The War on Snow

Northerners transplanted to southern climes often complain of the locals’ inability to deal with snow; “Back home we know how to deal with this,” says Wisconsin native, Virginia transplant Matt Mulroy. “Here you get out of school for a week!” Yet nowhere is the importance of snow cleanup as important as in China at the moment. Indeed, the country is engaged in a full-out “war on snow.” With hundreds of thousands of travelers stranded at rail and bus stations ahead of the Chinese New Year holiday, over 60 people killed, 200,000+ houses destroyed, 800,000+ damaged, power outages, water problems, and $8 billion USD announced in economic damage already, the effect on the country’s commodity production and food manufacturing could be severe. After the immediate Katrina-like relief efforts, look for more indicators about commodity production to emerge in subsequent weeks.

An interesting piece in today’sWall Street Journal sheds light on another European gripe concerning American policy – America’s central bank. In a statement this week following the Fed’s rate cut, ECB President Jean-Claude Trichet, according to the author

..came about as close as a member of the brotherhood ever will to calling out a fellow central banker: “In demanding times of significant market correction and turbulences, it is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility in already highly volatile markets.”

The author notes that although many Europeans blame the overly easy late Greenspan fed for the credit crisis and the housing bubble, it can also be blamed in part for some of the excesses that have benefited commodity exporting nations.

They shouldn’t get carried away, however, because their own stock markets were showing earlier this week what could happen to European and Asian economies if the U.S. heads into recession. The $7 billion fraud at Société Générale and the mess at Britain’s Northern Rock mortgage lender also make clear that American bankers don’t have a monopoly on bad judgment. The currency reserves and sovereign wealth funds that many countries have been piling up are in substantial part the result of that same Fed mistake. This means they can vanish as fast as they arose if commodity prices fall again and the dollar rises. Recall the Texas oil patch, circa 1983, as Paul Volcker’s Fed corrected the inflation of the 1970s.

The question is what could cause commodity prices to fall? A U.S. recession certainly would have an impact and could be exacerbated if the emerging markets followed more than expected. Although a tighter Fed is no where in sight, it appears a rift is beginning to develop between the ECB and the Federal Reserve. Will this have an impact on trade balances? This rift also sheds light on the differing mandates of the ECB and the Federal Reserve. The ECB targets just price level while the US Fed looks at employment as well. It will be interesting to see how this situation plays out.

Decoupling

With European and Asian markets falling in the past several days on fears of a U.S. recession, some pundits (such as Stephen Pearlstein in the Washington Post today) have been quick to proclaim that fears of “decoupling” (the belief that the U.S. economy has less impact on other economies than in the past) were overly eager.  Yet, no matter the verity of decoupling, observers must look beyond financial markets’ – which are clearly and necessarily pricing in fears about growth – 2-day returns and to economic indicators such as GDP.  The true measure of decoupling will be trade and investment flows (and thus GDP) in coming quarters.  And, while full-fledged decoupling is unlikely, the relative, secular decline of U.S. GDP as a percent of global output means that the correlation between American growth and that of other economies should weaken.

Beef Eaters Rejoice

According to a report by the International Food Policy Research Institute (IFPRI), low prices are of foremost importance to China’s beef consumers. This benefits China’s consumers but only at the expense of health and safety standards, which are costly. Thus, global food prices – and beef in China up 50% year-on-year in 2007 – soaring to new highs may create an easily overlooked silver lining for China’s government to take advantage of.

Traditionally in China, where increasing awareness of substandard food is growing and rising incomes are combining to stimulate demand for certified high-quality food, realizing safety improvements has been difficult. Imposing tough, costly quality standards on China’s hundreds of millions of tiny producer families (which produce up 90% of China’s beef output) might have put them out of business while the state-run General Food Company wasn’t able to produce safe beef profitably. Yet soaring prices – although discounted due to rising feed costs – might in the long-run drive prices higher, allowing producers to implement quality controls without losing market share.  China’s government has taken a number of health and safety steps in the past year and, despite the hit to their wallets, consumers could benefit in previously unexpected ways.

