Sources Needed for “why commodities can’t sustain their bull run”

[powayseller]

Yesterday at the meetup, both barnaby and another forum member made a good case that commodities cannot sustain their bull run when the US goes into recession. They say that commodity prices are high because China is buying lots of them to manufacture goods to sell to us, and copper is high due to construction excess. When the US goes into recession, the commodity prices will fall. Since the Asian export countries cannot stimulate internal demand within the time that the recession hits, they will be hurt too.

I agree. I made this case before, as a result of strong Federal Reserve Flow of Funds and IMF and stock market/commodity price data from 2000-2001. In the weak recession of 00-01, commodity prices fell. I posted the percentages of various commodities before; it’s all in the book The Dollar Crisis, by Richard Duncan, former IMF consultant.

My question is for the person who told me he heard a Puplov radio broadcast, debunking Jim Rogers’ claims of a commodity bull. Which broadcast is it, and do you have any other sources?

So far, the only analyst, banking expert, or economist, who is down on commodities is Richard Duncan. I would like to read the arguments of others with this view.

Thank you.

[OwnerOfCalifornia]

I think you are talking about Jim Puplava, and the broadcast in question may have been yesterday’s guest:

http://www.netcastdaily.com/fsnewshour.htm

For those who don’t know about the financial sense website, here it is:

http://www.financialsense.com/

Jim Puplava is local to San Diego, but his netcasts and show topics are national and international. Very good ‘alternative’ reading on that site, and the weekly broacasts are always interesting.

[jepsd]

Yes, that is the website with the mp3 download:
http://www.financialsense.com/Experts/2006/Christian.html

The author interviewed is Jeffrey Christian. The title of his book, “Commodities Rising”, seems a misnomer considering his views against a “super cycle” having such proponents as Jim Rogers and Marc Faber.

John–FYI powayseller this is my first post 😉

[rseiser]

Here is what the Stalwart had to say:
“But John Bergthiel of JP Morgan points out that some metals seem to be rising in price, regardless of their supply-demand mechanics. In copper, for example, inventory levels appear to be equal to just two weeks’ demand, so a price squeeze is understandable. But in nickel, inventories are equal to 11 weeks’ demand, and it is still being pushed higher.
Something else is clearly going on. The answer seems to be that institutional investors are increasingly moving into commodities, having become convinced that they offer returns that are both attractive and, importantly, not correlated with other assets.”

I agree that you should stay away from industrial commodities, especially the ones that have gone up a lot. This field is something for insiders (e.g. commercials), who know a lot of details, and might hedge or SPECULATE. Even though I own some futures myself, I can call it nothing other than SPECULATION.
These are the potential risks:
-Demand is slowing due to world recession.
-Demand is slowing due to more efficient use.
-Supply increases due to more efficient production or increaed by-products.
-Industrial commodities have NEGATIVE YIELD, since they degrade and are costly to transport and store.
-Unless futures trade at “backwardation”, you pay more for futures than for spot. Again NEGATIVE YIELD.
-There will always be replacements to be found for one commodity if it gets too expensive (see Palladium).
-There will never be long-term investment demand. It is a waste to hoard these materials.

I am not saying they can’t go up more. I am just saying this is not worth jumping on a bandwagon.
Jim Rogers might be right, since his index also owns agricultural commodities and gold and silver, and everything will go up more or less during inflation.
But you must beat inflation not trail inflation to come out even!

[powayseller]

jepsd – did I meet you at the meet-up the other day? Thanks for the information. What do you think about the commodities and oil pricing, and where it could head? My brother told me that China will keep producing even if the US stops buying altogether, because they are NOT getting paid now anyway! He is right! China is getting dollars, which they are recycling back into the US, so they are not getting paid at all! I think one reason they have bank problems is because of all the money they print to convert the dollars to yuan, so the yuan does not appreciate. Then the dollars go back to the US, and you have so much more yuan in circulation.

rseiser – thanks so much too. What do you think about long term prospects yourself? Do you agree with the writer?

[rseiser]

Well, call me skeptical, but I haven’t been in China, only in India, so I might not know enough. Obviously, Jim Rogers thinks they are the greatest economy of the future, since he even teaches his daughter Chinese. What worries me is this hype connected with China. Sure they produce real things, but nothing grows to the moon that fast. They had phenomenal growth and it might need a pause. A stop of the frenzy in the US might do it to them. Readjust some of their mal-investments. This costs a lot of money. It reminds me a lot of Silicon Valley. Yeah it was the greatest, and then suddenly all buildings and freeways were empty. I would never invest from a value stand-point in something that already has gone that far, and where everyone talks about it. It could, however, happen that they have a stumble, and after that they continue as the winner.
I think you should research the 1921 recession. It was the same with the US and Europe, where Europe was sucking up debt, and the US was providing it, and when it stopped the US went into a severe recession. They recovered very quickly though. jepsd knows more about it.

