Too Much Money Chasing Too Few Commodities

A historic rally is underway in the global commodities markets. Central bankers in 18 of the top 20 economies in the world have been expanding their money supplies at double digit rates for the past several years, trying to prevent their currencies from rising too quickly against the sickly US dollar.

Nowadays, fund managers are pouring billions of dollars into commodities across the board, as a hedge against the explosive growth of the world’s money supply, competitive currency devaluations, and the negative interest rates engineered by central banks. To the chagrin of central bankers, much of new money pumped into the global markets is also going into commodities, instead of the stock market.

The remarkable run-up in prices of wheat, corn, soybeans, cocoa, rice, silver, platinum, gold, copper, iron ore, and crude oil have been blamed on supply shortfalls, strong demand for bio-fuels, and an inflow of $150 billion from investment funds. There are big shifts in demand from the emerging economies, where incomes are rising, and folks are changing dietary patterns. The surging ethanol industry has put a squeeze on the corn market, and bio-diesel demand is fueling soybeans.

“I think it is something that the Fed has to watch, but I am not alarmed,” said retiring St Louis Fed chief William Poole, in reaction to news that the US consumer price index hit 4.3%, a 17-year high in January. “We can conclude that the current situation is one of substantial stability of inflation expectations. Recent relatively small increases in inflation are apparently due to transitory factors, and not to changes in inflation expectations."

But the charts don’t lie, and sophisticated traders are not easily duped by the Fed’s smokescreens and brainwashing techniques. The Fed is slashing the federal funds rate at a frenzied pace, to arrest a year long slide in US home prices, which if left unchecked, threatens to topple the US economy into a severe recession. The slide in US home prices accelerated in the fourth quarter of 2007, with prices tumbling 8.9% last year, according to the S&P/Case-Shiller US National Home Price Index.

During the 1990-91 housing recession, home prices were limited to a 2.8% drop. The number of US homes facing foreclosure jumped 57% in January from a year ago to 233,000 homes, and a wave of adjustable rate mortgage resets expected in May and June threatens to push many other homeowners into default. Nearly 8.8 million US homeowners hold mortgages that are larger than the value of their homes, providing an incentive to abandon houses bought on speculation.

In trying to put a floor under the housing and stock markets, the Bernanke Fed has cranked up the growth of the MZM money supply to an explosive 15.4% annual rate, which is also depressing the US dollar and pumping up the commodities markets to astronomical heights. The Fed has unleashed a speculative frenzy in commodities, and traders have lost faith in the central bank’s credibility.

The Bernanke Fed’s aggressive rate cuts have doing more harm than good for the US economy, by leaving the US consumer with slumping home prices on the one hand, and soaring food and energy prices on the other hand, otherwise known as the “Stagflation” trap.

According to Bill Gross, chief investment officer at Pimco, the Fed’s rate cuts of 2.25% since September have not brought mortgage rates lower, with the Fannie Mae 30-year mortgage rate stuck at 5-3/4 percent.

“Here is the startling point, the markets that the Fed is trying to affect haven’t changed,” he said. Gross thinks the housing downturn is still in its early stages, and expects a 20% decline in total. “A 20% decline in housing prices is confidence destabilizing, its credit imploding,” he added. And how long can US Treasury yields stay under the exploding rate of inflation, or negative rates of interest?

Commodities investment guru Jim Rogers said on Feb 25^th, “the Fed is printing money and are trying to prevent the recession, they are putting on Band Aids,” he told an investor conference in Dublin, Ireland. "As long as the US central bank and the federal government keep making mistakes, you will have a longer period of slowdown, and it will be perhaps, one of the worst recessions we have had in a long time in America,” Rodgers predicted.

Buoying the commodity markets across the board is the chronically weak US dollar, which has been stripped of its life support, by the Bernanke Fed. After a double barreled rate cut of 1.25% in January, the largest monthly reduction in 25-years, Fed chief Ben “B-52” Bernanke signaled yet another rate cut in March, as an “insurance policy” against an economic recession.

