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Monday, October 6, 2008

Recession, Commodities and Deflation

“The day of steadily rising commodity prices is over. A lot of the demand for commodities has been speculation, and now that demand is falling away because of fear taking hold in the market.” -Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi

Commodities R.I.P. as Leverage Vanishes, Growth Slows (Update1): “Commodities markets are heading for the biggest annual decline since 2001 as investors exit leveraged bets and slowing economic growth erodes demand for raw materials.

The value of the 19 commodities in the Reuters-Jefferies CRB Index fell $280.6 billion, or 43 percent, from its July 3 peak, a loss larger than their total worth two years ago, data compiled by Bloomberg show. UBS AG, the Zurich-based bank that bought Enron Corp.'s energy unit in 2002, plans to exit most commodity trading. About 15 percent of investors in Boone Pickens's BP Capital LLC hedge fund may want their money back.

The same credit-market seizure that led to last month's bankruptcy of New York-based Lehman Brothers Holdings Inc. and the forced sale of Merrill Lynch & Co. is squeezing speculators who drove commodities to record highs. Slower expansion in the U.S., China and India is also undermining prices of crude oil, which fell 36 percent, and corn, down 43 percent.”

The obvious has come to pass.

“A global slowdown may cause crude oil to plunge another 47 percent to $50 a barrel next year, New York-based Merrill Lynch said in an Oct. 2 report. Goldman Sachs Group Inc. cut its forecast for copper next year by 12 percent to $8,265 a metric ton and aluminum by 18 percent to $2,920 a ton.”

In Smashing the ‘Perpetually’ Growing Oil Myth I said, “If you believe that demand from India and China will send the price of oil and commodities to “infinity and beyond” you’ll end up losing your shirt and your sanity.”

I argued that demand destruction will move the oil price significantly below $100 per barrel:

“Even at $100 a barrel, prices have the effect of crowding out the marginal consumer. In this case, the cost of oil rises just high enough such that it becomes unaffordable to the marginal consumer. The marginal consumer happens to be almost everybody NOT in the first world. Basically prices will settle just high enough to wipe out any consumer surplus for these consumers and thereby severely limit demand to the highest socio-economic echelons in those countries. That level is most assuredly below $100 a barrel.”

Oil was done when the heavily subsidized emerging economies had to start moving closer to paying real market rates. I say ‘closer’, because they are still ridiculously subsidized, and still have a long way to go. I presented the consequences in Oil Drops on Subsidy Cuts in China, India, Malaysia, Taiwan.While everybody is worried about the U.S., don’t forget: The Other Bigger Shoe: The Rest of The World

In my recent post Inflation, Deflation, Money Velocity and Gold I once again emphasized that I was firmly in the deflation camp. (This always gets the tinfoil hat wearing goldbugs to go flailing about in the comment section, which is always amusing. It is amazing how personally they take a downtick in gold.)

The Baltic Dry Index continues to confirm the evaporation of demand. Since my last post, Baltic Dry, Commodities and Bubbles the index has gone into free fall.

Last week in Commodities: Hedgies Puke, Almost Done I argued that the hedgies are being forced to liquidate and that this particular wave of forced selling will almost have run its course.

Don’t mistake another bounce for a resumption of the Bull market. These bounces will be large and tradeable, but that is all they are BOUNCES.

We haven’t seen nothing yet. There is a LOT of debt that still needs to be destroyed. The chart in Total US Debt illustrate just how much debt still needs to be wiped out:

The losses will be so large, that the current recession will be one of the largest, deepest and longest in history as I argue in Credit Losses and the Shape of the Recession:

“There is no way ANYTHING has bottomed. In fact, the slide down is about to ACCELERATE. This won’t be one a quick and shallow recession. This not a ‘V’ shaped recession. This almost certainly is a ‘U’ shaped or ‘L’ shaped recession with a very real possibility of a ‘\’ shaped damn near PERPETUAL recession.”


Anonymous said...

What's the source of the data for that chart? Because if Total US Debt is 325% of GDP, that means its approximately $45.25 trillion ($13 trillion GDP x 3.25). Is that true? Treasury says that number is $9.x trillion. Are we talking about the same thing or comparing apples and oranges?

Anonymous said...

At what point do some of the best of breed commodity plays become interesting to value investors?

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