Commodities
A bit tarnished
Oil, gold and other commodity prices are sliding
ONE of the main selling points of commodities, according to the financiers who have been cheering their vertiginous ascent over the past few years, is that they do not move in lockstep with other assets. And so it had seemed in recent months, as commodity prices continued to climb even as disaster struck property, shares and bonds. Yet on March 17th the turmoil on Wall Street finally spread to the commodities markets.
On that day, oil set a new record of $111.80 a barrel before falling to $103.23 at one point—the biggest drop during a single day in 17 years. It was not alone: Goldman Sachs's main commodity index fell by over 4%. At the Chicago Board of Trade, wheat, maize (corn) and soyabean futures fell by as much as the exchange's rules permit. The price of coffee dropped by 11%. Although most commodities recovered the next day, the episode did call into question their status as a haven. By March 20th the prices of gold, oil and other commodities had slumped again.
Michael Lewis, the head of commodities research at Deutsche Bank, attributes the fall to investors seeking to cover losses in other markets, as well as to growing risk-aversion in such tumultuous times. But he does not believe that skittish investors will drive prices down dramatically, thanks to resilient demand for raw materials and meagre supply.
Although the economic outlook for America is grim, most analysts assume that emerging markets will continue to grow relatively strongly. Meanwhile, global copper inventories amount to only two weeks' demand. Lead stocks are closer to one week's worth. Stocks of oil are also unusually low. So even small disruptions to supplies prompt dramatic reactions from the markets. Aluminium prices, for example, have risen in recent weeks because of a shortage of power in South Africa, which has reduced output from several smelters. Fears of a shortage of hydroelectric power in Chile are helping to buoy the price of copper.
Jeff Currie, of Goldman Sachs, sees little prospect of a dramatic increase in the supply of most commodities. Nationalist governments, he argues, are impeding investment in the most promising new mines and oilfields, forcing Western energy and mining firms to spend lots of money developing less accessible and profitable reserves. Higher marginal costs of production, he believes, will sustain higher prices for a long time to come.
The dollar's decline also seems to be fuelling commodities' rise. Gold, in particular, has risen as investors seek a hedge against inflation and turbulent markets. The falling dollar also pushes the prices of other commodities higher, Mr Currie points out, because producers outside America need higher prices in dollar terms to maintain their margins.
Francisco Blanch, of Merrill Lynch, believes there is more to the story than that. He argues that the interest-rate cuts that have prompted the dollar to fall have produced a surge in liquidity in fast-growing emerging markets such as China and the Middle East. At the same time, governments in those countries try to insulate consumers from rising prices with subsidies and price controls. So demand for raw materials from such places continues to grow, despite high international prices.
If Mr Blanch is right the Federal Reserve's latest cuts will only spur faster growth in demand in emerging markets, and so higher commodity prices. That, in turn, will increase America's oil-import bills, which will add to the current-account deficit and therefore heap further pressure on the dollar, setting a vicious cycle in motion. On the other hand, if the dollar starts to rise in value again, the cycle might go into reverse, pushing the price of commodities down again. As in so many other markets, all eyes are on America's beleaguered central bankers.
The War on Recession
We all want to live well and no one wants their living standard to decline. That makes sense, right? It's just the way we are made.
What does not make any sense is the strange article of faith that has descended over Washington, DC, that says that no prices must ever be permitted to decline due to recessionary pressures. All resources in the national treasury, every conceivable monetary manipulation, all efforts of every regulatory body must be marshaled toward the great national goal of re-pumping the economy, which must never ever be permitted to fall even a tiny bit.
Welcome to the War on Recession, which is being pursued with the same vehemence and folly as the War on Terror, and will likely prove just as spectacularly destructive of its own aims as well as liberty itself. Maybe we need songs, banners, and little ribbon pins too.
Let's think about the big picture. The economy was overinflated due to reckless monetary policy and government agencies treating critical sectors such as housing as a democratic right and thereby too big to fail. The trend dates back decades but the bubble became insanely large only within the last 5–10 years. Something had to give. And it turns out that this was just the beginning. All sectors were puffed up and inflated.