Playing down the soaring costs of food and energy, Bernanke told Congress on Feb 15^th that “inflation expectations appear to have remained reasonably well anchored.” Yet even government apparatchniks said US inflation at the wholesale level soared 1% in January, led by rising food, energy and medicine costs. With the January jump, wholesale prices rose 7.5% over the past 12-months, the fastest increase since 1981, when the country was trapped in “Stagflation.”

His right hand man, the ultra inflationist Frederic Mishkin, defended the Fed’s policy of ignoring food and energy prices, when deciding on the correct level of interest rates.

“Stabilizing core inflation, which excludes food and energy, leads to better economic outcomes than stabilizing headline inflation. The shock of energy price rises is likely to have only a temporary impact on inflation, because inflation expectations are contained,” Mishkin argued on Feb 25^th. “When inflation expectations are well anchored, the central bank does not need to raise interest rates aggressively to keep inflation under control following a supply shock. If central banks raise rates aggressively to counter inflation caused by a sudden rise in oil prices, unemployment will be markedly higher, than if policy-makers set borrowing costs in response to fluctuations in core prices."

“I do not expect the recent elevated inflation rates to persist,” Fed vice chairman Donald Kohn told the University of North Carolina on Feb 26^th. “In my view, the adverse dynamics of the financial markets and the economy have presented the greater threat to economic welfare in the United States. Policy-makers must take into account the possibility of very unfavorable developments."

“We have the tools. As Chairman Bernanke often emphasizes, we will do what is needed!!” Kohn warned. Those tools include driving the federal funds rate to zero percent, if necessary, pumping the money supply growth to above 20%, or buying long dated Treasury securities with printed money. It could trigger capital flight from the US dollar, and send gold, crude oil, and grains into the stratosphere.

“The Fed’s credibility on inflation is rock solid,” said deputy US Treasury secretary Phillip Swagel on Feb 26^th. “Overall, inflationary expectations remain contained,” he declared. But in a show of hands, in a packed hall of delegates at the Euromoney Bond Investors Conference in London, listeners overwhelmingly disagreed with Swagel’s propaganda and brainwashing. Instead, the audience thought the Bernanke Fed had let the inflation genie out of the bottle.

Back to reality, Chicago Board of Trade wheat futures soared by the daily 90-cent limit or 8% to $12 per bushel, and are up 160% from a year ago. Spring wheat futures on the Minneapolis Grain Exchange staged a historic rally on Feb 25^th, rising more than 25% in a single day after the exchange lifted daily trading limits on the front March contract. March spring wheat settled at $24.00 per bushel, up $4.75, after reaching $25.00, the highest-ever price for any US wheat contract.

Soybean futures for July delivery rallied to a record $15 /bushel, up 90% from a year ago, fueled by aggressive Chinese demand for soybeans and soy-oil. China’s soybean imports jumped 41.5% in January to 3.4 million metric tons from a year earlier, and demand is expected to rise ahead of the Beijing Olympics. China bought up to 25 cargoes of soybeans and 300,000 tons of soy-oil last week alone. Rough rice is up 70% from a year ago, a big worry in Asia, where more than two billion people depend on rice as their main source of calories and protein each day.

Platinum is up 90% to $2,145 /oz, amid supply disruptions from South Africa, cocoa futures are up 65% at a 24-year high, coffee is up 60% to a 10-year high, sugar is up 35%, gold and silver are up 50%, and crude oil is banging against $100 /barrel, up 80% from a year ago. Crude oil or “black gold” is not just an industrial commodity, but is utilized as an inflation-hedge and alternative to stocks.

Thus, super-easy central bank money policies, and rate cuts in Canada, Hong Kong, Saudi Arabia, England, and the United States, combined with strong demand for industrial and agricultural commodities from emerging China, India, and the Arab oil kingdoms, are laying the groundwork for a new era of hyper-inflation worldwide.

Is the Fed Pumping Up America’s Oil Bill?

The Fed’s double barreled rate cuts in January, ricocheted into the foreign exchange market, weakening an already wobbly US$, which in turn, put a floor under the crude oil market at $87 /barrel. Nymex traders figure another half-point Fed rate cut could lift crude oil above $100 /barrel, and boosted their net long oil positions to 60,873 contracts last week, compared with 39,933 in the previous week.

