Commodity fundamentals, commodity speculation

The Economist is ceding (at last!) that loose monetary policy in the US may have something to do with the acceleration of commodity-price inflation, going as far as dropping the b-word!

There is no doubt that commodities have become an increasingly popular investment category — in fact they bear many of the hallmarks of a speculative bubble... The most recent circumstantial evidence also suggests that the Fed may bear some responsibility for the commodities boom. The dollar slipped after the Fed’s rate-cut decision as investors reacted to its doveish tone, though at $1.56 per euro, it was still up 2.6% from its low of $1.60 on April 22nd. The price of oil, after hitting a record high of almost $120 a barrel on Monday, had tumbled to $113 on Wednesday. But the price of crude and other commodities rose afterwards. If those reactions persist, America’s central bankers may have to reflect carefully.

I think that the conflict in this speculation-vs-fundamentals debate lies in (a) the overlap of the (possible) speculative price-increases we've seen over the last few months (sp. since the interest rate cuts in January) on top of a long-term trade driven by fundamentals and which has been in play for several years already; and (b) Jeff Frankel's attribution of the long-term trade to low interest rates also, rather than to fundamentals (as briefly explained in The Economist's article).

Clearly defining the time-horizon one's referring to should deal with most of the confusion arising to the first item. I doubt that most "fundamentalists" can deny that there's been an acceleration over trends over the last few months at the same time as some major economies have been slowing down. And most of us "bubble-heads" agree that there are long-term trades at play and that the really sharp drops in interest rates are fairly recent.

On the other hand, Frankel's arguments will fuel disagreement for as long as there is more than one sentient being willing to have an opinion on the issue. As usual, outside the realm of formal modeling, in which at most one explanation is admissible, reality is likely to be a combination of fundamentals and interest-driven investment/speculative reasons. The question is how much of each.

But since there's more than one sentient being still willing to have an opinion...

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Busy econ day

1. We're waiting for the Fed to say something about interest rates.
2. Commodity traders "realized profits" yesterday (read: "commodity prices fell a little yesterday"), perhaps to do something while they wait for the Fed's decision. Will the "low US interest rates have lead to speculation on commodities" crowd have more or less ammo if prices bounce back up/ the Fed does something different than cutting 25 basis points? (Full disclosure: for whatever it's worth, I'm part of the bubble-crowd. For a brief, but comprehensive discussion of the different explanations for the rise in commodity prices, see here. The bubble crowd tries to distinguish the continuous, fundamentals-led growth of the last few years from the vertiginous phenomenon of the last few months.)
   
3. Growing business inventories kept the US's GDP from contracting (it grew by 0.6% in the first quarter). While this is obviously better than a falling GDP, could there a less encouraging reason (looking forward) to have avoided the fall?
4. Thanks to Hillary Clinton, the mainstream media is awakening to the idea (ripped from McCain in a deepening of her mind-bogglingly bizarro attempt to contrast herself from Obama in the primaries by looking more and more... Republican?) of the gas-tax holiday. Can there a more idiotic, nonsensical policy proposal this campaign? Even Robert Reich's against it! The founder of the Pigou Club (and no Obama fan himself) says "Score one for Obama."
5. We're still waiting for Ben...
   

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Recovery? Shyeah, right!

Have you also been sent into hysterical giggling by the US markets' ability to rally at the sound of any news, good or bad?

Optimism, hope, faith when unexpected good news come out is endearing. But the current favorite rationale to buy, buy, buy when unexpected bad news come out, "it must mean we're near the bottom," is as intellectually satisfying as explaining price drops in "normal" markets as "profit taking." (Are price gains then the result of "loss taking"?)

Anyway, I digress. I read two weeks ago this nice little piece by John Authers in the FT. Now, I know two weeks is unbearably old for a blog, but there you go; it seems an appropriate snippet to have around the next time, the umpteenth time, that analysts come out to tell us that we must have touched bottom because stocks have gone up two days in a row (notice the prediction of a "bear market rally in the next few weeks"):

Perhaps the most convincing argument that we are not yet at the bottom is that so many people think that we are. The clamour to call an end to the crisis in recent weeks in itself shows that optimism has not been extinguished. History’s worst bear markets have been punctuated by many rallies when people thought the worst was over.

The collapse of the Dow Jones Industrial Average after 1929, and of the Nasdaq Composite after 2000, saw falls of about 80 per cent over three years. And yet both saw several “bear market rallies” when the index recovered by 20 per cent or more. Hope springs almost eternal.

In both cases the declines ended with the markets bumping along for a while, and then making advances that went unremarked at first. As Ian Harnett of Absolute Strategy puts it: “We’ll know we’ve hit the bottom when we look and see that share prices are a lot higher than they were a few months ago – we won’t know at the time.”

The case for a bear market rally in the next few weeks looks strong, provided the market can avoid more bad news on the credit front. But it looks hard to call a bottom. One sceptical analyst says: “The bottom will come when everyone at last gives up ever trying to find it.” That moment, unfortunately, is not yet in sight.

Source.

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The next bubble?

So I'm being facetious. Or am I? Bear with me if you're of the school of thought that loose monetary policy was behind the dot com bubble, then behind the housing bubble, and now behind...

The outstanding Econbrowser posted two weeks ago this little jewel. In essence, the Fed's pushed "risk-free" real interest rates into the negative (we've all seen that plot of the real return on the 5-year TIPS , right?) and now all that money is pouring into commodities. He presents this table:

Percent change in commodity prices since Jan

aluminum	29.2
barley	7.5
cocoa	25.9
coffee	23.5
copper	26.3
corn	21.2
cotton	32.0
gold	17.4
lead	32.7
oats	33.8
oil	6.8
silver	37.8
tin	15.5
wheat	32.7
zinc	20.5

Source

At a time of global slowdown, I call it scary (I still believe in decoupling, but as I said here, that perfectly compatible with the world slowing down because of an adjustment in the US's housing market). Nah, I call it bubbly: some investors might have gone in looking for a safe haven, but I'm sure lots more are going in just because of a believe in on-going asset appreciation. Look at those numbers! Let's hope there's a soft-landing for that one too. Wait: "too"?

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