Posts filed under “Commodities”
I try to find people to read who a) I disagree with 2) respect their methodology. It refines my arguments, and clarifies my thinking.
Doug Kass is one such thinker. So too are Jeff Saut of Raymond James, and Peter Boockvar of Miller Tabak (Peter publishes the very fine Macro Notes blog here on TBP). I am a big fan of both of them, so when Saut quotes Boockvar about the lack of deflation, it forces me to think carefully about my position.
Here’s Jeff channeling Peter:
“With Treasury bond yields at or near historically low levels on one hand but with commodity prices near 8 month highs, and with the personal feeling that outside of a home, a computer and a flat screen tv, the cost of living seems to only go higher on the other hand, here is another perspective on the inflation/deflation debate. Since June 1981 when Volker started to lower interest rates from 20% as high inflation rates started to fall, the absolute level of CPI rose 142% to the high in July ‘08 (90.5 to 217). Deflation is defined as a decrease in the general price level of goods and services but to quantify the current fall in prices, the CPI has fallen just 1% from its all time high.”
The Treasury rates certainly argue against inflation. But let’s look at two other factors, CRB and CPI.
The CRB is a measure of commodities, priced in dollars. Commodities rise in price primarily due to three factors. The classic inflationary reason is an increase in demand. Or, you can have a decrease in supply (or some combination of the two). But in any combination, too many buyers chasing too few goods = inflation.
But there is a third factor, based upon monetary considerations: Any decrease in the value of dollars. In the current circumstances, I believe that is what has driven the price of CRB over the past decade. From 2002 to 2007, the US Dollar fell 41% — and commodity prices soared.
Yes, prices have risen, but its not the surging demand / constricted supply we associate wit the 1970s type inflation. It can be cured by turning off BB’s printing presses.
Dollar Index (DY)
Hence, the CRB might not be the best evidence of a lack of deflation during a period of slack demand. The cost of commodities priced in hours worked yields a somewhat different conclusion.
As to the CPI, well, it has built into it an inherent error: Owner’s Equivalency Rent (OER). This understated inflation during period of rising house price — think 2001 -2007. As we noted in this Fed report in 2005, during housing booms:
“Downward pressure on rental prices mainly resulted from an increase in demand for homeownership, which was spurred by historically low mortgage interest rates. As housing starts and home sales surged in the recent recession and recovery, the national rental vacancy rate jumped from 7.8 percent in the fourth quarter of 2000 to 10.2 percent in the fourth quarter of 2003. This effect was compounded by the way owner-occupied housing prices are measured in the CPI. The CPI uses a rental-equivalence approach, measuring the value of the shelter services an owner receives from his or her home. Price movements in owners’ equivalent rent reflect changes in prices of rental units that are comparable in characteristics to owner-occupied homes. Therefore, increased demand for homeownership put downward pressure not only on tenants’ rent but also on owners’ equivalent rent — the largest component in the CPI.”
During the boom, renters became buyers. In the current environment, you must apply the opposite logic: People are reluctant to purchase a falling asset. Hence, traditional buyers become renters. This drives prices higher, and OER — anywhere from 23% to 30% of CPI — goes higher. This is true even as home prices tumbled in fact, its true because homes pries tumbled. Indeed, falling home prices appear cheap, when measured by Rentals — but that metric fails to consider the causal relationship between the two.
The bottom line to me is that neither the CPI nor the CRB Index gives an accurate read of what is gong on with price increases.
Deflation, not inflation, is present, but apparently not accounted for.
UPDATE: August 10, 2010 1:45pm
Peter Boockvar writes in:
“Another point I was trying to get across was that deflation is not always a bad thing as we are led to believe by central bankers. In an economic situation where demand is lacking, lowers GDP growth and thus creates disinflation/deflationary pressure, solving that problem by RAISING the cost of goods and services thru money printing is counterintuitive to the basic laws of supply and demand. The law says that if demand is weak, the cost of things must go DOWN to meet that level and thus create an equilibrium. For those however who are very overleveraged, whether business or individual, deflation is not good as debts are paid with shrinking income/revenue. In conclusion, the debate over inflation/deflation is not as simple as ‘it’s one or the other’ and the policy response to both sometimes misses the proper cure for the actual ailment.”