The United States imported a record $331 billion worth of crude oil last year, at an average price of $64.25 per barrel. Ironically, if the US is forced to import crude oil at $95 per barrel or higher this year, due to the Fed’s aggressive rate cuts, the import bill for 2008 could jump by roughly $150 billion, and completely negate Washington’s upcoming $152 billion economic stimulus package.

The US dollar is in a terminal decline marked by a loss of confidence in the Fed and weakened by big budget and trade deficits. A budget surplus of 2.4% of gross domestic product greeted Mr Bush as he took office, but under Bush, the US Treasury’s outstanding debt is about $3.6 trillion higher to a record $9.2 trillion.

To compensate for the dollar’s weakness, OPEC oil producers are aiming for higher oil prices. On Feb 22^nd, Chavez said $100 per barrel is a fair price. “This is not a situation that is a peak that then falls. We are sure of this and will do everything we can in OPEC to keep supporting the price of our oil,” he said. Venezuela produces 2.2 million barrels per day, and ships 1.5 million bpd to the United States.

But Chavez has warned that crude oil may reach $200, if Exxon Mobil wins a court battle over Venezuelan assets. “If you don’t stop trying to freeze, doing us damage, we can do you damage. We won’t send oil to the US. Get this, Mr Bush, Mr Danger. If the economic war continues against Venezuela, the price of oil will reach $200 a barrel. Venezuela will take up the economic war,” he warned.

In return, Russian kingpin Vladimir Putin shipped 85 tons of nuclear fuel to Iran after a US intelligence report released on Dec 3^rd, concluded Tehran had stopped its nuclear weapons program in late 2003 and had not resumed it since. Yet on Feb 24^th, Iran said it started using new centrifuges that can churn out enriched uranium at more than double the rate of the machines that now form the backbone of its nuclear program. A former UN nuclear inspector, David Albright, estimated that Iran could produce enough material for a nuclear warhead in a year.

Tension in the Middle East and saber rattling from Tehran and Caracas are familiar tactics to pump up the price of crude oil. But can the global economy live with crude oil prices ranging around $100 /barrel or higher? As far as the US stock markets are concerned, the Fed has pumped so much monetary morphine into the system, that equity traders don’t feel the pain of sky high oil prices.

OPEC oil producers can hardly believe their good fortune. The Bernanke Fed has driven US dollar deposit rates into negative territory, adjusted for inflation, and inflated the price of crude oil to $100 /barrel. For OPEC, the windfall could reach $1 trillion in oil revenue this year. Iran and Saudi Arabia are expected to lower their oil output by 200,000 bpd next month, to prevent a sizeable slide in the oil market, when global demand normally recedes in the second quarter.

“Commodity Super Cycle” Sweeps into Japan

Japan is an industrial powerhouse, but imports all of its oil, most of its raw materials, and almost two-thirds of its food consumption. So it wasn’t surprising to hear that Japan’s annual wholesale inflation hit a 27-year high of 3% in January, due to rising oil, raw material and food costs. Tokyo says its economy is still wrestling with deflation, but the truth is, Japan escaped the deflation trap four years ago.

Still, the Bank of Japan pegs its overnight loan rate at only 0.50%, the lowest on the planet, and far below the 3% inflation rate. In other words, Japanese bank deposits and bond yields offer negative interest rates, whetting the speculative appetite of Tokyo gold traders, who are bidding up the yellow metal to stay ahead of global inflation, and the arrival of a new Bank of Japan policy chief.

Despite the surge in inflation to multi-decade highs and soaring commodity prices, BoJ chief Toshihiko Fukui said he won’t react hastily to short-term developments. “Companies won’t be comfortable if we suddenly tighten or ease,” Fukui said, adding that the BoJ was examining both downside risks to the economy, and long-term risks of inflation overheating, before deciding on adjusting interest rates.

Gold traders have known all along, that Japan’s inflation figures are phony and designed to give the BoJ the cover to keep its interest rates pegged at negative rates. Tokyo gold closed above the psychological 100,000-yen /oz level last week, for the first time in history, and up from 45,000-yen /oz three years ago. In yen terms, crude oil is up 64%, and rice is up 60% from a year ago, yet Tokyo’s propaganda machine, indicates that consumer prices are only 0.8% higher.

