Commodities - The Long And Short Of It.

Commodity price performance has been a wild ride in 2008.

The record of price movement is outlined in the table and chart below. For each commodity, the table details year-to-date (YTD) %-age change, drop from 52-week high, and start of year to the 52-week high.

Oil has had the roughest ride falling 62% YTD, 75% from its 52-week high, and preceded by a rise of 53% to its 52-week high. This was followed by Copper, Platinum, and Natural Gas, which had a meteoric rise to its 52-week high of 83%.

Most of the commodities, save Gold, have behaved in kind, thanks to the long-only commodity indices like GSCI which enabled investors of all kinds to invest naked in long-only baskets of commodities. They all went up together, and they all came down together. Platinum and Silver, the other two precious metals dropped along with other commodities, while Gold resumed its dual status as favoured currency and store of value during periods of turmoil.

Commodities are indeed more volatile than stocks. When, and if, we see the return of expansionary and/or inflationary (or worse, hyper-inflationary) conditions, however, these will be a key asset class to allocate to. With all of the printing presses at the Fed whirring right now, some would say its inevitable.

The facts are that during this period in time, the only asset group to have its fundamentals unimpaired is commodities:

• Farmers can’t even get loans for fertilizer now.
• The supply of things is going to be in even worse shape coming out of this.
• Oil is crushed; it is below the cost of production in many places. It is below the cost of alternate sources of energy, so oil is going to make a huge comeback when it does go through the roof.
• The IEA recently came out with a study showing that the worlds reserves of oil are declining at the rate of 7% per year. You can do the arithmetic, the supply of everything is going down; oil and everything else; we’re going to have serious supply problems before too much longer. In 15 years there isn’t going to be any oil left unless somebody discovers a lot of oil quickly in accessible areas, and the price of energy has to go climb again.
• The fundamentals for General Motors are impaired, the fundamentals for Bank of America are impaired.
• The fundamentals for Zinc are improving, the fundamentals for cotton are improved.

Commodities will be the place to be if and when we come out of this crisis, but even if we don’t come out of it.

• In the 1970’s the economies were bad, but commodities went through the roof.
• In the 1930’s commodities were a much better place to be than stocks, because there was no supply.
• Gold will probably go much higher.

Platinum is more industrial, and certainly tied closely to the Auto industry; hen its time to buy Automobiles again, Platinum will be a spectacular play.

There are shortages, and then demand will suddenly come racing back, and there won’t be any inventories left; this is how economies have always evolved.

Where Do I Put My $200 Million Windfall?

Tomorrow's Europe-wide lottery offers a tax-free, lump-sum jackpot worth about $200 million. When I hand over my winning ticket, though, I will face a dilemma: Where do I stash my luck-gotten gains?

Burning through the first few million won't be a problem. I'll turn up for work on Monday morning with a case of champagne and get roaring drunk at my desk before someone calls security and kicks me out of the office. I'll limousine home, snooze for a few hours to sober up, and then hit the phones. "Hello, NetJets Inc.? I'd like to open an account, please. Oh, and once the funds clear, book me on a Dassault Falcon 7X to Aspen.''

Once I've bought the ski lodge, ordered an Aston Martin DBS sports car and selected my Sunseeker triple-decked yacht, bought the latest fashions from Versace and Chanel though, I have to find a home for my winnings. In these troubled times, there are few, if any, true havens.
I can't put my money in a bank. Deposit insurance programs are underfunded, overstressed and woefully inadequate given the size of my needs. Even with a smaller stash, do I really want to risk finding myself in a line of creditors when the authorities decide to let another institution follow Lehman Brothers Holdings Inc. over the cliff?

Banks still won't lend to each other, which is why the one-month money-market rate for US dollars is at 3.43 percent, its highest level since January. Why would I risk putting my money into an account, rather than under my mattress?

Defensively Dull

I'm sure Goldman Sachs Group Inc. and Morgan Stanley would welcome me with open arms, now that they have seen the error of their racy investment-banking ways and dulled down to become deposit takers. Nevertheless, I'm learning the lesson of recent years. Whatever Wall Street is selling, I'm not buying, no matter what Warren Buffett does.