How Housing Lowers CPI (May 21st, 2005)
Rent vs CPI (June 26, 2005)
From Bubble to Depression via Bad CPI Data (April 7, 2009)
Are Home Prices Too High — or Too Low? (June 28th, 2010)
I love the mere concept of this chart from Jim Bianco — the CRB Index going all the back to the year 1,450: > courtesy of Bianco Research > About now, you may be saying to yourself, “How on earth could anyone find this ancient data — and can it possibly be accurate?” The answers…Read More
Interesting parallels between the cost of shipping dry goods, and the prices of those goods themselves. The caveat is the past 2 years have been somewhat aberrational, and we would need to see much longer history: Baltic Dry Freight Index vs. CRB Index (weekly basis) Hat tip Bill King
Paul Brodsky & Lee Quaintance run QB Partners, a private macro-oriented investment fund based in New York.
Investing in gold is tough because it challenges the investor to come to terms with the faults of his or her government, and then to act upon them. It requires the admission that there is risk in holding cash. This is counter-intuitive to this generation’s vintage of financial asset investor accustomed to thirty years of a credit build-up alongside declining interest rates.
There is certainly much more chatter in the press than in years past surrounding gold, and there certainly is more US retail investment (through ETFs) than there has been. That has been reflected to some degree in its rising price, no doubt. An ounce of gold has risen from about $250 in 1999 to current levels, having moved higher in each year and making it one of the best performing assets over the last ten years. So then, is a person that pays $1,100 an ounce today top-ticking the market by entering a crowded trade that has little upside and great downside?
We don’t think so.
Do your own research. Call your investment advisers and ask them what percentage, if any, they recommend investors allocate towards precious metals. Ring up prominent friends with substantial portfolios and ask them how much gold they have as a percentage of their portfolios. What about your fund managers overseeing, say $50 billion? Are they actually long $2.5 billion to $5 billion in precious metal plays? Our guess is that the figures in both cases will be very small, say 5% to 10% (if any at all).
Let’s extend this thinking. If people you know have only dipped their toes in the water and are doing more watching than investing in gold, then the past ten years of price appreciation must have come from elsewhere. Did it come from institutional investors? No, not in any great way. Most mutual and pension funds that report their holdings don’t own any gold – zip – other than very minor positions in precious metal mining stocks (and these stocks usually comprise less than 1% of their holdings). Hedge funds? Yes, it seems hedge funds have been buying gold but of those that have, most have less than 10% of their holdings in precious metals.
What about foreign central banks, Middle-East sheiks, Russians, ultra-wealthy families around the world? Yes, we would argue they “get the joke” and have been diversifying their wealth out of their home currencies and fiat currency-denominated assets into this scarcer currency.
Currently there is about $55 billion in global gold and silver ETFs – that’s it. (Does that qualify to be in the top ten of the any single issue in the DJIA?) It is estimated that all the gold mined in the last 5000 years is about 130,000 metric tons (each tonne converts into about 35,274 ounces). It’s a cube that would be roughly the size of a tennis court.
So let’s say there are 4.6 billion ounces of gold above ground, which means that at about $1,100/oz, the total global market value of all mined gold is currently worth a little over $2 trillion. By comparison, US Treasury debt was approaching $13 trillion, last we looked and we believe total US equity market capitalization is about $11 trillion. And then there are other bond markets (at least $8 trillion) money market funds, etc. There is also real estate.
In the US alone there is estimated to be about $65 trillion in present value private sector credit outstanding and trillions more in unfunded government obligations. And then there are the financial assets (stocks and bonds), real estate and public sector obligations for the rest of the world.
Global central banks are trying to keep it all afloat by printing even more money (by making more debt). The response by central banks to declining velocity has been and will continue to be the same as their responses to credit deflation – they will continue to print money. They may give it to their fractionally reserved banks that may then use the money multiplier to distribute more credit and in turn raise systemic velocity, or they may give it directly to debtors in the hope they will spend like drunken sailors again.
