29 March 2008

Commodity market is no country for old men.

How about the zombie who, according to rumour, decided to electronically sell ±10,000 wheat contracts (spot month, short sale) even at when the bins were nearly empty? Apparently the trade was done in the wee small hours of the morning and, of course, it was unwound hours later (at a loss of one or two hundred million) and one more speculator bit the dust.

Meanwhile platinum swings a hundred dollars a day and amplitudes in grain markets are sometimes greater in a day than their prices were two years ago.

Wheat used to trade in increments of half a cent; now we're getting increments of close to 10 cents.

Silver, which was friendless at $4 five years ago, unobtrusively moved through $20 before a savage pullback. God only knows what gold will do as and when it gets well clear of the magic $1,000 number.

Finally peak oil seems to have arrived. The only thing that will stop the price rising will be serious declines in US consumption, because it appears nothing will stop the rest of the world consuming more. And more.

While establishment economists suggest, hope, and dream that the commodity boom is over, in all likelihood it's just beginning. That ill-advised short wheat trade is just a manifestation of frustration, incredulity, and, probably, a harbinger of things to come. Just as a lot of smart investors intended to "get out of" sub-prime products before any trouble started but were all caught instead, so a lot of smart investors have been caught short gold, grains, and so on. As always, they lament that the pullbacks have not been deep enough, or long enough, to permit covering (or going long).

And just as the people long sub-prime stuff found that there were no bids when they tried to exit, so the commodity shorts will find offerings scarce when they try to cover.

Yet for the moment, even as manifestations of inflation intensify, the popular wisdom is that commodities have been in a bubble phase. Nobody is worried about the integrity of money. Nobody sees well-publicized financial upheavals as propelling the flight out of money; rather, economic gurus argue that safety lies in holding cash or bonds.

The latter remain strong and it's still the mortgage/sub-prime/Bear Stearns/hedge fund stuff that makes the headlines. Soon enough it will be derivatives, and then perhaps people will grasp that this is a money problem more than anything else.

In fact the monetary system is moving into its death throes. Back in the early 1960s, when the first cracks in Bretton Woods and the US dollar appeared, the predecessors to the G7 cooked up the General Agreement to Borrow (GAB) with a whopping $6 billion aid package. Another innovation that was supposed to solve the world's problems was the introduction of Special Drawing Rights (advertised as "paper gold").

That's all ancient history; now the masters of the universe throw $100 billion here and $300 billion there. (The 40-year surge in the size of aid packages is yet another measure of inflation.)

The usefulness of the International Monetary Fund has faded; there is certainly no way it will be permitted to discipline its most truant member. Whatever, some members would like to recover their gold from the IMF, while others would like to use IMF gold to suppress the gold price. Either way, there's a good chance that the IMF will be gone within the decade.

Moving to a different arena, we paid a visit, after a generation's absence, to the recent PDAC (Prospectors and Developers) convention in Toronto. What a change. A generation ago it was like a produce market with a few hundred grizzled prospectors from Chibougamou, Timmins, and Yellowknife all trying to sell claims to Noranda, Conwest, Kerr Addison, and the like. We once even cut a property deal in the smoke-filled, alcoholic haze of the Royal York Hotel's Library Bar.

But during this last visit we didn't see any prospectors, just 20,000 slick, expensively dressed men and women working out of 400 booths selling stock, not mineral claims.

Just as investment banks have been selling dubious black-box paper, so an army of mining promoters has been selling dream paper: "We have the mother lode!" Canada has more than 150 uranium stocks but less than half a dozen uranium mines. Gold isn't any better. It costs about $500,000 a year just to keep a small mining company afloat (the annual burn rate) and lots, lots
more for the bigger ones. Collectively they have been pulling billions out of the market for years with pitiful results.

The days of investment dealer black-box paper are over, credit is tighter (even though marginally less expensive), and promotional mining la-la-land looks to be in for a shakeout.

We all seek refuge somewhere. Bond guys cannot believe stocks, gold guys think that "gold in the ground" is undervalued, and financial services guys are in shock. The hyperinflation guys (that's us) cannot believe bonds but see the resilience in solid stocks and commodities as a perfectly logical flight out of money. Strong manufacturers with sophisticated assets and proprietary
wealth (such as P&G or CAT) will thrive and prosper, along with resources, long after the money is gone.

Gold, the real thing, will probably outperform most shares.

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