The regulators, meantime, clearly don't want me to invest in financial markets. They have banned short selling in the stocks of such paragons of economic virtue as credit-rating company Moody's Corp. and hedge fund GLG Partners Inc. They look poised to regulate the credit-derivatives market out of existence.

Pretty soon, it will be illegal to buy anything that is rising in price -- oil and other commodities spring to mind -- and it will be forbidden to sell anything losing value. Why would I walk onto a playing field where the goalposts move arbitrarily and the rules are in flux? The mattress option is looking more and more attractive.

Negative Yields

Maybe I should blow my wad on U.S. Treasury bills, even if I end up investing at negative yields that mean I'm paying for the privilege of lending to the government. Do I really want to be in dollars, though, when China and other foreign holders of Treasuries look ready to dump the greenback, and the rating companies should be reviewing the U.S. government's AAA grade?

My lottery win tomorrow, however personally enriching, will be dwarfed by the largess the U.S. government is lavishing on Wall Street. "$700 billion,'' says U.S. Treasury Secretary Henry Paulson "$1 trillion,'' says Barclays Capital. "$2 trillion,'' says Tom Sowanick, the chief investment officer for $22 billion in assets at Clearbrook Financial LLC in Princeton, New Jersey.
Sowanick added together $700 billion for rescuing Fannie Mae and Freddie Mac, the $29 billion Bear Stearns Cos. backstop, the $85 billion loan to American International Group Inc., the $700 billion Paulson plan, $500 billion to the Federal Deposit Insurance Corp., plus sundry other new obligations.

Cover-Up

If Sowanick is correct, the U.S. taxpayer will be on the hook for quadruple the amount that banks around the world have written off so far. That makes the U.S. seem like a place to avoid for a lottery winner seeking security in securities.

Paulson's aptly named Troubled Asset Relief Program, a tarp being the sheet you spread over the junk in the garage to hide it from critical, prying eyes, has a twist. While the Treasury won't buy your damaged collateralized-debt obligations directly, there is a way to offload your toxic CDOs -- provided they have defaulted and you can break them into their constituent parts.

Standard & Poor's reckons about $240 billion of the $450 billion of subprime CDOs it rated has suffered an event of default, according to a research note published this week by Royal Bank of Scotland Group Plc. "When a deal is in EOD, the controlling investor can choose to liquidate,'' the note says. "The Fed plan makes liquidation potentially the best option, as then the Fed bid can be hit for the underlying bonds.''

There's a spoof e-mail doing the rounds, aping those Nigerian banking-scam letters. "I am Ministry of the Treasury of Republic of America,'' it says. "My country has had crisis that causes need for large transfer of funds of $700 billion. If you would assist me in this matter it would be most profitable for you. After you send me bank account details, I will reply with detailed information about safeguards to protect the funds.''

I think I'm going to need a bigger mattress.

Put Away The Shovel

Put away that shovel. Mining stocks are getting hurt as investors anticipate a profit squeeze between rising investment costs and falling commodities prices.

The DJ Basic Resources STOXX index, which includes some of the world's main metals companies, including BHP Billiton and Rio Tinto, is down 26% in the past three months. That has left commodities companies trading at historically low multiples of expected earnings, suggesting either the shares are undervalued or investors believe miners' run of profit growth can't continue.

The latter looks most likely.

Even if commodities prices don't fall further, rising costs could be enough to squeeze profit margins and slow earnings growth -- even if the volumes shipped by the biggest companies continue to rise.

The latest interim results from BHP, run by Marius Kloppers, showed signs of the pressure. Operating margins were two percentage points lower at its Escondida copper mine in Chile compared with last year, and BHP saw deterioration of nine percentage points at its Olympic Dam copper and uranium mine in Australia.

