I have been distracted lately by a major change on the home front, literally. In July, we decided we were tired of the hustle and bustle of the city and made a move to a quieter neighborhood. We're finally settled in....
A lot has happened. The electoral college has chosen a new path for US, and I may add a few cents about that in the near future. However, I wanted to provide a little update on what I've seen in the commodity sector. First, a little reminder from my first major post last February describing how financialization of commodities helped fuel a series of commodity bubbles from about 2002 to 2012:
Wall Street’s attempt to hype commodities over this extended period (2003 to 2011) helped create a debt-financed monster that has come home to roost. While most of the fear is focused on the shale oil boom and bust, the entire commodity sector is experiencing what Irving Fisher (America’s preeminent economist 100 years earlier) called the debt-deflation process.
The deflationary spiral is not limited to oil, it’s hitting all commodities. While the value of energy stocks has tumbled by some 50%, mining stocks are down over 70%, and prices for globally traded food commodities have also collapsed. Over the past eight years billions of dollars were invested in US farmland by private equity, hedge funds, and pension funds at a time when prices of wheat, corn, and soy were 50% higher than they are today. In 2014, the value of farmland experienced its first decline since 1986. As grain prices have continued to decline, so too will farmland values, and when Wall Street investors try to unload these very illiquid assets, things will get very ugly in the farm sector as well.
How will it end? Financialization means commodity prices are more volatile because investor bets drive prices. Assuming no unforeseen changes in markets (like a serious Middle East “event”), the glut in global markets will keep a lid on prices well into 2017, but volatility will reign because there’s no other way to make a quick buck when interest rates are zero and heading negative. “Smart” investors--those who think they can time markets—will jump back in at the slightest indication of “good news.” For example, if central banks announce another attempt to save the markets or a group of producers attempt to curtail production, there will be a quick jump back up in prices, only to be brought down by the reality of “pork oil”—the glut in global inventory and supply.I'll start with the last paragraph, as there has been another attempt to prop up oil prices through an OPEC-Russia agreement, which caused the price of oil to rise by 15% in one week. Here's where financialization provides its countervailing force to rising prices over the long term. An article from Bloomberg today discusses how shale oil producers have used the jump up in prices, also reflected in the futures price curve, to lock into prices for 2017-20 in the mid $50 range, providing a high enough price to generate profits. There's an interesting figure in the article that shows how the Shale "sells" (say that 3 times real fast) have caused the oil price curve to flatten out over the 2018-20 window, even displaying some backwardation. The UShale guys could help offset production cuts from the cartel guys! In other words, don't bet on any sustained price increase.
Regarding the second paragraph, I've finally come across a few pieces describing some of the impact in the farm and mining sectors. This article from Mining.com discusses a Moody's report on the sector. While it states that in its review of mining stocks many were downgraded at the start of this year, but the sector has now stabilized. While Moody's suggests the sector has stabilized, it also believes the global glut is still weighing heavily over prices:
However, Moody's believes the latest leg up for base metals (bellwether copper is up more than 25% over the last eight weeks) is not sustainable. Carol Cowan, Moody’s Senior Vice President says most metals markets remain in surplus and "supply-demand fundamentals have not improved meaningfully"...All base metals, with the exception of zinc, remains oversupplied and global inventories have also remained stubbornly elevated (again zinc is the exception) according to the report.Finally, regarding the farm sector, this from a Bloomberg.com article last month:
Betting the farm on record crop, livestock and dairy prices has turned into a losing investment for an expanding share of America’s agricultural heartland. The level of debt to income is the highest in three decades, and growers are increasingly unable to make loan payments.
Four years after record U.S. crop and farmland values boosted purchases of land and equipment, a global surplus has sent prices tumbling and farm income into the longest slump since 1977. The Federal Reserve says growers are borrowing more to pay bills, repayment rates are plunging, and the number of bankers requesting additional collateral is the highest in 25 years.
Bankers are getting more bearish about the farm economy. The Rural Mainstreet Index created by Creighton University, based on monthly surveys of lenders across 10 Midwestern states, sank in October to the lowest since April 2009. The banks expect about 22 percent of farmers to suffer negative cash flows in 2016, and some lenders said farm foreclosures will be an increasing challenge.The commodity boom fueled by global demand and speculation is experiencing a debt-deflation, and the debt-financed increase in production that started it will help keep a lid on prices for a few years longer. Certainly, there will be some unique situations, but don't bet the farm in the era of "pork" oil, minerals, and grains...