Can we agree that there was a problem — that not all was well, despite appearances? I think we can. So what do we do in this case? There has to be a downward correction, but there's no reason to panic. A good correction is just what a recovery needs to get going. Such is the nature of the Fed-created business cycle.
So what could it possibly mean to claim that the economy must never be allowed to fall into recession? I'm thinking here of similar claims:
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"That drunk is sobering up. Quick, give him a shot of tequila!"
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"That druggie is coming out of his acid trip. Get the syringe!"
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"Don't look now but that insomniac is going to sleep. Someone wake him!"
Now, it's fair to say that the person hollering out the solution to each of the above scenarios doesn't really understand the nature of the problem.
So it is with the Fed. It sees stocks falling, credit markets under pressure, unemployment rising, investment falling. But rather than conclude that all these factors represent a bubble, it has the opposite response: keep the bubble inflated at all costs!
It's time that we question the very foundations of this war on recession. The recession is a regrettable but inevitable backlash against a boom that was not justified by the fundamentals.
That last phrase is the critical thing. I am not saying that the recession is the price we pay for economic growth. Boom times are fabulous times, provided that they are rooted in sound fundamentals. And what are those? Essentially it is this: the timeframe of investment must match the timeframe of society at large. If people are long-term oriented and saving money, resources become available for investment in the future. When production is completed, there are consumers to buy. But if no one is saving money and there is no sound store of capital, there are no resources to invest — unless, of course, the Fed creates that money. The money the Fed creates is wholly illusory, a fiction of investors' imaginations. It will vanish when the economy wakes up to reality.
This is an example of investment unjustified by fundamentals. What to do in that case? There must be a correction. There is nothing the Fed or the Congress can do about it. They certainly shouldn't attempt to prevent it. To attempt to prevent the correction is like turning into the skid: it only makes it worse.
All this nonsense about digging ourselves out of recession through government intervention began with the New Deal. Before then, government didn't do much at all about the downside of the business cycle. And guess what? Recessions were short and less than lethal for economic health. Indeed, they were the essential foundations of future recovery. All that changed with FDR, who used the economic downturn as the great excuse to make himself the economic führer of America.
But here is the amazing fact: not once has this strategy worked.
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Not in the New Deal. Not in the 1970s. Not in the 1980s. Not in the 1990s. Not once has government done anything to restore prosperity during a slump. What happens again and again is that government spends, the Fed inflates, the regulators punish, there is wailing and gnashing of teeth, and then, at some point, we hit bottom, and normalcy begins to return again. The most government can do is prolong the period at the bottom. Otherwise, it is just wasting resources.
Take a look at Murray Rothbard's book The Panic of 1819. Here we have America's first big financial panic. The public was going nuts demanding answers. Congressmen proposed this and that. Debates raged in the papers. But government ultimately took no action at all. Sure enough, the panic went away on its own. So it was in 1920 and 1921. The government didn't intervene and voila normalcy returned.
Here's another strange thing about this antirecession mania: for years we've been hearing from the environmentalists that we need to live more simply, do without, cut back, drive bikes not cars, and generally lower our standard of living and look after the well being of plants and lizards and things. It turns out that Americans don't really go for this message. A slight downtick in the price of the house causes hysteria.
So as we look forward to the recession there is at least this one silver lining. The environmentalists won't get very far with their message that we should embrace poverty and call it our own.
Fed Bypasses Emergency-Loan Policy on Rate for Securities Firms
By Scott Lanman
March 20 (Bloomberg) -- The Federal Reserve bypassed its own emergency-lending policies to let securities firms borrow at the same interest rate as commercial banks as the central bank sought last weekend to stave off a financial-market meltdown.
Guidelines revised in 2002 say the Fed should charge non- banks more than the highest rate that commercial banks pay. Instead, Chairman Ben S. Bernanke and his colleagues, in emergency votes on March 16, invoked broader authority in the Federal Reserve Act to give Wall Street dealers the same rate as banks, a Fed staff official said on condition of anonymity.
