Interview: Kevin Kerr On the Commodities Pull Back

Part I

Mike Norman, anchor, HardAssetsInvestor.com (Norman): Welcome to HardAssetsInvestor.com. Hello everybody. I'm Mike Norman, your host. Today my guest returning to the show is Kevin Kerr, president and founder of www.kerralert.com and commodity expert. Kevin, welcome back to the show; it's good seeing you. Kevin Kerr, www.kerralert.com (Kerr): It's good to be back, Mike.

Norman: The last time you made an appearance here, commodities - all commodities, pretty much - were in a very powerful bull market with prices rallying across the board. Recently, though, we've seen a pullback, a pretty nice pullback, in a broad range of materials. What do you suppose this is? With some people, there's a debate now as to whether this is just a correction in an ongoing, longer-lasting bull market, or if it's a turn in the market. Kerr: We have to take a step back and really look at what the bigger picture is. Let's look at two, three years. We saw a parabolic rise in the commodities, and most of us who have been trading all our lives - or our adult lives anyway - looked at it and said well, it made sense to a certain point and then it got ridiculous. Certainly in energy, we looked at that above $120/barrel and said, where's the support for this? When it got above that, I think most of us stepped back, and of course it continued on to $145-$146/barrel, but there was really no tradability above that. Now here we are back at these levels; things have corrected. Whether there's further to go or not is yet to be seen; it's very choppy right now with the dollar the way it is. Let's not underestimate two things: speculators and the dollar. OK? The dollar higher [means] commodities lower, the dollar lower [means] commodities higher; that's basic trading. And of course, speculators have had a huge role in this, and I think it's been downplayed quite a bit. Speculators have also had a huge role in pulling it back, so we have to realize speculators are a big part of this market, and to deny that is silly. Norman: Now some of them are liquidating, or in fact, betting that prices will go down. But that's certainly been one element of the story. Let's talk about the real underlying economics fundamentals. We've seen over the last six years very strong demand growth out of China, India … all these emerging and developing economies. U.S. growth was strong up until recently. But now we see a cooling off of growth here in the United States; indeed, we see a cooling off of growth in China, in India, in other countries where a lot of the new demand has been coming from. Talk about this and what sort of an impact it's having, and how long this could play out. Kerr: Well, short term, it could have a significant impact. We've seen a slowdown … let's take one example … a slowdown in driving here. High gas prices certainly put a crimp on drivers, and we saw fewer miles driven. Now we can go around the world and offset that with the increase in driving, say, in China. So it all pretty much balances out, and I would say demand is not something we should be concerned about, certainly longer term. Short term, though, we have seen a reduction in demand, and that could continue as prices stay high. But of course, now that prices have pulled back, we could see that same situation pop back up, and its price could move high. Norman: Now, is this more in the economically sensitive materials, like metals for example? Metals are probably at the front of the line, with industrial metals at the front line in terms of their sensitivity to economic cycles. Will they be the most impacted? Kerr: I think so. Let's set precious metals aside - silver and gold - because that's an emotional trade; it's an inflation trade to some extent. Norman: Some people think of them as money, so there's another whole aspect. Kerr: Exactly. It's a quality vehicle and all that, so let's set that aside. The industrial metals, though, are the real engine of the economy, and so steel and zinc and ore and all these things we use to make these plasma screen TVs … when we start seeing those industrials metals be picked up at whatever level that might be … and we know that demand is picking up. I do think that some of these commodities got just out of sight, as far as people melting down light poles and going to graveyards and digging out … pretty extreme. Norman: When you start behavior like that, that's sort of a tip-off that we might be getting to a peak in the cycle. Oil perhaps is a little bit different because you do have maybe some monopolistic forces within the market: You have the OPEC cartel - certainly the Saudis could be deemed as price setters at the margin; you have geopolitical developments recently with Russia and its move into Georgia. What about that? It was perhaps difficult for OPEC to raise output and meet all that new demand, but it seems to me it would be an easy thing for them to cut back on production and put a floor under the price. Kerr: Sure, and they can at any time. We've seen these recent reports that we have plenty of supply in hand of crude and not as much product [like refined gasoline]. That's because the crude has been so expensive, and we're going to need all that product - heating oil and all the gasoline - is good for. And sure, the Middle Eastern countries - Saudi Arabia being the biggest one - could just instantly cut production. They don't want us to have more oil, they want us to have less oil. Norman: And they want more of the money. All right, folks, stick around for our second part of the interview with my guest Kevin Kerr. This is Mike Norman, your host on HardAssetsInvestor.com. Part II

Mike Norman, anchor, HardAssetsInvestor.com (Norman): Welcome back everybody to the second half of my interview with Kevin Kerr, president and founder of kerralert.com and noted commodity expert. Kevin, last time we spoke, we were talking about different segments of the commodity markets and how the impact of the commodities pullback will be felt differently.

