Tuesday, April 13, 2010

The commodity V-boom (2)

This may be the most V-shaped recovery of any I've seen of late. It's an index of the prices of some relatively obscure commodities (hides, rubber, tallow, plywood, and red oak) that are included in the larger Journal of Commerce index. Now, I would argue strongly that these commodities are simply not the object of speculators' affection. If I'm wrong, please point me to data which show that speculators are gobbling up tons of this stuff and storing it in massive warehouses around the world. There's a very thinly traded futures contract for rubber, but the fact is that none of these commodities have an easy way for speculators to accumulate large positions in anticipation of price increases. The inescapable conclusion here is that prices are up (and have reached a new all-time high) because global demand is strong. You can't argue with a bullish price signal like this.

Oh, and the last time this index surged was in the latter half of 2003, which just happened to be when the U.S. economy grew at a 5.2% rate.


Benjamin Cole said...

Red Oak? I am impressed! What about hard maple?

Rubber tracks oil, and oil is the NYMEX and OPEC.

Witticisms aside, I am happy to see a robust economic recovery, and I sure hope this is a harbinger.

My argument has been that jumps in commodities prices no longer harbinger inflation as they once did, especially in the USA.

China is the biggest buyer of commodities. They have expanded their money supply by 22 percent in the last year. The yuan is pegged to the dollar. China alone can cause inflation in commodities, even while our economy is slack, and our monetary authorities reasonable.

So we have a trifecta of reasons why commodities no longer signal US inflation.

1. Demand increasingly comes from mainland China, not the USA. In many categories, they are the biggest buyer.

2. Commodities are a smaller fraction of the US economy. Especially red oak.

3. Demand for small-market commodities may be inelastic in the medium-run. Buyers keep buying, as the purchases are so small it isn't worth the time to find a substitute.

In short, the globalized commodities market no longer forecasts US inflation.

Vastly more important are US wages (60 percent of final price), property rents (about 10 percent?), worker productivity, regs and taxes.

I predict no meaningful inflation in the USA for three years. Is there a way to bet on this?

John said...

Yep. Buy the longest dated US Treasury zero coupon bond on the market.

You could also trade the major commodity stocks such as Vale (vale), Freeport McMoran Copper & Gold (fcx) or BHP Billiton (bhp) from the short side (or purchase put options). You can do the same with the gold and silver commodity exchange traded funds (gld) and (slv). Also the gold stocks. They are out there in the hundreds.

If you do so, please take a little unsolicited advice and trade small. I think you are going to get your financial head handed to you.

Scott Grannis said...

Benjamin: echoing John's comments, the market is currently priced to something very close to what you are predicting (no meaningful inflation for years). TIPS spreads are pointing to roughly 2.5% CPI inflation for the foreseeable future. That also happens to be the average of the CPI over the past 5 and 10 years. In other words, the market is priced to an inflation environment that is about as good as it has ever been. There's no room for error if you want to bet on inflation being lower than the market already expects.

John said...


Maybe my above comment is a little too strong. I do think the primary trend on commodity prices in general is up and I think you are fighting the general trend to bet against it but that does not mean you can't do so and be successful. I think you need to be nimble and pick your spots to trade. I do think gold, for instance, can be traded from the short side. You can use GLD as it also has many active options traders. Be careful. If you go into these markets you are swimming with sharks. Very intelligent sharks.

Benjamin Cole said...

Well, the TIPS projection of 2.5 percent annual inflation for next three years is about where I am, so for once I agree with the market (not a comfortable feeling, but there you have it).

2.5 percent might be a litle high, but nothing to bet on. Plus, you guys scared me.

Anything under 3 percent doesn't bother me. Sometimes I think we need several years of moderate inflation to deleverage, as the feds lack the resolve to do it honestly.

Low inflation will mean low interest rates (besides, we have a global glut of capital.

That should shape up well for stocks and property, though I think passive investing is a squishy place to be right now.

If you can, take a participant stake in an operating business. I think you can make excellent returns, and the exit startegy of selling out will probably reap large rewards (a lot of capital hungry for real returns will pay top dollar for operating business with upside).

I think we are enetring a general bull market globally, that the USA will participate in, but as a sluggish follower, not a leader.

John said...


I was going to suggest equities for a low inflation environment on the premise that sustained low inflation and interest rates will serve to expand PE multiples over time.

You have a very coherent view. I hope the low inflation scenario plays out.

BTW Intel just released earnings. Blew the estimates away. Nasdaq look higher tomorrow. Global economy looks good, as anyone reading Scott's charts the last few months with an open mind should know.