Why No Commodity Inflation?  The Government Changed the Laws

By Victor Sperandeo with the Curmudgeon




One has to wonder why commodities have been depressed for such a long time, especially in light of all the “free money” the Fed created through its multiple QE rounds and “operation twist.”  Victor provides an answer in his comments below.

Commodity Cut Back at Goldman:

In a sign of the times, the WSJ reported (on line subscription required) this week that Goldman Sachs is planning to scale back its commodities-trading division, once a huge moneymaker and training ground for a generation of executives including former CEO Lloyd Blankfein. “The retreat follows a month’s long review under new CEO David Solomon that showed the commodities business’s dwindling profits don’t justify its costs, according to people familiar with the matter. Executives are discussing pulling back from trading iron ore, platinum and other metals, and are ordering cost cuts to the sprawling logistics network that handles the transport and storage of physical commodities,” according to the Journal article.

Just two weeks prior, Goldman's global head of Commodities Research - Jeff Currie told CNBC:

"We're bullish on commodities….One, because you don't have the rising (interest) rates anymore and in fact, they've come off and they're on pause. Two, the dollar is really strong and likely to weaken from here as opposed to strengthen like it did last year." A weaker dollar makes oil (and other commodities) more attractive as commodities are priced in U.S. dollars.

Global Growth Deteriorates:

Meanwhile, global growth is rapidly decelerating which is very bearish for commodities (and corporate profits).  Last week, the European Commission lowered its estimate of 2019 GDP growth for the euro zone by nearly a third, to 1.3% from 1.9%. Italy is already in recession, while German growth is faltering as its export-dependent economy is being hampered by a slowing China, which in turn is a result of increased trade frictions and its domestic deceleration. Australia’s central bank lowered its outlook for growth, while India’s central bank cut interest rates in a surprise move.

Barron’s reported in its February 11th print edition that last week, nearly $9 trillion of global debt securities had negative yields, according to Bloomberg data charted by Deutsche Bank. The yield on the 10-year German Bund, the European benchmark, sank below nine basis points, or 0.09%, from over 50 basis points last October. The 10-year Japanese government bond yield sank a couple of basis points below zero.  “Such yields indicate an extreme desire by investors to stash their cash in havens (it helps that global government bond markets have greater capacity than mattresses) amid increased signs of (economic) deceleration abroad.”

It’s certainly astonishing to this old timer that negative yields can compete with gold and silver as a store of value.  Yet both those precious metals are well below their 2011 highs.

Victor’s Comments:

The Dodd-Frank bill was passed in 2010, but unlike the typical way laws are passed, the details of the law had not been completed or understood at that time.  It would take over 18 months before the interpretation of the regulations began to have a little clarity, following a long period of industry input to the CFTC.  Senator Carl Levin (D, Michigan) was prominent in his suggestions to the CFTC that “excessive speculation in the commodity markets” should be curbed, in theory to promote “fairer prices.”  In his letter, which was one of other 5,000 the CFTC received, Sen. Levin demanded more position limits in all commodities, including oil. 

“Until this proposed rule is adopted, and effective position limits are put in place, the American economy will continue to be vulnerable to excessive speculation and the violent price swings it can cause,” Mr. Levin wrote.

The CFTC also eventually curbed buying in commodities by changing the swap rules for pension plans.

Although generally not recognized, QE2 was primarily responsible for curbing commodity investment (and thereby keeping prices and interest in commodities very low).  Former Fed Chairman Ben Bernanke’s QE2 resulted in the Fed buying $600 billion in Treasury and Mortgage-Backed securities. That drove interest rates down which in turn boosted equities, gold and commodities. 

From August 2010 through April 2011 the S&P 500 Index rallied more than 29% and the NDX moved up nearly 35%.  In the same period, Gold rallied over 25%, our Commodity Trends Indicator® ETN went up over 40%, and The Consumer Price Index increased to a 4.67% compounded annual rate.  Despite the Federal Reserve keeping the Fed Funds rate at zero, yields on U.S. Government Notes and Bonds increased.  These higher yields affected home and auto loans and threatened to put a halt to the already slow economic recovery.

The legislative reduction in commodity investment was then coupled with the policy of paying banks interest on their free reserves.  This gave banks an incentive not to loan out their reserves, which curbed the money supply and greatly decreased the multiplier effect.  We wrote about this in our last Curmudgeon post, saying: “We claim this is a circular loop of deception whereby the banks make free money, but the economy doesn’t benefit much, if at all.”

Combined with the expiration of the Bush tax cuts, this allowed QE3 to take place with a much less noticeable effect on inflation.  The Fed had found their “magic formula” to keep rates and inflation low at the same time.

Lastly, the Obama administration proceeded to promote their policies of globalism under the banner of “Free Trade” which encouraged consumption (through purchases at credit card interest rates), moved manufacturing jobs overseas to keep prices low, and exacerbated the stagnation of middle-class wages.  The low-cost debt service for corporations and rallying stock prices multiplied the “wealth effect,” leaving the ratio between equity prices and commodity prices at historic levels (see chart below).



In my opinion, U.S. government corruption has nullified free markets and led to huge distortions in the price of most financial and hard assets.  The quotes below may help you better understand what I refer to as “legal crony corruption.”

End Quotes:                                                                                                                          

 “As long as government has the power to regulate business, business will control government by funding the candidate that legislates in their favor. A free-market thwarts lobbying by taking the power that corporations seek away from government! The only sure way to prevent the rich from buying unfair government influence is to stop allowing government to use physical force against peaceful people. Whenever government is allowed to favor one group over another, the rich will always win, since they can "buy" more favors, overtly or covertly, than the poor.”  Mary J. Ruwart, author of Healing Our World.

A confirmation by “The Maestro,” who initiated the Fed PUT to keep stock owners fat, dumb and happy:                                                                                                                                          

 ”Crony capitalism is essentially a condition in which... public officials are giving favors to people in the private sector in payment of political favors,“ Alan Greenspan, former Fed Chairman.

Good luck and till next time…………………………………………………..   

The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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