Commodities

What is happening with commodity prices is very much the same as what happened in 2008. A massive increase in speculative money rushing into commodity futures that drives prices for physical commodities higher. The only reason commodity prices haven’t generally reached 2008 levels is because there is far less physical demand than then.

But the downside of speculative money moving into commodities is that they eventually move out. Fast. Like overnight and all at once. And since most of this money is in commodities as an anti-dollar hedge, any dollar strength is the event that will trigger a collapse in commodities. Especially if that strength is combined with questions about physical demand — rather than simply “euro-weakness” like we had from Nov-Jun.

Commodity prices are really vulnerable here. There are obviously going to be exceptions but, in general, speculative money is a very high proportion of the total and physical stockpiles are very high. Further, most commodities have “normal” (contango) futures curves rather than “inverted” (backwardation) curves — so speculators are already paying 1-10% annually (in negative roll yield because of contango). If they lose their expectation of future price increases; they will dump those commodity futures like a hot potato — because a zero % yield is far far better than a negative 1-10% yield.

Current commodity price volatility is a symptom of deflationary pressures — not of inflationary pressures. It is sending a message that commodity inputs will NOT be suffering deflation. In large part because there is a shortage of commodities IF global manufacturing capacity approaches normal (which it obviously isn’t right now). So commodity producers are spared (as long as they aren’t wasting capital to increase production volume). Since central banks worldwide are propping up asset prices, that is sending a message that governments will not allow asset prices to suffer that deflation either. So the asset-wealthy are spared (assuming it works). And in the US, the federales are gonna prop up state governments and entitlement spending. So public unions and the elderly are spared (assuming that works).

So who in hell is gonna take the deflation hit? Answer — private-sector workers. And they are gonna take a massive 2×4 in the groin. In large part because they are taking the entire deflation hit. Ultimately, if we continue on the “free trade globalization” religious mantra that we’ve been on for the last two decades; the downside for the American worker is – roughly – the same pay level as an illegal Mexican worker. I doubt it will actually get that far because that is the stuff violent revolutions are made of. But this deflationary pressure is what is going to drive the next few rounds of trade protectionism — just like Smoot-Hawley.

In the meantime, expect commodity prices to ride a most violent roller-coaster. With, IMO, the next leg being down.

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