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Happy New Year everyone.
This article of mine re markets might be of interest (also below).
http://seekingalpha.com/article/245574-who-s-to-blame-for-high-commodity-prices-it-s-the-producers-stupid v=1294568746&source=tracking_notify
In my view commodity markets have two price boundary ‘trend-lines’: a ‘sellers’ market’ upper boundary, where consumer demand destruction sets in, and a ‘buyers’ market’ lower boundary, where ‘production destruction’ sets in.
The current situation, where finance capital (money) is in the markets, reminds me irresistibly of a RoRo ferry with water swilling around the car deck against the two sides. Any external shock, and over it goes, giving rise to a market discontinuity, where the price collapses to the lower bound from the upper bound exactly as happened in the Tin market in 1985 which fell – literally overnight – from the artificially supported price of $8,000/tonne to the lower bound clearing price of new low cost producers of $4,000/tonne.
My thesis of ’financialisation’ by risk averse investors seeking a safe hometheir dollars (as opposed to the Greedy Speculators) accounts for the divergence of natural gas at the lower bound – which is over-supplied, and has as yet no global organised market – from crude oil and product markets which are marginally over-supplied at best, and IMHO routinely manipulated/supported by producers with the aid of investment banks.
Best Regards
Chris
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Who’s to blame for high commodity prices – it’s the producers, stupid
For some time now the conventional wisdom has been that commodity market ‘speculators’ are to blame for current high prices across precious and base metals, in most energy markets, and, of course, in the sensitive agricultural commodity markets where high prices are, in many countries, a matter of life and death.
This has been propagated by lurid and ill-informed articles in the press – most notably ‘Daily Mail’ images of tankers full of oil moored off the UK coast. This greedy speculator myth has been taken up by politicians who have driven almost entirely useless action by US regulators in particular.
While the blame for high prices correlated across commodity markets is being firmly ascribed to greedy speculators intent on making transaction profits, I do not believe that they are to blame.
QE and the Zero Bound
The US government has reduced interest rates to zero, and for good reason as the credit markets collapsed. They have also been assiduously pouring in money in order to save the US financial system through Quantitative Easing (QE) and other monetary strategies.
QE is the creation of credit (eg dollars) by Central Banks, and in the US this means the Federal Reserve Bank. This was necessary to replace the money draining out of the financial system as legions of US borrowers were unable to perform in respect of the unsustainable loans they had taken on, and had QE not happened there would have been massive defaults, and a Depression.
But a side-effect has been a huge pool of dollars roaming the global financial economy looking for a safe home, and this has reduced short term dollar interest rates on US government debt to zero.
Anything but Dollars
Investors see the Fed flooding the US financial economy with freshly created dollars and they conclude that this will mean that asset prices, and retail prices generally will rise. So if dollar interest rates are at zero what is an investor to do?
The answer is that investors are flocking to buy anything but dollars whether or not it carries an income. They firstly flocked to the traditional haven of gold, which soared in price to over $1430 per ounce, but frankly this is a matter of indifference to the man in the street because he can’t eat gold, heat his house with it, fuel his car with it, or type e-mails on it.
But in recent years, facilitated by the financial services industry, new asset classes of Exchange Traded Funds (ETFs) and related ETCs and ETPs have sprung up which enable investors to invest in any commodity which is traded on an organised market. Tens of billions of dollars are therefore being invested in commodity markets through such funds or through other more exotic products.
The outcome has been that most markets: precious and base metals; energy markets except natural gas (which is an oversupplied and fragmented market); and of course many agricultural commodities; are being simultaneously financially inflated.
These markets have therefore become correlated, and move up and down at pretty much the same time. They are doing so because demand in these hugely diverse physical markets is moving in lock-step. But demand is not the same thing as consumption, and the difference lies in the ability to stockpile commodities, which is more easily achieved in some commodities than others. Metals are easy to store indefinitely, relatively inexpensively; crude oil and products less so; food commodities are bulky and perishable; while electricity is virtually impossible to store.
While China in particular is a buyer of most commodities, this is not necessarily for current consumption, but rather for future consumption, and like financial buyers they prefer spending their dollars on such hard assets to buying US T-Bills bearing zero per cent. The difference between buyers like China and purely financial buyers is that China at least has a use for the commodities.
While the purpose of physical markets is to enable ‘end user’ physical producers and consumers to transact at an agreed market price, it will be seen that in most markets that is no longer the case, since participation by risk-averse financial investors who are ‘hedging inflation’ has driven the physical price to levels at which demand dries up, because consumers can no longer afford to pay.
Cui Bono?
