A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Monday, October 3, 2011

Transcript 461: Forecast Commodities

Long-time listeners will appreciate that our call for negative growth in the second half of 2011 was made in the first days of 2011, not at the end of Q3.

Now, just as last month the turning in the sky was from recovery to no recovery, it is now from recovery to recession. This was epitomized by Laksman Achutan of Economic Cycle Research Institute when he rushed to press in the last days of September to announce, yes, recession, either now or in the 4th quarter. But Demand Side listeners had the same information back when it would have made a difference to planning. That was a forecast. Saying it is happening now is not a forecast.
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And we can’t go very far without a comment on Europe. As the same January forecast made clear, and even into last year, we said – following Nouriel Roubini and others – that there was no option but default for Greece. We added that this was essentially a cost of the financial crisis and would not be a problem except that it exposed the banks. That is, policy makers would be willing for Greece to undergo whatever austerity they could impose, but asking the banks to take a hit on the other side of the contract for bonds? There would be hysteria. Now there is hysteria.

And we’re going to cut it there.

We are in 1932, 2008 was 1929. Now as then, we didn’t fix the problem but kicked the can down the road. Now we’ve run out of road. The kicking of the can has let us imagine we are going somewhere. But we needed to fix the road and the bridge, not comfort ourselves or our elites.

Long-time correspondent and frequent contributor to the Demand Side Economics dot net comments section, David Lazarus, commented again this week. Most of the time we don’t have much to say in response because we agree with him, and take more than a few notes on what he says. This time, however, he disagrees with us.

And as we look back to retrieve the comment, we see the blog ate it. For this we apologize to David. His comments are a very useful part of our blog. We have it up there now. I’m not following on how those disappear sometimes, but it is now there and it says, in part,
I think that there are serious problems with the definitions of investment as you portrayed them. An office building is often defined as an investment. The problem is that once the building is resold it is not an investment. It becomes a fixed cost for that next business. So if a building increases in value from $1 million to $10 million it is not an increase in total investment. That increase in value is inflation not investment. For a business that is starting out it is simply a tax on start ups. It is a capital gain for a business but not investment.

This is undoubtedly true, and I am sorry if I portrayed investment in a way that conflicts with this. In our simple two-good model, there are investment goods and consumption goods. Investment goods are those which require capital and which foresee a return over time to pay off the production of the good and add a profit. Once the good has been produced, it is an asset, as David goes on to discuss in the comment. Its value is bid up or down by the prospects for its return as an asset. It is a real asset, but often the claims on it go into the financial asset territory.

The thing about investment goods production is that they are what grows the productive capacity of the economy, and they are produced by workers not involved in the production of consumption goods. If all workers were involved in consumption goods production, there would be no inflation, in our simple model, because there would be no incomes that were not the result of consumption goods production. If some workers are involved in producing investment goods, there will be more incomes bidding for the same amount of consumption goods, thus inflation.

This could take off into a whole discussion, which we might have, but a point here is that Steve Keen has pointed out that the bidding up and down of asset prices is a playground for debt and Ponzi financing. We’ll leave it there.

And in doing this section, we apologize to Nathan Tankus, another frequent correspondent for having misfiled his contribution on Modern Monetary Theory. That was our bad, not bloggers. We’ll get that up soon.

In cleaning up the transition from DemandSideEconomics to DemandSideForecast dot nets, we’re going to change our mind. What we’re going to do is cast the Forecast site in more objective tones and make it a resource that can be mailed without the political tones. We see economics and politics as intimately entwined, particularly since policy can only be enacted through a political process and particularly because one political attitude has corrupted 90 percent of economics as it is practiced today. Market fundamentalism is a politically sponsored approach looking for any theoretical cover it can find. When supply side fails, it moves to rational expectations, monetarism, and down the line. Not by an experimental process to find out what works, but by a careful path to avoid the economics that does work, which is not particularly kind to the powerful or to entrenched interests.

So that should make it obvious. The Forecast section of the podcast will be scrubbed and set up on the Forecast dot net site. The full Monty will be as usual on the Economics dot net site.

That’s our plan. We take them seriously. Doesn’t mean you have to.

This week is forecast lite.


Demand Side is an economic forecaster, not a market predictor. In terms of investment advice, we don’t. The markets are a herd or behavioral field. They react to what they perceive the economy to be doing. That perception today is the perception of a herd of cattle in a lightning storm.

And today we are forecasting markets. We are not forecasting demand and supply for individual commodities based on global production. Because all that is washed out by the market dynamics. Commodities are trading in close correlation with other financial assets. Financial assets? Commodities are goods, right? Not when the traders need a profit. Your food and fuel is their bread and butter.

The market is being driven not by demand for the product, but by demand for financial returns. Speculation. There is immense liquidity sloshing around in the system. There is massive paper wealth looking for a place to be. Markets resist going down together. That money has to go somewhere. This is part of the dynamics of commodities. As the real economy failed over the past dozen years, that money has moved more and more into liquid financial assets and away from real productive assets. No investment in the private economy, particularly with the housing crash. As we noted a couple of weeks ago, there is a glut of productive capacity in any event, brought on by focus on the private consumer economy at the expense of the public goods economy.