There is enormous embedded inflation already and more to come. The high-powered money has already been created; it is leveragable and it is there to increase velocity. Higher prices must follow.
Will the Fed and other central banks withdraw liquidity? No, never. They never have and they never will regardless of how many tools they proclaim are in their toolbox to do so. If money velocity picks up leading to rising consumer prices, it will also lead to rising market-priced interest rates. They may decide to cut back their monetization, but they will not drain money.
We can look at price inflation contemporaneously or we can throw the ball ahead of the receiver. The result will be the same. The defense is blitzing; Jerry Rice is standing all alone in the end zone; Joe Montana is going to get sacked….but the ball is already in the air.
At current valuations the gold market is a tiny speck in relation to where perceived global wealth is being housed. The fundamental issue is one of ratios and relative future value. Our bet is that the gold-to-everything-else spread will narrow substantially. We are indifferent to whether gold rises to $10,000/oz. while the DJIA stays at 10,000 or gold stays at $1,100 while stocks and bonds crater. (In fact, we would love it if gold stayed at current levels while financial assets fell because then we would greatly increase our purchasing power vis-à-vis the rest of humanity and wouldn’t owe any capital gains tax!)
Further, we think that fundamentally gold is worth many multiples of its current price. Remember, it rose from $35/oz to $880/oz in a matter of nine years from 1971 to 1980, and the piece de resistance came in the last few months when everyone had to own it and its price went parabolic (it became a bubble).
There is chatter and there are fundamentals. (Consider that 250,000 people watch CNBC on a good day and 10 million people regularly watch Good Morning America. And remember CNBC and most business media focus on financial assets, not commercial business.) We think the gold chatter is a bunch of financial asset predators talking up their businesses. Needless to say, we don’t think gold is a crowded trade.
Recent substantial increases in the price of crude oil and other energy products have had a significant impact on American consumers. These increases have been, and continue to be, a matter of intense focus at the Commission due to the key role that futures markets play in the critically important price discovery and risk transferal processes. The CFTC shares the concerns of Americans and Congress, and is committed to ensuring that the nation’s futures markets operate fairly and efficiently, and that the price of crude oil and other energy products is determined by the fundamental forces of supply and demand. The CFTC has undertaken a wide-range of actions to ensure that the energy futures markets are operating free of distortion.
One of the many actions taken by the CFTC to study the effect of speculation on energy prices was to reclassify its Commitment of Traders (COT) data. The old data used to offer a look at the net positions of Hedgers/Commercials, Large Speculators, and Small Traders. As the markets evolved throughout the years, these classifications became blurred by hedge funds, index traders, and swap dealers. For this reason, the CFTC now offers its COT data in a different classification format. As the second chart below shows, this same COT data is now broken down by Managed Money, Producer/Merchant, Swap Dealers, Other Reportables, and Small Traders. For a complete explanation of what is included in each category, see the following CFTC link.
By classifying the data in this way, the CFTC hoped to offer more insight into the effect of speculation on market prices. Unfortunately, as the highlighted quote in the story above suggests, the data has been somewhat underwhelming so far in this aspect.
Charts after the jump . . .
The Quote of the Day comes to us via Bloomberg’s Alice Schroeder: “We’re in the midst of a deflationary trend that is temporarily being masked by inventory restocking and free lunches like Cash for Clunkers. Consumers are done with borrowing. They’ll keep refueling the deflation by going through their attics and garages to find stuff…Read More
Those who believe the rally in gold is sending the wrong message on inflation might take comfort from the fact that the price of the yellow metal relative to that of the 30-year Treasury bond is approaching a 30-year high. Perhaps not coincidentally, the earlier run-up marked the peak of hysteria about inflation — and a multi-decade top in…Read More
While everyone remains focused on Gold, I suggest checking out other Precious metals. Over the past year, Palladium, Platinum and Silver have been kicking Gold’s shiny yellow ass! > > Chart courtesy of Ron Griess of The Chart Store.