Who is Blowing Bubbles in the Commodity Markets?

By: Gary Dorsch | Tue, Feb 26, 2008
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"Too much money, chasing too few commodities," might be the best way to explain the historic rally that is underway in the global commodities markets. Central bankers in eighteen 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," Poole declared.

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 25th, "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. Rogers added, "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 15th 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 25th.

"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," Mishkin said.

"I do not expect the recent elevated inflation rates to persist," Fed vice chairman Donald Kohn told the University of North Carolina on Feb 26th. "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," he added.

"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 26th. "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 25th, 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.

In other words, Washington is going deeper into debt, to help American motorists pay for the higher cost of imported oil, which in turn, will flow into the hands of Iran's Mahmoud Ahmadinejad, Saudi king Abdullah, Venezuela's strongman Hugo Chavez, and the Kremlin's FX reserves, already at $480 billion.

On Jan 15th, Saudi's oil minister Ali al-Nami pointed out that, "Financial speculators are adding $20 to $30 to the price of oil. If you look at who is in the market, you'll find a lot of financial institutions, players who are speculating, using the market as a hedge against a weak dollar."

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 22nd, 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.

Iran expects to earn a record $63 billion from oil sales in the year ending in March, and has boosted its oil output to 4.2 million barrels per day, the highest since its 1979 Islamic revolution.

Following the collapse of the Bush administration's campaign to economically isolate Iran, Tehran signed a contract with China's Sinopec for the development of its giant 18.3 billion barrel Yadavaran oil field. Russia's Gazprom also signed a deal to develop Iran's South pars gas field.

In return, Russian kingpin Vladimir Putin shipped 85 tons of nuclear fuel to Iran after a US intelligence report released on Dec 3rd, concluded Tehran had stopped its nuclear weapons program in late 2003 and had not resumed it since. Yet on Feb 24th, 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.

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Gary Dorsch

Author: Gary Dorsch

Gary Dorsch
http://www.sirchartsalot.com/

Gary Dorsch

Mr Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group.

As a transactional broker for Charles Schwab's Global Investment Services department, Mr Dorsch handled thousands of customer trades in 45 stock exchanges around the world, including Australia, Canada, Japan, Hong Kong, the Euro zone, London, Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts, ADR's and Exchange Traded Funds.

He wrote a weekly newsletter from 2000 thru September 2005 called, "Foreign Currency Trends" for Charles Schwab's Global Investment department, featuring inter-market technical analysis, to understand the dynamic inter-relationships between the foreign exchange, global bond and stock markets, and key industrial commodities.

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