Backstopping securities firms, coupled with last week's action to keep Bear Stearns Cos. afloat before its sale to JPMorgan Chase & Co., represent the central bank's first lifelines to institutions other than banks since the Great Depression.
``They certainly pushed the limit,'' said Brian Sack, a former Fed researcher who is now senior economist at Macroeconomic Advisers LLC in Washington. The law probably has ``enough gray area'' to allow the decision, he said.
Bernanke raced to unveil the steps before trading on the Tokyo Stock Exchange began on March 17. The weekend action, timed to complement JPMorgan's rescue of Bear Stearns, included a cut in the so-called discount rate and the opening of borrowing to the primary dealers in Treasury securities, not all of which are banks.
Regulatory Navigation
``They used what authorities they thought they had and went ahead,'' said Oliver Ireland, who worked as a Fed counsel for more than two decades and is now a partner at Morrison & Foerster in Washington. ``From a public-policy standpoint, if this is important to do, you wouldn't want to be tripped up by your own regulatory structure.''
The changes were the Fed's most aggressive response to the 8-month-old credit squeeze that's worsening the housing recession and the economic slowdown. Bear sought the Fed's help after a run on the firm, the second-largest underwriter of U.S. mortgage-backed securities.
Not every former Fed employee was as forgiving. The Fed's haste in setting aside its own guidelines is ``troubling,'' said Vincent Reinhart, who worked at the central bank between 1983 and 2007 and is now a scholar at the American Enterprise Institute in Washington.
``The regulation is very clear as to the circumstances of the loan, and it is odd that they wouldn't apply a regulation that would seem to encompass what they want to do,'' said Reinhart, who served as head of the Division of Monetary Affairs under Bernanke and his predecessor Alan Greenspan.
Imposing Penalty
The 2002 guidelines say that non-banks may only receive emergency cash ``at a rate above the highest rate in effect for advances to depository institutions.'' That means securities firms may normally have to pay more than the current 3 percent rate reserved for banks that are less financially sound.
In deciding to charge securities firms such as Goldman Sachs Group Inc., Morgan Stanley and Lehman Brothers Holdings Inc. the same rate as commercial banks, the Fed used 1920s-era authority provided by Congress to set interest rates that the law says ``shall be fixed with a view of accommodating commerce and business,'' the Fed staff official said.
The Fed will give the first glimpse of how much banks and securities firms are borrowing under the new programs when it releases weekly money supply data at 4:30 p.m. in Washington.
Seeking Order
In its March 16 statement, the Fed said the lending was ``designed to bolster market liquidity and promote orderly market functioning. Liquid, well-functioning markets are essential for the promotion of economic growth.''
The Fed reduced the primary discount rate March 18 by 0.75 percentage point to 2.5 percent. The secondary rate, offered to more-distressed banks, is a half-point higher, at 3 percent.
The federal funds rate, the more closely-watched U.S. short-term benchmark, was cut by the same margin to 2.25 percent.
In December, the Fed went around requirements for prior notice and public comment when writing the regulations to authorize new funding auctions. The Fed's statement then said any delay caused by following standard procedures would have been ``contrary to the public interest.''
The central bank's regulations were revised in 2002, as part of a decision to make the discount rate higher instead of lower than the federal funds rate, removing a long-standing subsidy.
The Fed hadn't previously taken advantage of the power to let individuals, partnerships and companies borrow since the 1960s, when it authorized lending to savings institutions that weren't covered by the Fed at the time. The banks didn't draw on the loans.
``The Federal Reserve Act is somewhat obsolete today,'' and that's why Fed officials probably had to take such action, said Sack of Macroeconomic Advisers.
Gold Leads Commodities Plunge on Outlook for Dollar, Economy
By Glenys Sim and Claudia Carpenter
March 20 (Bloomberg) -- Gold headed for its biggest weekly drop in 25 years, leading a drop in commodity prices, after the dollar rallied and concern mounted a U.S.-led slowdown in the global economy will reduce consumption of raw materials.
