A Word of Warning About Commodities
Commodities appear more attractive in rough times than in good times. But remember that booming commodities don't reflect their fundamentals alone.
I love movies. They’re American. Hollywood may be the most important influence this country has ever had and ever will have. I’m no left-winger, and I get just as irritated as anybody else when some actor shoots off his mouth about “climate change,” but the signature on what comes out of the Left Coast on celluloid is as red, white and blue as Sam Adams or Betsy Ross. Nobody else does it like the USA.
Having thus vented my spleen, I’ve never understood why Gordon Gekko’s “greed is good” speech takes top bill over “Larry the Liquidator’s” impassioned exhortation to stockholders near the end of Other People’s Money regarding the seductive nature of a rising share in a declining market. It’s simply brilliant:
This company is dead.
I didn't kill it. Don't blame me.
It was dead when I got here.
It's too late for prayers.
For even if the prayers were answered
and a miracle occurred...
...and the yen did this
and the dollar did that...
...and the infrastructure did the other thing,
we would still be dead.
You know why?
We're dead, alright.
We're just not broke.
And do you know the surest way
to go broke?
Keep getting an increasing share
of a shrinking market.
Down the tubes.
Slow but sure.
You know, at one time...
...there must have been dozens
of companies making buggy whips.
And I'll bet the last company around
was the one that made...
...the best goddamn buggy whip
you ever saw.
Now, in the case of commodities, we’re not necessarily talking about rising shares in declining markets. We also need to be specifically mindful of the distinctions between spot commodities, the companies that mine (or otherwise produce feedstocks and raw materials), manufacturers (for which the play would be stocks or bonds or derivatives), and the futures markets -- they all behave in related ways, but for unique sets of reasons, and they are anything but monolithic.
But here’s the seduction that can kill you, and it goes to the very core of what makes people in the middle of a bubble complacent enough to get wiped out when the bottom falls out. Commodities are commodities. Each in its own right, they’re essentially the same (yes, I am aware of grades and purities but I emphasize “each in its own right”), and that means distinctions and competition in the marketplace revolve mostly around price, which in turn revolve around supply, demand, etc.
But there are huge macro factors, too. In robust economies, there is little talk about commodities unless inflation becomes a problem, or unless a large exogenous event occurs (e.g., the Arab Oil Embargo, 1973). That’s because boom times tend to accompany stable currencies, low borrower default rates, adequate employment and income trends -- thus favoring equity/fixed-income investment and enterprise-oriented capital formation focused on creating value in new and creative ways (e.g., the technology sector). While commodities figure into evolving economic sophistication, and importantly so, they’re still commodities. Stability makes commodities sleepy.
Commodities earn far greater attention when the bloom is off and uncertainties are on the rise. That’s when the alarm bell rings and commodities wake up.
When central banks around the world are scrambling through the mechanisms of monetary inflation to keep the wheels on the wagon, stave off deflation, save the financial system and its subsegments deemed “too big to fail,” and prop up confidence about that which undergirds enterprise, then the whole perspective changes from prosperity to scarcity, from growing the pie to fighting over the slices.
We are in such a latter phase now but it’s easy to overlook, given the rising stock market. And the mood is very skeptical. Did we overpay on TARP, TALF, stimulus, and the rest? Most people think we did, especially when they look at the unemployment rate, weekly jobless data, and recollect on phrases such as “green shoots” and when those acorns were supposed to have become mighty oaks. So we can see the “economy of scarcity” part, and while we can also see the increased action in commodities, we’re still seeing what appears to be a pretty healthy situation for stocks (although bonds have sold off lately, despite Fed QE I and QE II, and we may well look back upon that in time to come as an important precursor signal).
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