Rival Rio Tinto, facing a takeover bid by BHP, also demonstrates how cost pressures are affecting capital investment. Inflation alone accounted for about half of the increase in its capital spending from 2003 through 2006, according to Lehman Brothers. Since then, Rio Tinto is likely to have found it is getting even less from its capital-expenditure dollars. Its capital spending was $5 billion in 2007, up 25% from 2006.

The rising cost of fuel, transport and equipment as well as hiring and retaining engineers explain the squeeze on miners' margins in some areas.

Miners can't expect higher commodities prices to come to the rescue, either, as consumption slows. Sector consolidation ought to offer safety from a price war or overinvestment. But this strategy, born during the boom, has yet to be tested in a downturn. Forcing more price rises on weakened customers looks unsustainable.

Goldman Sachs reckons half the world economy is in or facing recession. Even China might not spend so heavily on infrastructure in the short term. Some see a post-Olympics slowdown, if not a pause, resulting in the reduction of metal inventories.

With investors able to invest directly in commodities through exchange-traded funds and other vehicles, they don't have to dig into mining companies themselves to retain long-term exposure to metals. Mining stocks now trade on an average of around seven times bullish 2009 earnings estimates, compared with more than 12 times forward earnings at points in the recent past.

The sector looks cheap. But given the potential margin squeeze, only deceptively so.

Those Who Hesitated Have Lost Even More

A year into the credit crunch, banks should have learned a lesson: It pays to be first.

The small number of financial firms that acted early to repair balance sheets must be glad they bit the bullet when they did. It was easier and cheaper to raise equity capital in the early phases of the crisis. In January, when Citigroup raised $12.5 billion from selling convertible preferred shares, its stock was just shy of $25. At Monday's closing price of $17.61, shareholders would potentially face far heavier dilution.

Firms jettisoning troubled mortgage assets today would likely get worse prices than at any time in the crisis. Bonds backed by Alt-A mortgages and jumbo prime mortgages are trading at record lows, according to Credit Suisse, while subprime loans are only slightly above their mid-July trough.

E*Trade Financial looks lucky to have unloaded $3 billion of toxic mortgage assets to hedge fund Citadel in November. Market participants were aghast at the $800 million Citadel paid, because it implied a hefty 75% write-down. But a fire-sale discount today could be even larger.

Admittedly, firms that were quick to take bold steps did so because they had to. Others should have taken the cue from their sicker brethren. In fact, in today's markets, even hitting the wall first could end up being an advantage. Bear Stearns's shareholders should now feel lucky they got $10 a share, as should debt investors who were made whole.

Today, shareholders might get nothing. The Fed is open to the idea of structuring investment-bank bailouts so that shareholders get wiped out completely, according to a speech Friday by Chairman Ben Bernanke. And debt holders might also have to take losses.

It isn't too late to act.

The Greatest Transfer Of Wealth In History

No, this discussion is not about oil.

The credit crisis really puts the free in free market. The freest market is supposed to be the United States, and the evidence in favour of that argument is mounting. It's just not what you think. Free, in this case, means a free ride for a select group of people. Wall Street never looked so good, or bad, depending on your perspective.

From early 2004 until mid-2007, the big Wall Street investment banks made $250-billion (U.S.) in profits. (That's Bank of America, Citigroup, JPMorgan, Morgan Stanley, Goldman Sachs, Lehman Brothers and Merrill Lynch.) During the past year, they've written off $107-billion. Keep in mind as we follow the money that if you include smaller dealers and commercial banks, the profit number swells and the writeoffs are even bigger.

As fate would have it, the writedowns, mostly garbage subprime loans, equal almost perfectly the amount of money Washington will dole out in stimulus cheques to get the economy going again. The House of Representatives Speaker said last year that the stimulus package would create 500,000 jobs. She got the number more or less right, but it was actually a loss of jobs.
Meanwhile, recent figures show that of the money that's been mailed and spent, only a 10th has gone to new spending.

The rest of it has been consumed by inflation (that is, because prices have gone up, even if consumers take their money to the mall, they're not helping the economy much).
Inflation is partly a product of easy money or low interest rates.