In any event, this massive amount of capital needs a home. It can go into cash. But at its base cash is just a government bond with no interest on it. “Federal Reserve Note.” It has gone into stocks, bonds and commodities and derivatives of these. Commodities are perceived to be a liquid asset that will maintain its value. This is in spite of all evidence to the contrary.

The commodities bubble of 2011, which is now collapsing, was a core predictor of the new leg down in the economy. We used it in January, saying it would be the trigger. And so it has proven out. So far, 2011 is a repeat of 2008, only on a weaker economy, with far less appetite for the stimulus of 2008-09, and thus much more likelihood of serious further suffering. We didn’t fix the banks the first time. All the old troubles are still with us. We kicked the can down the road instead of fixing the bridge.

Shall we do copper?

Shall we do Gold?

Gold is interesting as a commodity, because it has no real industrial use. Other precious metals do. Gold is simply a bet. Some see it as inflation hedge. Some see it as a hedge against instability. But it is a bet that people will continue to buy gold. The new ETF’s for gold have undoubtedly raised the price by allowing purchase of gold without holding it in your house. If you have one, look closely, it may be a virtual fund which operates on the “value” of gold, rather than actually owning gold.

So recently when commodity prices went south, gold should have gone north. it didn’t. We have a very loose understanding, but it came a little tighter when someone revealed that traders take positions in gold as a liquid value that can be tapped to cover other positions. This is what we think happened to gold. As stocks and bond yields came down, investors covered their losses by liquidating gold. Much to the consternation of the world. Or at least to the financial speculators. We understand the buying of gold to hold in India and China dried up when the price went over $1,700. They may be coming back now.

What about oil?

Here is the poster child for all commodities. You can see the up-to-the minute action on the right side panel on the transcript. The bubble is bursting, hopping down now to under $79 a barrel West Texas and under $103 in the much more relevant Brent Crude.

Oil and commodities are bouncing around in complete correlation with the rest of the markets. A correlation incidentally that is closer than at any time since the maps of correlation became detailed.

Last week we did L.Randall Wray on the commodities nuclear winter approaching.

But speculation as the cause. Senator Bernie Sanders let the cat out of the bag in August by leaking data from the CFTC, Commodities Futures Trading Commission, which clearly shows that financial traders have positions in oil futures which dwarf those of any legitimate hedger. And as we showed last year, it is the futures market – not the spot market – where real oil prices are set. Apologies to Paul Krugman. Here is Sanders, making his point.

This is information that I think our friends on Wall Street did not want to come out. It is supposed to be top secret information. And in fact, many of the folks on Wall Street were very disturbed that we made it public.

The reason that we made it public is we wanted to end this debate about whether or not excessive oil speculation is driving up gas and oil prices.

The answer is, when you have companies like Goldman Sachs and Morgan Stanley owning and buying and selling hundreds of millions of barrels of oil, dominating the oil futures market, there is no more debate. Excessive speculation is one of the reasons the price of oil is where it is today.

We have got to do what Congress passed legislation to do, and that is mandate that the Commodities Futures Trading Commission end excessive speculation, and have limits on how much these companies can own.

So, that’s commodities.

We were ahead on the bubble, and our only glitch is the bunny hops down, which are visible in the charts but which have yet to be explained in any terms that make sense. Our view is again, a trading strategy designed to limit losses in the Big Houses. Big house? Don’t you wish that’s where they were.

We’re leaving a lot on the cutting room floor.

Next week we’ll get to the GDP and Net Real GDP and point out the obvious. The so-called recovery was borne on the back of the much-maligned government deficits. Without government deficit spending, the private economy would be generating growth right down there with house prices and unemployment rates. Without government deficits, the corporate earnings that floated Wall Street would be negative, even with the brutal downsizing they have undergone to keep their bonuses up on the top floor. Government deficits have saved this economy. Those who work on Wall Street or in corporate America and play holier than thou with regard to government spending don’t know what they are talking about, or are being cynically malicious.

1 comment:

  1. One of the problems with definitions of assets and investment is that the units of production can be very interchangeable. A construction worker can build a factory which is investment, even renovating and improving a factory can be investment. The problem is that the same workers can build houses which really become just goods. Even improving that property is just adding to it but still not investment because it does not increase the output potential of the economy.

    As for commodities I see falls for a while, until real world demand balances supply. Longer term those prices will be higher as world population grows and commodities become harder and harder to extract. Though this would be over multiple decades, and there will be many cycles in commodity prices before then. The EU suggestion of a Tobin tax on commodities might stabilise the markets somewhat as it might squeeze non specialised investors out if the market. For consumers and manufacturers who would be the end users this would add very little to the costs but might stop the violent swings in the market.