“Concerns over a recession are emerging not only in the US, but in Japan as well,” said Kozo Yamamoto, the Liberal Democratic Party’s chief on monetary policy. “The BOJ should cut rates back to zero immediately. When stocks are tumbling globally like this, central bankers have little choice but to ease monetary policy all at once,” Yamamoto said. If a super-easy money man succeeds Mr Fukui at the BoJ next month, another round of hyper-inflation could be the main course.

Who Will Clean Up After “Helicopter” Ben?

Rapid increases in the money supply lead to higher inflation, which in turn, robs consumers of their purchasing power and savers of their wealth. Workers’ expectations for higher inflation leads to demands for higher wages, and businesses try to pass these wage increases on to consumers by raising prices. It’s a vicious cycle that can lead to hyper-inflation. If prices rise much faster than wages, such as we’re seeing today, it could deal a major blow to the economy, and political change.

“As I have stressed already, the prevention of deflation remains preferable to having to cure it. If we do fall into deflation, (ie lower housing prices) we can take comfort that the printing press can assert itself, and sufficient injections of money will ultimately always reverse a deflation,” Mr Bernanke said in his infamous “Helicopter” speech, presented in November 2002.

“The US government has a technology, called a printing press that allows it to produce as many US dollars as it wishes at essentially no cost. By increasing the number of US dollars in circulation, or even by credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation,” Bernanke concluded.

That infamous speech landed Bernanke a job as Fed chairman in October 2005. On April 17, 2006, Bernanke said in a letter to South Carolina Republican Gresham Barrett, “The run-up in energy prices since late 2003 will not have a lasting impact on US inflation as long as the Fed conducts policy appropriately. In the longer run, these inflation effects should fade even if energy prices remain elevated, so long as monetary policy keeps inflation expectations well-anchored by responding appropriately to future price and output developments,” he wrote.

One month later, on May 25, 2006, White House economic adviser Allan Hubbard said in an interview with CNBC. “Inflation is a concern to all of us. But we’re very, very confident, the president is very, very confident in Ben Bernanke and the members of the Federal Reserve Board. They have made it very clear they are going to be very hawkish in keeping inflation under control. There is no question that Bernanke is not going to allow inflation to increase,” Hubbard declared.

It is interesting to note that former Fed chief Paul Volcker endorsed Illinois Senator Barack Obama for president before Super Tuesday. Will Mr Volcker be called upon again in 2009, to rescue the US economy from “Helicopter” Bernanke and “Madman” Mishkin, and their radical experiment with hyper-inflation? In 1980, Volcker allowed the fed funds to trade within a range from 13-19% to combat double-digit inflation, - a therapeutic shock treatment for Wall Street, which had been spoiled by the brazen political opportunism of former Fed chief Arthur Burns.

Comments

[mark mchugh]

Great article Gary,

One small point that I would sort-of disagree with is about wages. The American worker doesn't have much pricing power right now (partly because the government can't calculate employment right either). So the impact of monetary policy is pretty much a wage-cut for most Americans.

Another thing that's been bothering me lately is the way we externalize groups of Americans. Will we ever figure out that there's a great deal of overlap when talking about "consumers", "sub-prime borrowers" and "wage earners"?

[hugho]

Excellent article, Gary.I came to the same conclusions 6 months ago and moved the entirety of my cash and investments out of US stocks except for miners and drillers into commodities, energy and shippers and all my cash into other currencies.It pains me making money betting against my country. Pull up a 5 or 10 year graph of the S&P and it will make you seasick.Superimpose it with say the drop in value of the dollar and you see real negative returns.

[User 157690]

In trying to put a floor under the housing and stock markets, the Bernanke Fed has cranked up the growth of the MZM money supply to an explosive 15.4% annual rate, which is also depressing the US dollar and pumping up the commodities markets to astronomical heights


Yes but isnt there similar money supply growth for instance in the Australian and Uk economies?

[deuxsous]

This inflation was all predictable and predicted in the late 1990's when all the "smart people" were deflationists. Greenspan and Bernanke didn't create inflation. Falling supply (due to twenty years of underinvestment) and mariginal growing demand from newly developing countries created inflation....as was true after 1949 and after 1896. It's a simple cycle.