Why does the Federal Reserve keep interest rates low? To stimulate the economy, which is being ravaged by the housing recession. The housing recession, meanwhile, was fuelled by Wall Street's greed and recklessness, aided and abetted by the easy money and the fraudulence of builders, appraisers and mortgage brokers.

Back to Wall Street to start connecting the dots. According to the New York State Comptroller's Office, the big banks paid $33.2-billion in bonuses in 2007, down only slightly from 2006, an even more splendid year for subprime origination. During the past four years, bonuses closed in on $100-billion, not far off the writeoffs and the stimulus package.

Back to Washington, whose coffers are bare, meaning that $107-billion is borrowed money. Borrowed from whom? Savers, mostly foreign. Borrowed by whom? The taxpayer of course. So in effect, the stimulus package is simply a matter of the cash-strapped, highly indebted U.S. consumer borrowing to spend (or pay debts) to save the economy. Not good.

It's pretty clear what's happening. Ultimately, the people are borrowing to pay Wall Street bonuses. After all, these handsome rewards are based on the earnings of the banks, but they're not real earnings, since the assets that produced them are subsequently written off. The bubble that created these bogus earnings was inflated with the help of low money costs and lax supervision of financial firms.

The bursting bubble is roughing up the economy so badly that the government has to borrow to stimulate spending, which it fails to do. It might also have to borrow $25-billion to bail out government-sponsored mortgage insurers, including Fannie Mae. And since the government is really just the people who are getting hurt by the slowing economy, with no bonuses to comfort them, is this not the greatest transfer of wealth in history?

And we haven't touched on other largesse the people have extended Wall Street, such as the loan guarantees that helped JPMorgan buy Bear Stearns.

Karl Marx has nothing on these people. But Groucho might.

And you can argue that some of the losses are marked to market and might be reversed and that some of the bonuses were paid to people who had nothing to do with subprime. Probably true, but hair-splitting I say.

As individuals, we can learn a lot from these lessons -- especially what not to do.

INFLATION - The Next Crisis

One thing we find truly amazing about the markets is that they’re much more than just investments. Markets provide a way of peeking into the future, if you understand what they’re trying to tell you.

These lessons are ongoing but it’s fascinating and like a giant puzzle.

MARKETS TELL THE STORY

Sometimes the messages are pretty subtle. But other times they’re major, signaling massive economic, political or geopolitical shifts.

Most interesting is that the markets lead. So it’s important to recognize that whatever a market is telling you, it’s not going to be obvious when that market gives the signal. The message will become obvious later.

Let’s take gold as an example. It started moving up in a major bull market in 2001, and it’s been rising strongly and consistently ever since. Gold always leads inflation, so it was telling us that inflation was eventually going to head higher. That didn’t happen for quite a while, but now it’s another story. Plus, gold’s been telling us much more…

INFLATION ON THE AGENDA

I’ve been writing about inflation for a long time and why we thought it was coming back in a big way. As the years passed, the evidence became more overwhelming.

But most people haven’t been paying much attention. Aside from concerns about high oil and food prices, there are plenty of other things that are more worrisome.

In the U.S., for instance, consumer confidence fell to a nearly 30 year low and a recent poll showed that 81% feel that the U.S. is on the wrong track. This is primarily due to the war, the slowing economy and the housing situation.

And while these conditions remain serious, along with a slew of other concerns, like the heavy debt load, soaring foreclosures and so on, it’s important to recognize that this is the current situation. It’s not what’s coming.

What’s coming is higher inflation and it could prove to be more serious than most people think, at least based on what we’re now seeing.

NOW IT’S HERE...

Suddenly, there’s a lot of talk about inflation in official circles and that wasn’t the case before. But over the past couple of months, comments or inflation warnings were made by the Fed, the European Central Bank and the Bank of England. Government officials are speaking out, and so is the press. The International Monetary Fund was the most direct, warning that global inflation has re-emerged as a major threat to the world economy.