[powayseller]

jepsd, can you elaborate on the similarities/differences between the US/China deficit/export relationship compared to the US and Europe in 1921? Do you know about the history of collapse of various currencies, and how likely it is for the euro to become the next reserve currency?

[jepsd]

powayseller, yes, I met you on Saturday and you said I should post…

So, you have about 5 other questions… I will try to address a couple, but this will be a long post.

At commodities and oil: I think these have in general had a fantastic run in a short time but I personally would not label them a bubble yet. A bubble/mania could materialize, but I prefer to find value elsewhere now. Lots of money could be made speculating, but my opinion is that you should have gotten in 5 years ago, not now. If you got in now, a downside break could wipe you out. Sure, they (gold and oil) could double again, but the easy money has already been made. It’s like buying a house in 2002 or 2003. Most of the easy money (less risk) had been made up to that point, and more money was made between 2003-now, but you hopefully agree that the risk in the latter timeframe is much greater.

RE: China and US: Similarity between Europe and US in the post-WW1 era is discussed in “Economics and the Public Welfare” by Benjamin Anderson. Read the first 8 chapters or so (much much longer than this post). The book is out of print, but you can find a copy on the internet or at a library.

In a nutshell, because the US got involved in WW1 at the very end, our manufacturing had been growing to meet the needs of the Allies in Europe. Also, we didn’t suffer losses of homes and factories in the war. After the war, the US govt loaned money to the Allies so they had time to build back their manufacturing sector. The thing is, when you loan money to people, they just buy stuff. Since US manufacturers relied on this demand, they were happy to make stuff to sell to Europe. Commodity prices soared because of the demand. Prices of stuff also went up since there was US demand for the same products that were sold to Europeans. When the US govt realized that Europe wasn’t doing anything but consuming, then they realized that they had no means to pay back the debt. Don’t think about currencies. Currencies will confuse you. If one sits around borrowing and spending and the other works and lends, then there is an imbalance. Ask yourself what a person sitting around is doing in return for your hard work. So, the US govt stopped the loans. But it didn’t end there! The US manufacturers saw that the demand for their products would disappear, so they loaned money to buyers in Europe! The US businesses then went to their own banks and borrowed money to keep their businesses going. So, finally, the US businesses also realized that the borrowers were not going to pay them back. At that point, it was over. Commodity prices dropped in half in about a year. Recession was short but many businesses were hit hard. Because the government didn’t intervene but instead just allowed the prices to drop, the economy self corrected. This means wages dropped and prices dropped. This is how an economy corrects. Money printing props up wages and prices and makes things worse.

The recovery was rapid and of course the boom/bust everyone remembers is the 1929 stock market crash because the 1920-21 paled in comparison.

So, what about today? My opinion: China is essentially lending money to US consumers via treasury purchases. When the US consumer finally stops borrowing it will be over. Houses will no longer be built and tapped for equity. China will have lost its largest customer. They will not be able to pick up the slack. Commodity prices will fall. However, our Fed will likely lower interest rates to desperately try to stimulate the economy. This will only make things worse. If borrowing got you into crisis, how does more borrowing help? It’s like trying to drink yourself sober. It doesn’t work.

Sorry for the long post, but you asked…

[qcomer]

jespd,

Thanks for the interesting history. Could you please elaborate what happened to the European countries in 1920s when they couldn’t pay back their loans? Bankruptcy? Currency devaluation? Huge number of foreclosures or assets were sold to account for the losses.

Why do you think that the Fed can lower rates if foreigners stopped buying treasuries? Who will buy all the treasuries then if rates went down? The reason US could afford to lower rates after the tech recession was because foreigners were buying treasuries and pumping money that was being passed to the US consumer. I don’t think Fed will be able to reduce rates as it was the foreign investor who pumped capital into US and not the Fed.

[jepsd]

The Europeans had currency devaluation because they began printing money to pay their debts. The US then helped to stabilize these economies by giving loans again, but the countries that received the loans needed to go to a strict gold backed basis to stabilize their currencies, e.g. the Dawes Plan for Germany in particular. I believe the bailout loans were successful in all cases.

The more important issue, though, is what happened in the US during this brief period? Businesses had inventory that decreased in value and accounts receivable that weren’t paid. Large companies that didn’t need loans survived. Small businesses needed loans to keep going. I assume that some went bankrupt. I don’t know how many. The US consumer didn’t keep things going, nor will the Chinese consumer keep things going today.

