With over 20 years' experience in natural resources, Kevin Kerr (the "Maniac Trader") is one of the most recognizable analysts in the commodities biz today. Kerr is the president and CEO of Kerr Trading International, editor of the "Global Commodities Alert" and a frequent voice at Hard Assets Investor.
Editor Dave Nadig recently sat down with Kevin to talk about how the markets have changed over the past year and where he sees the markets going, including how ETFs and position limits could affect the markets, why investors think of gold as a new reserve currency, and why high commodity prices might just end up being the cure for high prices.
Nadig: As one of the great generalists in the pace, I’m curious to hear your perspective on 2010’s great commodity run. What was the biggest surprise in the markets for you over the past year?
Kerr: I think that the biggest surprise was that we continued to see commodities prices climb, considering the state of the global economy and the collapsing dollar. Commodities continue to rise as unemployment levels rise, and the news remains very negative.
Many of us did predict prices would go higher. But I expected a correction here towards the end of the year. And we really haven't seen it yet. And into 2011, we may continue to see prices climb.
I'm just growing a little more concerned, though, as prices get to certain levels and we reach record levels in gold and silver and some of the agricultural products, that were getting a little frothy here. We’re probably heading to a point where high prices will become the cure for high prices.
Nadig: Was the action that we saw in 2010 the result of investor behavior? Or supply and demand fundamentals?
Kerr: I think it was more driven by investment factors than actual demand. However, in many sectors-- and some more than others-- we have seen real pent up demand.
One good example has been the rare earths metals market. Now, of course, a lot of that [action] has been driven by fears of China controlling and cutting back on the supplies and exports. But there is real demand in this sector for hard goods requiring these metals, and we’ve seen equities in the related space jump. The sector is really kind of best of both worlds, and we see a lot of investment pouring into the sector.
Now, in some markets, like energy, we’ve also seen quite a bit of demand. But I just think that the consumer is just so strapped right now. I hear a lot of calls for a $100, $110 oil. Remember that these prices translate into four and five dollar a gallon gas. And at some point, consumers who are out of work, have been out of work for a long time -- the government’s employment number is at about 15 million, probably more realistically 30 million people – prices for these commodities will just become too unreachable. We’ll start to see demand destruction.
So, I do think we’re reaching a pinnacle level, at the end of 2010, for many commodities.
Nadig: Then where do you see the opportunities in 2011? If it’s not $100/barrel oil, and it’s not $2,000/oz dollar gold or $4,000-$5,000 dollar copper, what should the average commodity investor look at in the next year?
Kerr: My approach has always been a long-term, macro commodities bowl. But, when we reach certain levels-- and we went through this in 2007 and 2008-- you have to take a step back. This is a time to be a bit cautious. There is upside to all of these commodities, if you can play them cautiously.
We trade options on commodities and futures, and we can get short just as easily as we can get long. And we’re looking for the commodities we think have been overbought or getting close to that, and probably less upside potential short-term.
The market that’s really confounded me, quite frankly, is the copper market. This market has just been on fire. Yet, with the housing market and the global economy implosion, you really would have expected these ace metals, certainly like copper, to pull back. We just have not seen it.
Nadig: Right, and you haven't seen inventories collapse much. There has been no real reason for the rise in the traditional sense, right?
Kerr: That’s right. And it does bring up my suspicions a bit. Of course, you’ve heard these stories about the cornering of the copper market and supplies being held by one individual and all these theories. But, at the end of the day, there is demand for copper. And there’s demand for a lot of these raw materials. So it’s very hard to know what the true story is.
One of my researchers sent me a story about China: all these real estate developments here and there, and just sitting empty. While people are earning more there, they're not able to afford housing. And so, you have these huge ghost towns and developments, whole cities taken by satellite pictures by Google (GOOG), that are just empty. And this just defies logic, when you look at a market like copper, which is so dependent on the construction industry. Yet, these prices just continue to surge.
Nadig: Do you think physical copper ETFs that we’re going to see in the beginning of the year will have any real impact? Or is copper such a big market that the presence of a billion or two dollars in assets coming in through ETF investors just won’t make a difference?
Kerr: I think it’ll be very interesting to see what happens. Anything physically based, I think, will have an impact. Copper is one of the most liquid markets in the world, though. So, you know, how much impact it will have, we’ll have to wait and see.
But overall, I think all the new instruments we’re seeing, all the ETFs and certainly the new investors have moved into the commodity space, have all had an impact on the markets. Some of that impact has been very, very positive. And some has caused a lot of change that can be confusing: Things that never would have happened in the past happen now. We see gold and the dollar rallying at the same time, for example. That relationship always used to be the opposite. And now, they often trend together. So many, many things have changed, and traders have had to adjust the way of their thinking to new market conditions worldwide.
Nadig: Let’s talk a little bit about gold. Is gold in 2010-2011 a fundamentally different asset class than it was back in the ‘70s, ‘80s and ‘90s? Is it a different world for gold now?
Kerr: Absolutely. People have become so disenchanted with paper currencies. For such a long time, the U.S. dollar was the “gold standard” for currencies, and now it’s really a tarnished currency. The euro is very uncertain. People want something they can hold in their hand, that they can believe in. And they're turning to metals for that reason. You know, gold has become, really, the new reserve currency. Commodities and raw materials and certainly precious metals are the new reserve currency for many people. They just don’t believe and have faith in the paper currency that they're holding.
But it’s not new; in the ‘70s and ‘80s, there were people that would say that. But now, it’s a real fact. We’re seeing these record prices for a reason—and we still have a long way to go. I mean, even with just adjustments for inflation, gold is not even close to where it should be, to make a new high.
At the end of the day, you cannot have a policy of printing endless amounts of paper money and expect not to have hype- inflation. Denials from Mr. Bernanke are not going to fix the problem of all this extra paper floating around.
Nadig: Some of the touchstones gold investors have used for years to evaluate whether gold is fairly valued or not include the gold to silver ratio or gold to oil ratio. Do these things still make sense in a historical context? Or do we live in a brave new world, where today’s gold-silver ratio is now the new normal?
Kerr: Yeah, many things have changed. They have to be adjusted, but they're still very good benchmarks for a basis of historical standard.
As we move into the new decade, we’re going to have to adjust those numbers to keep up with the changing world economy. S many more people are now able to access these commodities that never were able to before. This is the good side of the double-edged sword, you know. ETFs and equities are more accessible, trading 24-hours worldwide, so more people can access this kind of protection for their portfolio or investment opportunity.
But it’s added a lot of liquidity to these markets, and some volatility. Typically, when we see a lot of liquidity, that’s supposed to reduce volatility. But it oftentimes also brings in a lot of investors who may not be used to these markets. So, we can see some very rapid swings, as we’ve seen.
I don’t think we’ll see a correction as violent as we did in 2008, because I think investors are a little more savvy now, and in it for the longer term. But we do have to remain cautious.
Nadig: Looking into 2011, do you think that the position limits that will eventually get implemented will have any teeth, any impact at all on the futures markets?
Kerr: That’s a really great question. I think they won't, because the funds and other players that want to go around the position limits put in place, have places they can go to do that. It just won't be in the U.S.
I’m a real free market trader, and any time the government gets involved, I tend to get very concerned. I mean, they can certainly do that; that’s their job. But it can also go too far. And, when we start to see too much regulation and too much restriction, then we have the governments running the free market.
I'm not sure how much tape these regulations really will have, though, because we are such a global market, now, that that’s not really going to affect global traders and where they go to get what they need to get.
Disclosure: No positions