Oil fell below $100 a barrel for the first time since March 5, soybeans erased this year's gains and cocoa headed for its steepest decline in more than five years. The UBS Bloomberg Constant Maturity Commodity Index of 26 raw materials is having its worst week since at least 1997, led by declines in silver, cocoa and sugar.
``Global recession fears are causing selling pressure in all commodities,'' said James Mound, head analyst for MoundReport.com, a commodities newsletter, in Palm Coast, Florida. ``The markets are focusing on want-based items instead of need-based items.''
Gold in London has plunged 11 percent from its record $1,032.70 an ounce on March 17 after the Federal Reserve cut its overnight-lending rate less than expected by 75 basis points to 2.25 percent. The dollar has recovered 3 percent from an all-time low against the euro and rallied almost 4 percent from a 12-year low against the yen.
Commodities have advanced in each of the past six years, driven by demand from China seeking to feed its population and power its expanding economy. The dollar's slide has boosted demand for raw materials, which become cheaper for buyers holding other currencies, while some investors are seeking higher returns following a slump in equities.
`Absolutely Enormous'
The money flowing into commodities is ``absolutely enormous,'' James Proudlock, commodity product head for Europe, Middle East and Asia at JPMorgan Securities Ltd., said at a sugar conference yesterday in Geneva.
There are 361 commodity funds that had $98 billion in assets as of Feb. 28, compared with 345 funds with $80 billion at the end of 2007, he said.
The rally, according to Paul Touradji of the $3.5 billion hedge fund Touradji Capital Management LP, was a ``buying orgy'' that had inflated prices and increased the risks of a collapse.
Commodities ``have all gone parabolically higher on frenzied money flow,'' New York-based Touradji wrote to clients March 10. ``Unless that money flow continues ad infinitum, in which case prices would go to infinity, then the fundamentals had better be improving as quickly as prices have been, otherwise there is nothing else to keep the markets at these levels.''
Good for Nothing
The UBS Maturity Commodity Index has slumped almost 12 percent from a record Feb. 29. The gauge dropped 3 percent as of 12:23 p.m. in London, the fourth drop in five sessions.
``A protracted slowdown is ultimately not good for commodities as people won't have enough money to buy anything,'' said Hong Kong-based Dick Poon, manager of the precious metals trading desk at Heraeus Ltd., a unit of processor Heraeus Holding GmbH in Germany.
Gold for immediate delivery dropped as much as 4.1 percent to $905.41 an ounce, the lowest since Feb. 19, and traded at $920.65 as of 12:53 p.m. in London. The metal's 8.3 percent drop this week would be the biggest since March 1983. The U.K. and U.S. are on holiday tomorrow.
Gold may slump to $840 by April, said Michael Lewis, Deutsche Bank AG's head of commodities research in London.
Oil soared to a record this year even as analysts forecast that consumption would increase less than in 2007. Crude oil for May delivery fell as much as $3.62, or 3.5 percent, to $98.92 a barrel on the New York Mercantile Exchange, and traded at $99.26 as of 12:18 p.m. in London.
U.S. prices are likely to fall toward $90 a barrel this spring as the country's slowing economy encourages traders to exit commodity markets, Goldman Sachs Group Inc. analysts including Jeffrey Currie wrote in a report today. Deutsche Bank's Lewis said prices will be $90 by next month.
Fundamental Focus
``The oil price slump along with all the other commodities resulted from the dollar staging a rally, so the large funds flowed out of the commodities complex,'' said Victor Shum, senior principal at consultants Purvin & Gertz Inc. in Singapore. ``Investors have found a trigger to focus more on fundamentals.''
Copper declined to its lowest in a month on the London Metal Exchange on concern the reduction in borrowing costs won't stop the U.S. from slipping into a recession. Corn and soybean futures in Chicago extended losses as the dollar's rally reduced the appeal of commodities as an alternative investment.
Cocoa futures for May delivery dropped $243, or 9.6 percent, to $2,290 a metric ton at 8:56 a.m. on ICE Futures U.S., the former New York Board of Trade.