The FED is making it more certain and perhaps speeding inflation up a bit, but they are really powerless to make a lot of difference in the long run. As inverstors our job is to make money for ourselves and families (clients?) to try to stay ahead of inflation and taxes. It's harder now than when bonds are going up year after year and stocks too, but it can be done.

If you are in commodities and gold and infrastructure (shipping) you should be proud, not feeling guilty. You are following the market instead of fighting it. You are a hero to those you are responsible for now or in the future, and you are paying taxes which may help others. You'll be paying a lot more taxes by 2010. :))

[deuxsous]

This inflation was all predictable and predicted in the late 1990's when all the "smart people" were deflationists. Greenspan and Bernanke didn't create inflation. Falling supply (due to twenty years of underinvestment) and mariginal growing demand from newly developing countries created inflation....as was true after 1949 and after 1896. It's a simple cycle.

The FED is making it more certain and perhaps speeding inflation up a bit, but they are really powerless to make a lot of difference in the long run. As inverstors our job is to make money for ourselves and families (clients?) to try to stay ahead of inflation and taxes. It's harder now than when bonds are going up year after year and stocks too, but it can be done.

If you are in commodities and gold and infrastructure (shipping) you should be proud, not feeling guilty. You are following the market instead of fighting it. You are a hero to those you are responsible for now or in the future, and you are paying taxes which may help others. You'll be paying a lot more taxes by 2010. :))

[deuxsous]

This inflation was all predictable and predicted in the late 1990's when all the "smart people" were deflationists. Greenspan and Bernanke didn't create inflation. Falling supply (due to twenty years of underinvestment) and mariginal growing demand from newly developing countries created inflation....as was true after 1949 and after 1896. It's a simple cycle.

The FED is making it more certain and perhaps speeding inflation up a bit, but they are really powerless to make a lot of difference in the long run. As inverstors our job is to make money for ourselves and families (clients?) to try to stay ahead of inflation and taxes. It's harder now than when bonds are going up year after year and stocks too, but it can be done.

If you are in commodities and gold and infrastructure (shipping) you should be proud, not feeling guilty. You are following the market instead of fighting it. You are a hero to those you are responsible for now or in the future, and you are paying taxes which may help others. You'll be paying a lot more taxes by 2010. :))

[huangjin]

MZM includes credit and Bernanke can't control credit markets. In fact, he's been cutting the growth of money supply since he took office, barely skipping a beat. Lower rates appear inflationary, but base money still isn't growing. I don't think Bernanke planned this, but it's almost a perfect set-up. Just when people are worried about a collapsing credit market and deflation could kill confidence, we have at the helm a man who people call "Helicopter Ben". But he is quietly pulling money out of the system and taking out the housing bubble, while speculators pour into commodities. I think we're going to see the dollar rebound like a bat out of hell once the market catches on to what has been going on for the last two years, and instead of $200 oil, Ben Bernanke will be drinking the tears of Hugo Chavez.

[eric hart]

Its worth noting that the president and his administration has been very, very confident about a lot of things.

[Travis]

huangin: I hope what you are saying is correct, but can you show evidence of where Ben has been "quietly pulling money out of the system"?

[huangjin]

www.lewrockwell.com/no...
www.garynorth.com/publ...
www.minyanville.com/ar...

Shedlock has been covering this for quite awhile, as have a few of the followers of Austrian economics who focus on the base money supply. I'm not bullish—this economy has problems—but I also don't think he's inflating like a madman. For a bad analogy, the U.S. is driving its car at 45 mph into a brick wall and passenger Chavez isn't weaing his seatbelt.

[RichardSchweitzer]

Generalizations are always risky. But, in monetary terms, "inflation" is generally perceived in terms of prices; and prices are always relative (absent interventions).

Witout getting too "marxian" with a labour theory of value, we might consider that "real inflation" occurs when the amount of effort required to satisfy or meet needs, wants and desires increases relative to the returns on those efforts.