8 More Fat Years?

Commodities love-crush Jim Rogers likes to say that in the 20th century the average commodities boom, caused when supply and demand fundamentals get out of whack, lasted 18 years. Given Rogers’ placement of 1998 as the beginning of the current upswing, we should have approximately another eight fat years. Yet Rogers also points out that by the time he starts getting investment tips from shoe shiners and taxi drivers and hears of new oil finds and technological advances that were too costly to develop in leaner times, it’ll be time to get out.

The question is, are there eight more years to the boom, delighting all the fresh commodities investors? Or do new oil finds – Petrobras’ Tupi in Brazil – and the fact that everyone is talking about even agricultural commodities signal that this bull market is nearing its peak? Is Tupi an exception? If not, why has the commodity cycle shortened?

If the Economist Was Right I’d Still have my ’72 Dodge Dart

With oil hovering at record levels, it is hard to believe that in 1999 the Economist was warning of the dangers of cheap oil.  From the magazine’s March 4th, 1999 issue, when oil had plummeted to around $10 a barrel.

“Yet here is a thought: $10 might actually be too optimistic. We may be heading for $5. To see why, consider chart 1. Thanks to new technology and productivity gains, you might expect the price of oil, like that of most other commodities, to fall slowly over the years. Judging by the oil market in the pre-OPEC era, a “normal” market price might now be in the $5-10 range. Factor in the current slow growth of the world economy and the normal price drops to the bottom of that range.”

They go on to write,

……..”The six biggest American oil firms posted grim fourth-quarter results for 1998: their after-tax profits fell by 90%, or $4.8 billion, compared with the same quarter a year earlier. The recent mergers of BP with Amoco and Exxon with Mobil mark a new round of consolidation in the industry. A big motive is to take costs out of the business: Exxon-Mobil for example, expects to save $2.8 billion from its merger. With its own reorganisation and internal streamlining, Shell is hoping to save $2.5 billion a year. “

And more.

In Venezuela, where production costs are lower, the bursting of the oil bubble has helped to propel a populist military man, jailed for two failed coups in 1992, into the presidency. Prolonged low prices could trigger social explosions in several other unstable producing countries.

Oil at $5 a barrel?  Plummeting oil company profits? A reference to Hugo Chavez without naming him explicitly?  It is amazing how much market conditions, and perceptions, can change in in less than a decade.  All of those investors who thought they were smart buying oil company shares in 2007 were not nearly as smart as those doing so in 1998.

Check it out here 

Investment Funds Hold 25% of Current World Coffee Production

A recent move by the $255 billion California Public Employees’ Retirement System to further diversify out of stocks, mainly those of U.S. companies, and into commodities and emerging markets equities is just one example of a shift in investor sentiment towards the historically volitile asset classes. According to the Canadian Globe and Mail:

“There’s no doubt that the macro guys are pulling money out of some of the underperforming assets from last year like stocks, allocating a bit more to bonds and definitely allocating a larger percentage to commodities,” said Lars Steffensen, managing director of commodity trading at Ebullio Capital Management. “Even a 1 or 2 per cent shift into commodities is massive in pure dollar terms,” he added. March robusta coffee futures in London rose to a peak of $2,039 a tonne, up $25 and the highest level for the second month since May 1998. The contract has risen around $300 since early December. “Funds hold 25 per cent of world production and currently appear to have an insatiable appetite for softs in general,” brokers Sucden UK said in a daily coffee market report.

Looking backward at the huge runup in prices that commodities have experienced over the last few years it is possible to forget about the historical volatility of the asset class. The increased liquidity brought about by noncommercial speculation has tended to exacerbate price swings. In early 2007, when oil was in the low $50s, down about 35% from its July 2006 high of $78, noncommercial speculators were net short, according to businessweek. This was a far cry from investor sentiment in mid 2006. One has to wonder about the implications that increased commodity exposure in traditionally conservative mutual funds and pension programs may have if commodities fall out of favor.