At the old Chicago Mercantile Exchange, there was a butter contract that was so obscure and thinly traded that they used to make an announcement to gauge whether anyone would like to buy or sell the contract. I thought back on this recently when I read about the explosion of speculative interest in egg futures on the Dalian Futures Exchange. Eggs, Iron Ore, Rebar, and a myriad of other commercial commodities are the newest entrant in the Chinese world of leveraged gambling. We know that the authorities have cracked down on real estate speculation and a few other forms of levered carry, but it would appear that the excess capital sloshing around China (and elsewhere) has found its way into some very unexpected places. The problem with such unfounded speculation in this instance is that the prices determined by said gambling sets prices for a whole host of other ancillary commodities worldwide. One more unintended consequence of the Great Monetary Science Experiment, hereafter known as GMSE.
I just heard an analyst describe the current period for Tesla as being “catalyst light”. I have never heard this term before, but I assume it means that one can wait to buy the stock until such time as there is a newsworthy event to get speculators juices , and momentum, flowing. Another sign of the times I guess, but we have always preferred to position ourselves when price is a reflection of catalyst blight. In other words, we look for those opportunities where the price in the marketplace is indicative of a market that places a very low probability on any significant shift in the current environment.
A favorite comic of mine does a bit where he describes the New York Post (paraphrasing here) as” if someone read the news from a real paper and then tried to text it to you, accuracy is not important as long as it is short”. It occurred to me that this characterization could also be made about the current state of the capital markets where news bites drive prices. In addition to these snippets of” news”, add high-speed algorithmically driven trading, and a global central bank environment where no policy is discounted as too extreme. The result for investors is that we are increasingly vulnerable to a severe market dislocation.
This could have applied to almost all commodities at the beginning of the year, but none so more than the crude oil and associated markets. However, with a 50% price appreciation in Crude since the bottom in early January the question becomes: What has changed in the interim other than a precipitous decline in the dollar? We maintain that not much has fundamentally changed during this period for commodity markets. However, potential inflection points in markets are often accentuated by a mis-pricing of the current reality. That current “reality” we refer to is framed by the momentum driven consensus view that derives its underpinnings primarily from the most recent price action. In other words, as price shifts the new view of reality shifts and a new consensus is formed. The “real reality” however is much different, with price signals taking some time to work through the global marketplace: rigs must be laid down, capex budgets slashed, etc.. Market noise is deafening at present, look through the din and focus instead on the fundamentals which often are not accurately reflected in real time pricing.
The recent de-classification of information regarding Osama Bin Laden sheds some light on his investment philosophy. These documents showed Bin Laden firmly in charge of the directives regarding the allocation of a $5MM ransom. Bin Laden allegedly gave instructions to divert a large portion of those funds to gold. He reportedly commented on the historical price action of the yellow metal and its future appreciation potential. Clearly, he was interested in the portability of the metal, but he was most likely also intent on avoiding the problems associated with holding dollars.
Fast forward six years and one can only surmise that the rise in the gold price to date is not wholly unrelated to the negative rates that exist across a number of sovereign government bond curves. It is not our intention to equate the war on terror with the war on wealth, but the aforementioned negative rates are the direct equivalent of a CIA confiscation.
The lockstep moves in the price of crude oil and global equity markets brings to mind the old adage ” Don’t confuse correlation with causation”. But, in a world where algorithms drive markets, the fundamental underpinnings behind a specific correlation are completely irrelevant. In fact, as the Crude/Equity correlation has become more ingrained, we have been constantly bombarded with commentary on how weak crude oil prices may actually spur a global recession. However, in our estimation the weakness in global capital markets has less to do with the price of crude oil, and more to do with the sudden realization that Central Bankers have completely jumped the shark. However, much as Fonzies hokey shark episode marked the demise of a TV classic, the move towards negative interest rates by Japan and others is a clear demarcation between rational and irrational monetary policy.
The dramatic decline in the price of oil, along with the entire commodity complex, has led to increased chatter about the possibility of low prices extending out years to come. The phrase lower for longer has been bandied about, having previously been coined in reference to global central bank interest policy. It is important however to make a distinction between centrally administered prices (interest rates) and market driven prices. Putting the power of OPEC aside, one only need look at the crude oil market to see how market forces interact with price, leaving predictions about eternally low prices highly suspect. In free functioning markets, low prices ultimately cure low prices, the only question being, what defines “low”.