Productivity increases (greater returns from less efforts) in the recent past have been the offset to other inflation factors. The capture and redistribution of the results from such increased productivity into non-productive applications (socially and politically) have had (and are having) as much impact as the symbolic monetary "floods" we have been seeing.

[BrucePile]

Even if there were no currency debasing issues, most things in the commodity space should be entering a long bull market simply due to supply and demand for global construction metals and the imposition of fuel crops on an already maxed out food crop market. When you look at what just the currency issue is doing with a commodity having little practical use, such as gold, it suggests a compounding effect where the things of the most vital practical use, such as food and fuel, may attract money at a faster rate adding still more to their appeal as a dollar hedge.

The crops market in particular will be under huge pressure from the effects of peak oil and the aggressive but misquided food based ethanol mandates. Compounding idiocy with stupity, our government has responded from their 35 year sleepwalk on energy policy with the idea of hogging the food supply to make a low EROEI foreign oil replacement that actually displaces very little oil and serves only to add severe food inflation to severe oil price inflation, which they greatly help out with their severe currency debasing campaign. How many "stupid" pills do these guys take a day? If they're going to do ethanol, wait intill the high EROEI, nonfood cellulose designer feedstocks are out of the labs in a few years instead of grabbing up whatever happens to be laying around in our backyard and causing inflation havoc.

[BlueSky&Sunshine]

Brucepile: The "guys" in DC don't take stupid pills. They take political contributions. If you want to understand why our government has pushed the ethanol thing so fervently, just look to the disproportionate influence corn belt senators have over the federal government. Then look at the dollar value and destination of political contributions of Archer Daniels Midlands and a few other well healed special interests who were in on the ground floor of ethanol. It's not stupidity so much as callous greed. This kind of corruption won't be rooted out in a generation.

[zenalgorithm]

Outstanding article!

Greenspan made it so that I couldn't afford a house.

Bernanke is making it so that I can't afford anything else.

At least the FED is doing one thing right - they've allowed our banks to retain their AAA values.

[pseydocyst]

Kinda scary time we live in today. Looks like the commodity cycle is back again, just like the 70's.

Amazing to see all the grain prices just shoot up
so fast recently, soybeans, wheat, rice, all gone parabolic. My DBA I bought just 3 months ago gained 30-40% already.

Crude oil has gone up now to all time high of
$100. It seems all the other commodities are
just catching up with it. E.g. now it takes around
10oz of gold to buy 100 barrels of crude, or 5 oz of silver to buy 1 barrel of crude. This still somewhat undervalues gold and silver based on historical averages (~8 oz for gold and 3-4oz for silver).

Where oil is headed I think is the important question. If the central bankers have lost control, and oil heads up higher, you better have a huge position in gold and silver to protect yourself. Today the $US is backed by oil, which is in demand by all the other countries to buy oil. If somehow this system erodes, maybe the US FRN will be worth much less.

A second demand for the US dollar comes from the US stock market. But now we're in a bear market. The DOW valued in gold terms has been declining from an incredible 40 oz in '99 to less than 15 oz today. The money simply is not going into stocks anymore. The stock market (US) is deflating and going into commodities. But this declining stock market produces even less demand for the US dollar. Which produces a vicious cycle.

Overall the argument is just too compelling to put your money in gold and silver. Despite all the Gov't propaganda, with the manipulated/massaged CPI, all the market hype you see on CNBC, and business news channels, the reality is just too painfully obvious. All these financial asset's that have done well in the 90's, stocks, bonds, and even housing are basically wealth sinks, and only hard commodities that you can hold in your hand will protect your wealth from confiscation.

It'll be interesting to see what'll happen over the next decade, maybe the US dollar will become like the next Mexican peso. The middle class will be slowly wiped out and the wealth of the country will be in very few hands.

[User 158535]

Wow. Great article and great comments guys. I'm glad I found this. By the way, I was able to attend Gov. Fredrick Mishkins speech at East Carolina University on Feb 25th. A question was posed to him about the rising energy and food costs -- Mishkin repeated over and over that their focus (the Fed) is core inflation, not headline inflation and their goal is "long-term" stability not "short-term."... So expect a lot more bumps and drains in your pocketbook as the Fed continues its move to control and stabilize core inflation. Either way, its gonna hurt.