Who gains from high prices? The answer is obvious: producers gain from high prices, and if there is one thing that the history of commodity markets tells us it is that producers can and will attempt to maintain prices at high levels wherever possible. They do so publicly by creating cartels to support prices by stockpiling and otherwise – such as in the tin, cocoa, coffee markets in the past – or by privately manipulating prices, such as Yasuo Hamanaka’s escapades on behalf of Sumitomo over 10 years in the copper market.
While there are indeed speculators in these markets, for them it is a less than a zero sum game. Their motive is Greed, and in their search for transaction profit they may either buy first and sell later, or vice versa. While they certainly add to short term volatility, they have no medium and long term effect on market prices because they neither produce nor consume the physical commodity.
It is in fact producers, who are currently – in the finest tradition of market capitalism – dipping their bread in the economic gravy through selling at the highest possible price to risk averse financial purchasers whose motive is not greed, but fear.
The outcome is therefore a massive wealth transfer from consumers to producers as a result of the inflated prices in the physical market. But that’s just the way it goes when it’s the producers’ turn. When markets are over-supplied and investors are absent, then producers engage in a ‘race to the bottom’; the lowest cost producer is the last man standing; and it’s the consumers’ turn at the gravy.
The only constituency who always wins in our casino market capitalism are the casino operators: ie the exchanges, banks and brokers. Producers; consumers; speculators and traders all pay a ‘cut’ to the casino, but the problem is that on this roulette wheel there are at least half a dozen zeroes…..
Re-Inventing the Markets
The current generation of markets has become entirely financialised and dysfunctional, and is no longer fit for purpose. If and when interest rates rise; or investors become less fearful; or the price of commodities chokes off demand, as it did in 2008, then we shall again see commodity prices collapse to the ‘lower bound’ of over-supply. In other words, the market will transition from a ‘sellers’ market’ to a ‘buyers’ market’.
As long as dollar interest rates are at zero the demand will recover, and the market price will once again, as it has already, march up to the Top of the Hill, like the Grand Old Duke of York’s Men.
The only long term solution is to completely re-architect markets. Firstly, cutting out middlemen – which is a process already under way. Secondly, a new settlement between producer and consumer nations – a Bretton Woods II. This is not feasible unless and until commodity markets collapse from their current financially pumped-up unstable equilibrium – probably later this year. The currently triumphant and increasingly macho producers will then temporarily lose the whip hand, and at this point a sustainable market architecture may at last be achieved.
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Great article on the present complete inability of economists and politicians to see what is actually going on:
See full thing at: http://www.onlineopinion.com.au/view.asp?article=8817&page=1
It is fascinating to watch the behaviour of our political and business leaders as they attempt to cope with the world’s deepening financial crisis. It is becoming clear that they don’t have a clue what is actually going on. Their blindness is explained by confusion about what actually enables economic growth. The shared delusion is that money makes the world go round.
As share and asset values crash we hear talk of deflation. Many nations are trying to counter this by expanding their money supply. However, they seem to have forgotten the most basic fact about money that we are taught in school – that it is a medium of exchange. Money allows agreements on relative “value” (how much of one thing will be exchanged for another) but it has no intrinsic value itself. It is simply a mechanism that allows the distribution of real “stuff”. So if the economy is crashing what is this “stuff” that is disappearing? It can be summed up in one word – energy.
Energy is everything
No living or manufactured thing exists on this planet without energy. It enables flowers and people to grow. We need energy to mine minerals, extract oil or cut wood and then to process these into finished goods. Without energy the goods would not exist so we can think of each product as containing “embodied energy”. So the most fundamental definition of money is that it is a mechanism to allow the exchange and allocation of different forms of energy. The economy is energy
The most important source of energy in the world economy is hydrocarbons – molecules made up of hydrogen and carbon atoms. Small hydrocarbon molecules form gases such as natural gas. Larger molecules form the liquid we know as crude oil. Hydrocarbons can be burned to provide heat energy to power generators and motors. Almost all transport relies on liquid hydrocarbon energy. Hydrocarbons are also incredibly useful for making plastics. It is difficult to find any manufactured thing that does not now include plastic. Oil and natural gas provide almost 2/3rds of the energy used in the world economy. A simpler way to say this is that hydrocarbons are 2/3rds of the world economy.
Until recently (about 2005) the world economy was growing. The number of people has been increasing which requires increased production of food, clothing and shelter – the basics. On top of this, many of us have been using more energy than previously – to travel farther, eat more food, buy additional clothes and enhance our shelters. Until 2005 we could expand our energy use to meet this demand. This is something we were able to do – with occasional interruptions – for the past 150 years. However, after 2005 we could not expand our energy supply. In other words we could not expand the world economy.
