not only is he a truly incompetent CEO, he is also just an awful person..

Silicon Alley Insider Reports:

Yahoo (YHOO) will drop the axe on December 10, Kara Swisher says, smack in the middle of the holidays (earlier, Jerry said Thanksgiving).

The company is still reportedly planning to can about 1,500 Yahoos. A cut of that size would only roll the company’s workforce back to Q2 levels, and, in our opinion, it would leave Yahoo in a position where it might have to make further cuts next year. This is not the way to set the company up for a clean, fresh start.

In better news, Yahoo and AOL are reportedly far apart on price in their merger negotiations: AOL’s at $6 billion, Yahoo’s at $3 billion. Given how little interest either side has in doing this deal, it would almost certainly be a disaster if they did it, so better to just let it go. (If Yahoo can get AOL for $3-$4 billion, however, it should take it).

So, with shares at $10, does the $33 a share offer from Microsoft (MSFT) seem so insulting now? I already documented some firsthand information about the mental state of Yahoo employees as they have watch Jerry wash their saving away in some bizarre line in the sand stand, now they have the specter of wondering if they are the ones to go before the Holidays. Nice work Jerry.

Carl Icahn and several other investors who owned shares during the Microsoft talks all have said the same thing. Upper management and the Board at Yahoo are by far the worst bunch out there. It is hard to argue this is anything but a willing destruction of shareholder value or delusional thinking…too close to call.

Every piece of subsequent news to come out since then has only reinforced that…

Disclosure (“none” means no position):None
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Not actually Mr. Rogers’ quote but the unmistakable tone of the interview.

Part 1: Will again short the dollar & this recession will be the worst since second World War.

Part 2: Obama will “tax capital” and “protect workers” and both have proven by history to be disasters.

Part 3: China, “selling China in 2208 is like selling the US in 1908”

Part 4:Bernanke and Paulson have not let the market work and are making the crisis worse…The current commodity sell0off has been a forced liquidation and prices are going much higher.

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Not gone, Goldman, Gas, Vitaliy

– Bigger than 9/11?

– No bonus

– Still dropping

– In Barrons….congrats

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Simmons, Soros, Falcone, Paulson, Griffin….Congress looks really bad here. They are asking basic tax questions of the Hedgies…Ought they know the answers?

Disclosure (“none” means no position):
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