U.S. Stocks Rally; Fannie Mae, GE Advance on Analyst Upgrades
By Eric Martin and Michael Patterson
March 20 (Bloomberg) -- U.S. stocks rose, extending the first weekly advance in a month, after an analyst said more mortgage purchases by Fannie Mae and Freddie Mac will help stabilize the home-loan market and Merrill Lynch & Co. advised clients to buy General Electric Co.
Fannie Mae and Freddie Mac, the biggest sources of money for U.S. mortgages, rose after Keefe, Bruyette & Woods upgraded the shares. General Electric Co. climbed after Merrill Lynch & Co. said the company's range of businesses will help it weather a U.S. recession. Exxon Mobil Corp. and Chevron Corp., the two biggest U.S. oil producers, fell as crude dropped below $100 a barrel.
The Standard & Poor's 500 Index added 13.18, or 1 percent, to 1,311.6 as of 10:35 a.m. in New York, pushed higher when the Federal Reserve Bank of Philadelphia said business activity fell less than forecast this month. The Dow Jones Industrial Average advanced 126.92, or 1.1 percent, to 12,226.92. The Nasdaq Composite Index rose 19.47, or 0.9 percent, to 2,229.43. About two stocks gained for every one that dropped on the New York Stock Exchange.
``It's reassuring news that the rest of the economy is holding itself together,'' said Jack Ablin, chief investment officer Harris Private Bank in Chicago, which oversees $64 billion. ``Investors can take comfort from that.''
The S&P 500 has increased 1.6 percent this week including its steepest one-day rally in five years, helped by speculation the Federal Reserve will revive the economy with interest rate cuts. Economists predict U.S. growth will slow to 0.1 percent this quarter before accelerating in the next two, according to the median estimate in a Bloomberg survey between March 3 and 10.
Asia, Europe Fall
Asian and European stocks fell, led by banks and commodity producers, after Credit Suisse Group said the freeze in credit markets may force it to post the first loss in five years.
Exchanges in North and South America will be closed tomorrow for Good Friday.
Fannie Mae gained $2.67 to $33.38. Freddie Mac added $2.57 to $32.47. Keefe, Bruyette & Woods analyst Frederick Cannon upgraded the shares to ``outperform'' from ``market perform.'' The government-sponsored enterprises had their surplus capital requirement cut to 20 percent from 30 percent by the Office of Federal Housing Enterprise Oversight yesterday, which may help pump $200 billion into the mortgage-backed securities market.
Other banks and brokerage firms also advanced after Punk Ziegel & Co. analyst Richard Bove wrote in a research note that ``the financial crisis is over'' and the declines in shares of banks created a ``once in a generation opportunity to buy bank stocks.''
Banks Advance
Citigroup Inc., the largest U.S. lender by assets, climbed 86 cents to $21.27. Bank of America Corp., the second-biggest, increased $1.11 to $39.67. Goldman Sachs Group Inc., the largest U.S. securities firm, rose $3.46 to $169.95.
Price swings and trading volume may be larger than average today because futures and options on indexes and stocks expire at the close of trading. So-called quadruple witching occurs once every three months.
The S&P 500 has declined 11 percent this year and is 16 percent below its record high of 1565.15, set Oct. 9. Its members trade at an average 13.6 times annual earnings, 48 percent below the average this decade.
``I really have to think that we're coming very close to a market bottom,'' Peter Sorrentino, who helps manage about $15 billion at Huntington Asset Management in Cincinnati, said in an interview on Bloomberg Radio. ``We've been developing a list of financial stocks.''
The Fed Bank of Philadelphia's general economic index rose to minus 17.4 from minus 24 in February, the bank said today. Readings less than zero signal contraction. Economists had forecast the index would rise to minus 19.0, according to the median of 53 estimates in a Bloomberg News survey.
A private report showed an index of leading U.S. economic indicators fell in February for a fifth straight month. The Conference Board's gauge, which points to the direction of the economy over the next three to six months, declined 0.3 percent after decreasing 0.4 percent in January, more than previously estimated.
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