Sunday, November 27, 2011

The Commodity Story: Bull Horns or Bear Tracks

Commodities are used in the creation of economic activity around the world. So a review of the markets that are sensitive to commodities is one method of watching the condition of many pieces in the global economy and some individual markets. It is also worth noting how Federal Reserve policy can influence prices of commodites, such as the price inflation observed early this year created by excess liquidity finding value in commodites which are both a real asset and have scarcity.

The economy of South Korea provides an interesting window to their primary trade partner, China. The China economy is important for its consumption of commodities from Australia and Brazil and its purchase of material and services from other global economies. The Kospi is a South Korean stock exchange and coincident barometer of economic change in China. It appears that the Kospi was hit hard in the beginning of August. The timing suggests to Americans that the US Congress debt ceiling discussion impacted the Kospi. The weeks long discussion confirmed that the Congress is more dedicated to partisanship than to the good of the country and that may be part of the story. The beginning of August was also when Greece's debt default, and associated threat to the European banking system, became a serious outcome without intervention. That is a much larger economic threat for most of core Europe, at least at this point in time.

The commodity markets are generally priced in US dollars. Keeping the US dollar index in reference is helpful. The dollar strengthened in September, hurting users of commodities, a condition that appears to be repeating again in November. If the dollar is breaking out of resistance near 80, then commodities will become more expensive and that will be inflationary. A sideways trend would provide some currency stability that has been missing, and not a realistic expectation here. A weaker dollar would be welcome relief for commodity buyers and relieve concerns about inflation, supporting prices of many stocks and metals. The 10 week moving average illustrates the trend is suggesting a breakout through the 80 level. The Fed FOMC is also monitoring this movement. They are not likely to allow a big strengthening move in the dollar index with intervening. The problem is, what if they do allow it? That won't be fun to answer.

News from China is that they are raising interest rates on bank loans and requiring higher reserves on banks, all in an attempt to slow the internal growth and real estate development. The sluggish global economy outside of China is no longer supporting the export based economy they had enjoyed up until 2008. Since then the government is struggling with the demands of a growing percent of the population who want to raise their standard of living and work for a wage better than subsistence in their home villages. The graph above illustrates the Shanghai index, one of several widely traded stock exchanges in China. The current level is nearly on support last seen in the summer of 2010. Holding this level and lifting would be a big positive for global markets.

Since April 2011, the CRB index has been in a bear market.

Since April 2011, the West Texas Intermediate Crude index has been in a bear market which is a friend of oil consumers and corporations in the US. That trend has reversed during October and November indicating rising oil costs, or no drop, in the next few months.

Since April 2011, the Brent Crude index has been in a bear market or friendly to world consumers and corporations. The trend is also a sign of slowing demand and sluggish economic activity.

Consider the Emerging Market shares.

Consider the Australian All Ordinaries shares.

Consider the Toronto shares which are commodity weighted.

Consider the Brazil Bovespa shares which are commodity weighted.

 My conclusion is that there is a very thin layer of support for major economies. Emerging market economies are in the same condition. Nothing looks good and trends are weaker. The US Federal Reserve FOMC is watching these trends, without question, and are probably anxious to renew their practice of quantitative easing. The current committee has been unable to vote in favor of more QE during 2011. The FOMC will get new membership in 2012. Each January there is turnover of at least four of the eleven seats on the FOMC. The committee will hold its last 2011 meeting on December 13 and it's first 2012 meeting during January 24-25. Anticipating that the new committee membership will be more supportive of balance sheet expansion, Bernanke may be comfortable hinting about the committee's QE intention in 2012 at the meeting on December 13. It won't take a strong hint to see price support on expectation of new Fed intervention. In addition to Fed intervention in the US, there needs to be intervention in the Euro as a defense of US banks that are exposed to the major Euro banks. That is a more politically complex issue because the Euro does not have political integration of the various countries into one fiscal and monetary policy voice. That may be in the works, but some other political solution will be needed before the Euro gets a renegotiated treaty, which is inevitable IMHO. In the meantime, the IMF is a likely co-conspirator with the Fed. The job will get done!

Minutes of the last FOMC meeting were released recently and this report was posted by Econoday.

11/22/2011 2:00:00 PM ET, Econoday reported, There were no surprises about potential changes in monetary policy but there was likely greater than expected detail about how wide ranging internal Fed debate is about future direction on guidance… First, most FOMC participants see downside risks to growth greater than upside risks. The biggest risk to growth is the potential effects from European sovereign debt developments on financial markets. Also, the FOMC sees higher risks on the unemployment rate… In contrast to recent FOMC meetings, participants see the risks to their inflation forecasts to be evenly balanced… There was discussion about the possibility of implementing explicit inflation targets. While many saw the merits in such a target, there was concern that the public could misconstrue such a target as downplaying the Fed's dual mandate which includes maintaining maximum sustainable employment growth. No changes were made to the FOMC's policy on guidance… The FOMC discussed wide ranging possibilities for other types of guidance. The idea is that guidance provides stronger impact from policy decisions than purely discretionary policy decisions. One possibility is guidance based on conditional thresholds for unemployment and inflation… There also was discussion of possibly targeting an intermediate target such as nominal gross domestic product or the price level. While the applicability of such a target was a major issue, there also were concerns that a switch in policy targets would lead to increased uncertainty… Overall, the Fed clearly is willing to take on innovative approaches for consideration for monetary policy. And despite internal differences, the bottom line for the FOMC appears to be efficacy in monetary policy for meeting the Fed's dual mandate for maximum sustainable economic growth and employment. There clearly appear to be more adults in the room at the FOMC than in Congress.