As I’ve often pointed out, inflation has been creeping back and it’s gaining momentum. In the past six months, for example, we’ve seen some huge double digit annualized jumps in U.S. wholesale prices, along with soaring money supply.

But what’s happening in other countries is even more interesting and it’s intensifying the global inflation concerns, which gold saw coming way back when.

Globalization boom...

As you know, many developing nations have been booming, thanks to globalization. This is taking place all over the world and this growth is much greater than in the developing countries.
It’s estimated that half of the world is leaving poverty behind as standards of living improve. That’s especially true of the BRIC countries, which are the emerging market leaders (Brazil, Russia, India and China). It’s also true of many Asian countries, as well as many of the Eastern European, Middle Eastern and Latin American countries.

As living standards improve, people in emerging nations are able to buy things they couldn’t afford before, like food and cars. This has greatly increased demand, and it’s put massive upward pressure on agricultural commodities and oil. It’s actually been the driving force behind the commodity boom.

Heating inflation

Over the years, I’ve taken quite a few trips to developing countries and we’ve seen grueling poverty up close. It’s a terrible situation and the fact that millions of people are escaping this lifestyle is a good thing, but like most things, there’s a price to pay. In this case, it’s inflation.

Inflation is picking up in most countries, for example, inflation is above 15% in many emerging countries like Vietnam, Latvia, Estonia, Pakistan and Egypt. It’s more than 10% in a lot of other countries and it’s a huge concern in Russia, China and India.

The bottom line is that inflation is at a 10 year high in emerging countries and The Economist says that two-thirds of the world’s population will probably suffer double-digit inflation rates this Summer. This is a huge deal and it explains why officials are concerned, but there’s more…

SOARING MONEY SUPPLY... GLOBALLY

Global monetary policy is now the loosest since the 1970s and money supply is growing almost three times faster in emerging countries than in the developed world. As you know, that’s the direct cause of inflation.

Plus, as The Economist points out, there are alarming similarities between emerging economies today and the rich world in the 1970s when the Great Inflation took off.

For example, in many emerging countries policymakers view the inflation rises as a short-term phenomenon and they’re taking superficial measures to deal with it.

So the causes are similar and the results will be the same for everyone, no matter where you live. As we’re already seeing, commodities, food, oil, building materials and so on… they’re all going up.

IN SUMMARY

It’s still to be seen how this will end. But so far, this inflation rise is coinciding almost perfectly with the commodity cycle. If this continues, and I believe that it will, then there’s a lot more inflation to come in the years ahead.

What’s currently happening also strongly favors the outlook for gold and the other commodities. It’s going to boost demand for gold as a safe haven during inflationary times and these ongoing developments are telling us to stay with commodities, gold and precious metals positions.

In fact, gold’s been telling us this all along. Now we’re starting to see why.

Sudden Slowdown or "What I Learned In The Dentist's Chair"

I was horizontal in the dentist’s chair yesterday when BBC’s World News reported a slowdown in the rate of growth in India. I had an hour of construction going on in my mouth to ponder on that before the good ole BBC news loop came round again, and I heard it repeated. The drill’s vibration was insufficient to thwart the bells ringing in my head.

The entire bull market in base and industrial metals is, according to many institutional investors and economic theologians, based on the fact of India and China’s unstoppable growth.

Admittedly, one quarter’s statistic indicating a deceleration in the rate of growth is hardly cause for alarm. However, should this pan out to be the first iteration of a change in the pattern we’ve grown accustomed (actually…more like addicted) to, we could be in for some serious trouble.

The world over, observers have been watching the ripple effect initiated by the real estate and credit bubble implosions comfortable in the knowledge that the Asian growth machine was proceeding seemingly unaffected by the carnage in London, New York and Berlin.

So if India is now to fall victim to higher capital, energy and raw material costs, is China right on its heels?

What is the greater implication for the United States and the rest of the G8 nations if this last bastion of economic fortitude is also to crumble?

According to the BBC (and yes I was taking notes while the dental crew was unleashing its own economic expansion in my yarp), “Growth is expected to continue to slow this year, but will remain higher than most other economies in the world.