Metals, for example, are very economically sensitive, and will be impacted by the global economic slowdown. Oil is perhaps also, to some degree, impacted by the economic slowdown, but because of monopolistic forces - the OPEC cartel, geopolitical developments - there may be some limit to how much that can fall. Let’s talk now about the grain markets, which are perhaps operating on their set of fundamentals. Talk a little bit about the supply outlook and also how the whole movement into biofuels perhaps supports prices long term. Kevin Kerr (Kerr): It does. I think clearly biofuels are dependent on if the crude oil price is high, because this is just an alternative fuel, and of course if fuel comes down, then those prices go out the window. But at the end of the day, we still have a huge demand for grains. In the recent pullback in commodities, we’ve seen grains get thrown out like the baby with the bath water - out the window. As energy corrected, and it should have, we saw grains just fly out the window, and the bottom line is, we won’t know what we have from the harvest until we go to harvest. A lot of these agriculturals got in the ground late because of the cold weather, the wet weather, and at the end of the day, those farmers are going to leave those crops out there as long as possible, and that subjects them, especially soybeans, to early frost. Norman: But haven’t the estimates … let’s just understand for the folks listening: The estimates on the harvest have been phenomenal, above prior high expectations. Kerr: I read my daughter bedtime stories each night. I was going to read her the grain report because it sounds like a fairy tale. Everything is wonderful. Norman: I thought you were going to say because she has insomnia and that will put her to sleep. I wasn’t sure. Kerr: I don’t think it’s as good as what the government’s telling us. I call farmers every day and I talk to people in the Midwest. On this side of the street, you have great crops … best ever. On this side of the street, the worst crop … worst ever. This report reflected that everything looks fantastic; it will be a bumper crop. I just don’t believe it. Norman: Everything … we’re talking soybeans, we’re talking corn, we’re talking wheat, we’re talking cotton even. Kerr: We’re talking peppermint. Any of these crops that these guys grow - and they do grow peppermint - are not looking that great in some places, while in other places they are looking fantastic. I just think overall the yield is going to be lower than what we need. Norman: Let’s get back to this speculator angle. Recently we saw the Commodity Futures Trading Commission reclassifying the position of a large trader in oil. The trader was technically a hedger, but the positions were not being used to hedge. And you talked about speculators playing both sides - buying long, selling short. But we still have the interest on the part of the so-called index speculators, these long-only passive investment funds, pension funds and endowments. Won’t they continue putting money into materials, because they now view that as an asset class? Kerr: They do. It was a long stretch to get those guys to come over and start looking at commodities as an asset class, and now that they have - and even though they might have left because of the pullback - they’ll probably come back a lot faster, because it’s now a part of their lexicon. Before for years - and you know this - for years it was never part of something they would ever invest in, and now they’ve been there, left, now they’ll probably come back even quicker. I really think that the paradigm shift has happened for commodities. Norman: So given that and the potential that that represents in terms of … look, there’s trillions and trillions of dollars under management in traditional assets, and even if a small part of that continues to flow into commodities - which are relatively small markets compared to securities markets - it could represent really an upward slope for the long term. Kerr: It could, and it’s truly global. I’ll be traveling later to Europe, and I speak to people in countries all over the world, and we’ve never seen that before. This is money that comes in in huge numbers and leaves almost as quickly, but it will come back in quickly as well. Norman: Now the last thing I want to touch on is policy, monetary policy: A lot of people have been critical of the Fed for keeping interest rates down, and some say the next move is going to be up. I don’t think it’s going to be soon, but if that happens, do you think that will have a negative impact on commodity prices? Kerr: I’m pretty vocal about that. A stronger dollar means lower commodities prices. I think you’re right; I don’t see it happening any time soon. That’s the dilemma, how can the Fed raise? But honestly, yes, I believe that if they could raise, and then can raise when they can, and the dollar starts to firm for real - not just interim pullbacks - then we’ll see weaker commodities. Norman: All right, well, there you have it folks. Thanks for tuning in. Stick around, there’s a lot more to come here on this great Web site, HardAssetsInvestor.com. I’m Mike Norman. That’s it for now. See you later. Bye-bye.

Comments

[JasonC:]

Commodities bulls in deep denial 3-6 months into a raging bear market in commodities, with all the major items down 25 to 30%, descending and accelerating.

Just clueless. Folks, it was a bubble, same as dotcoms or real estate, and it has burst. It isn't coming back, for a decade.

2008 Sep 11 12:34 PM

[Ivan the Cr...:]

JasonC, we are not 3-6 months into a bear market in commodities, we are 2 months into a correction in a long term bull market. If it was a burst bubble we would see huge unsold inventories, like we have unsold houses from the real estate crash. This is not the case with commodities. People are still going to consume food and energy in ever greater quantities.

2008 Sep 11 02:04 PM

[DM226:]

JasonC, did people stop eating? Did the Chinese decide to stop building forever?

2008 Sep 11 02:36 PM

[NOWHEREMAN:]

You do mean the end of 2009, of course.

2008 Sep 12 03:52 AM

[kebu77:]

Kerr: ". . . the Middle Eastern countries - Saudi Arabia being the biggest one - could just instantly cut production. They don't want us to have more oil, they want us to have less oil."

Maybe not between now and November. Kerr's comment parallels views recently expressed by CIBC, which "cut its 2008 target for average oil prices from $125 per barrel to $115 and from $150 to $130 in 2009."

In spite of OPECs announced intent to reduce production, look for the Saudis to continue its high level of production thru the Nov. election, in its second attempt to decide a US presidential election. (The case can be made that KSA succeeded in 2004 when it produced way over quota beginning several months before the election and Bush won by a hair - - compare KSA actual production to quota, April-October 2004.) This time, they will fail due to the political fundementals (Google: lichtman + 13 keys). Even so, if I was Obama, I'd be pissed for the next 4 to 8 years.

So Kerr, Rubin and other (temporary) bears may find, when the dust settles that the avg. oil price in '08 is closer to $100 than $115. Then, in 2009, geology oil fundementals replace the geopolitical issues and oil starts its march to the Maxwell-Pickens-Simmon... $200 level. Things happen, like KSA lets its wells rest, Iraq fails to settle down, the North Sea and Mexico continue their precipitous declines, the engineers running China continue their massive capital expansion, and 2009 marks the fourth straight year of declining oil exports (Google: "Jeffrey Brown" + "Export Land Model").

More bullish views will return as it, again, separates itself from the herd. "Just my opinion, I could be wrong," but for starters watch the next eight weeks.

2008 Sep 12 02:01 PM