[jepsd]

The Fed can set the discount rate to 0% as far as I know. Of course, no one who cared about the US dollar would do this, but Bernanke is famous for his helicopter speech. The Fed can also purchase US Treasuries; no foreign purchaser is required.

[jepsd]

Foreigners buy US treasuries to keep their currency in a position to keep their exports flowing to the US. If the consumer falters in the US, I assume China would stop purchases of US treasuries, but they have another reason to do it: they already own so many that if they stopped purchasing more, what they already own would decline greatly in value. Their position is too large for them to exit. Both the US and China are backed into a corner together. This won’t end with China continuing prosperity if the US consumer backs down. Both countries will suffer consequences when the game is finally up.

[powayseller]

jepsd, wow! Interesting stuff. Why do you think the Fed will lower rates? With high inflation, how can they do so? Perhaps inflation will be reduced when the recession starts, and then the interest rates can be lowered. Why would that “make things worse”? If the dollar falls, our exports will go up, and that will help balance the economy, right?

One more thing about China that nobody ever talks about: they are printing money like mad, at the rate of their exports to us! Every year, China’s central banks print $600-700 billion or more, of yuan. [Q: do they print the full amount of exports, or only the deficit amount?]

The reason: to keep their currency from appreciating, they cannot exchange the dollars they get for yuan, so they print yuan to give to the person who brings them dollars, and invest the dollars in the U.S. I am sure nobody really understands this, but I know this from reading The Dollar Crisis. So my question is: how is this affecting China’s economy, and how long can they get away with it?

jepsd, why didn’t US consumers start purchasing back in 1921? Why isn’t China taking steps to make their citizens into consumers? Don’t they see the US recession that is looming? Why are they backing themselves into a corner?

Most important, why does China really need the US? They are exporting to us ON CREDIT. Why not “export” to their own citizens? They are making goods so cheap, they could just consume it themselves, right? They get no interest off the Treasury notes they buy, so basically they are giving away all the things we buy from them. If we stop buying from them tomorrow, it won’t affect them at all, since we are not paying them anyway! This is the biggest joke of all. We think China needs us, but we buy on credit, so who needs whom? China can dump their treasuries all at once, and use the proceeds to buy up natural resources all over the world.

[rseiser]

PS, let me answer and let’s see if jepsd comes up with the same.
-Yes, they can lower interest rates to some extent using the slowing economy (falling asset prices) as an excuse.
-Yes, we will be fine ultimately, just have to work hard and enjoy very little for a while.
-Yes, they print the difference only. (Plus what the US prints I guess)
-It is currently a loss to China, since they could also give the printed money (or the exported product) to their citizens. It’s like lending a relative money (you don’t really expect it back, since he is a nice guy)
-When people expect bad times they will not buy, no matter how much money or incentive you give them, except they might buy for hoarding (e.g. gold). This was the Depression and Japan.
-China wants to stop at some point, but according to them doesn’t want to upset the system. So they take the loss to try and build a world-wide customer base, good political relations, a good banking system, infrastructure, etc.

[jepsd]

When housing prices drop, the Fed will lower rates. The Fed is the engine of inflation. Why would they NOT do this? You write as if inflation is something controlling the Fed. They are creating the money and credit expansion (that is the definition of inflation).

Rising prices are a RESULT of inflation. Some prices go down when there is inflation (e.g. Chinese goods have lowered prices of retail items). Rising prices are a general effect of inflation. They are not the same thing. It’s like saying that your rash is poison ivy (like many people say “I have poison ivy” and point to their rash). In reality, poison ivy (inflation) gave you a rash (rising PPI and CPI). Similarly, it takes time for the rash to form just like it takes time for the inflation to cause price movements.

If the dollar weakens, yes we could theoretically export more, but it takes time to get a factory going that can compete in the world market.

I don’t know what is going on in China, but I’ve heard that the Chinese govt is making loans to Chinese businesses that probably can’t be paid back. They will get away with it until it doesn’t work anymore. Anyone’s guess.

Consumers can’t buy things when they don’t have jobs. You can’t “make” consumers if you don’t pay them enough to buy the stuff. And, no, they probably don’t see the recession looming. They got themselves into a corner because nothing bad has happened yet. It doesn’t matter until it matters. It’s like asking me why people don’t see the housing bubble? They don’t see it because they have been successful in the face of all the evidence against them.

China can’t just turn the US loose and become consumers themselves. The dollars they hold are not entirely worthless. They can buy real estate when it crashes or equities. Now, you may understand why the Fed will try to prop up prices in the US.

[Author]

Posts