"There will be deceleration this year coming from industry and high interest rates," said economist Saugata Bhattacharya, from the Mumbai-based Axis Bank.

"Industrial impulses will be curtailed. However, there will be a partial offsetting if agriculture and monsoons will be good," he said.

If agriculture and the monsoons are good?!

Isn’t this the nation where 17,500 farmers commit suicide in their fields each year precisely because agriculture and the monsoons are not good? That’s right. 17,500 farmers every year between 2003 and 2006 took their own lives standing in their fields because they owed, on average, US$1,000 or less. If I committed suicide every time I owed somebody a thousand dollars, it would be a most disagreeable movie version of Groundhog Day. At least 160,000 farmers have committed suicide since 1997, said K. Nagaraj of the Madras Institute of Development Studies.

The BBC's Karishma Vaswani in Mumbai said the rising cost of living had had a negative impact on consumer spending and the situation was likely to get worse before it got better.

India’s main growth slowdown occurred in the manufacturing sector. As it turns out, the same thing is happening in China. A Reuters story crossed the wire at 1:05 a.m. Eastern stating that "China's manufacturing sector slowed last month for the first time since January as export orders and domestic investment both weakened”.

And why should we be surprised?

China has essentially become the world’s manufacturer. If the G8 nations are in a pinch because the credit they’ve been “spending” for the last 10 years has in fact turned out to be play-dough, and the dismantling of the Betty Crocker Easy Bake credit oven has eliminated the clay ducats we’ve been using to acquire overpriced bricks and mortar, the obviously the world’s manufacturer is going to experience a reduction in demand, and by extension, Gross National Product.

Dare I say it? Is this the onset of global recession?

Do you ever feel like you’re on the Titanic, and you’re looking over the rail at the icebergs thinking, "Shouldn’t we be proceeding a little bit more cautiously?", while the men in uniform keep shouting, "Full speed ahead!"?

Alas, that is the world we live in. If our elected officials declare "Full Speed Ahead", then full speed ahead it is. Democracy’s Achilles heel, apparently.

So now what? Is it time to sell base metals, precious metals and all the juniors exploring for same? What about the big boys – the producers? As I said, this is the first news of diminished growth in China/India, and so a knee jerk reaction would be just that, at this point. But it’s a nervous eye watching the data today on my part.

If the Asian juggernaut has exhausted its momentum, all the gold, silver, oil and metals stocks in the world won’t feed a planet torn by food riots and civil warfare.

A Eulogy for Bear Stearns

Every crisis has it's unsung heroes. When the history books are written on The Great 2008 Credit Crunch, Bear Stearns shareholders - who today handed over their shares to JP Morgan for an Alexander Hamilton - will almost certainly have fulfilled that role. Investors everywhere owe them their gratitude.

The superheroes of the credit collapse have already been well eulogized. There's JP Morgan boss Jamie Dimon in his pin-striped cape swooping in to buy Bear and save the markets from mayhem, alongside Wonder Twins - New York Federal Reserve Bank chief Timothy Geithner and Treasury secretary Hank Paulson.

But the deal these Wall Street Super Friends structured to avoid Bear's spider web of counter-party relationships collapsing the global financial system would not have been possible without the sacrifice of the firm's equity holders, a third of whom included the company's own employees.

Their sacrifice served two purposes. By allowing JP Morgan to assume the 85-year-old firm - the alternative to a rushed bankruptcy and the liquidation of hundreds of billions of dollars of trades - financial Armageddon was arguably averted. Second, by getting no more than a tenner for a stock not long ago worth $170, Bear shareholders became sacrificial lambs for regulators intent on avoiding the nurturance of moral hazard.

So in addition to their $10, should we award Bear shareholders a Lucite plaque for their saviour status? The answer is no. Though they may deserve our thanks, they would have done a greater good by forcing Bear's hapless board, led by absentee chairman Jimmy Cayne, to better fulfil it's fiduciary obligations. Had they done so, the crisis - and the evaporation of Bear Stearns - might have been averted.