ON WITH THE SHOW....(A LITTLE READ FIRST)
http://www.financialsense.com/stormwatch/geo/pastanalysis/2010/0514.html
A Word to the Wise
by J. R. Nyquist
Weekly Column Published: 5.14.2010
Last December I received a curious email from a friend in South Africa who wrote, "Some kind of psychological war is raging, causing paranoia and hysteria in your country." Accustomed to the tricks of the Russian-backed Communists within South Africa's ruling ANC Party, my friend added, "Some days I ask myself if Russians want to successfully start a Right Wing rebellion in the USA. In other words, Left supports Right against the liberals while at the same time Left plays the liberals too. In other words, supporting both sides so that strife becomes a reality." This remark, though outlandish to most readers, cries out for elaboration. But first we should consider the overall economic crisis which serves as fuel to this very fire.
We have reached yet another phase in the global financial crisis. There has been unrest in Greece, and Europe is greatly troubled. More bad news for America is inevitable, as well. There is a strong impulse to blame somebody for what is happening: to blame big business, to blame America, to blame capitalist greed or socialist subversion. It is important to realize that most of our problems, throughout the world, are due to an inborn human propensity to self-destructive behavior, corruption and dishonesty. Theologians have long referred to man's "fallen nature." We see this fallen nature most obviously in common criminals, but also in those who have perpetrated the financial frauds of our time. With our lust for consumption and our growing tendency toward unethical acquisitions, we have done great damage to ourselves, day by day, and predictably so. But there is something more, as well.
Clever people, called Marxists, have long talked about a coming "crisis of capitalism," predicating their revolutionary ideology on the inevitable crash of markets, the resulting bankruptcy of nations, and subsequent political unrest. Did anyone notice how the hammer and sickle appeared by the Acropolis in Greece last week, along with a banner that reads: "PEOPLES OF EUROPE RISE UP"? This is something that deserves our attention. At the same time, however, the revolutionaries who want to overthrow capitalism and replace it with socialism are not the cause of the crisis. Since 1917, the Communist movement has represented a measure of our overall corruption, and makes a fair contribution to the same. It is no wonder that Communist intelligence services have made alliances with organized crime groups, narcotics traffickers or corrupt financiers. The destructive side of human nature now demands a reversal of our fortunes, taking advantage of our own wickedness, by its very nature and its self-chosen path to power.
As Vilfredo Pareto pointed out in his masterwork, The Mind and Society, wealth does not increase at a steady 4 percent rate throughout history. Economic growth only applies to those periods when society is healthy, not to those periods when society becomes sick. There are not only periods of wealth creation in history, says Pareto, "History is replete with descriptions of numberless causes for the destruction of wealth. Some of them bear upon total wealth: wars, revolutions, epidemics, plunderings and burnings, wastage of all sorts. Others bear upon the distribution of wealth and prevent protracted accumulations in ... given communities, not without indirect reactions upon total wealth; and such are individual attacks upon private property ... and transfers of wealth resulting from force or from prodigalities."
Prodigality is a good word, and readily applies to America as well as Europe. But returning to the theme of my opening paragraph, the coming word is even more negative and regressive; and that word is "paranoia." Considering the political divide that separates those who want a revolution, and those who advocate capitalist principles, the future is far from bright. Both parties are focused on the acquisition of political power, increasingly worried that the other side's policy will bring about general impoverishment. While the capitalist system has proven to be a good system in the past, it now proves to be a fragile system insofar as society itself has become less ordered, less honest, and more corrupt. Anyone who has studied crime statistics gathered over the last sixty years will see that something akin to a breakdown has occurred. This breakdown is in our dutifulness, our honesty, our integrity. And so, with this breakdown far advanced, we naturally demonize others -- forgetting that the peace is fragile, and trust is fragile. The system can break entirely.
Our manners and kindness have already declined to an alarming extent. But even more alarming, our judgment has declined. Yes, the capitalists have made terrible mistakes. Bankers and financiers have figured out ways to steal enormous quantities of money. Welfare frauds, shirkers and common thieves daily exploit the system as well. Whether you have socialism or capitalism, common decency will be your only salvation. The difference between the two systems, and my own preference for capitalism, has more to do with putting too much unchecked power into the hands of government officials. A financial Ponzi scheme can make you poor, but a socialist dictatorship is -- as George Orwell described it -- "a boot stomping on a human face forever."
The experience of loss tends to generate its own system of accountability, although our present system appears utterly without accountability. As troubles increase, the corrective will become more and more irresistible. It will also become increasingly unpleasant. The more we deny responsibility, the more we want to blame somebody else, the more paranoid we become, and the closer to civil war. As our emotions are increasingly engaged, we will tend to accuse others even as they accuse us. The danger to liberty and to our national unity becomes great. Enemies abroad would take advantage of our disunity. A propaganda which blames the world's problems on America already energizes an envious multitude toward new totalitarian horizons.
There is danger from the Right as well as danger from the Left. How do we realistically navigate between this Scylla and Charybdis? We must remember three things: first is the Golden Rule, which calls us to justice; second is to recognize the frailty of all human reason when subjected to passions; and third, is adherence to constitutional government and the non-violent resolution of disputes. Regarding this last point: once our system of peacefully resolving domestic differences is broken, the loss of money and the crash of markets will be the least of our worries.
Copyright © 2010 Jeffrey R. Nyquist
Global Analysis Archive
AZG.V...REVERSAL OR REHEARSAL ? ONE OF THE THREE TOP SCANS PF THE NIGHT HERE FOLKS. THE SCANNER IS TELLING US THAT ITS READY TO BREAK UPSIDE ANYTIME. SO THE PIG SAYS THIS COULD BE AN OPPORTUNITY IF LIQUIDITY PERSISTS AND INCREASES. A WATCH LIST PRIORITY !
GCR.V...HOW THE MIGHTY HAVE FALLEN. LOOKS LIKE A NEW MOVE PENDING FOR THIS OLD PIG FAVORITE. A PERENNIAL TRADING MONEY MAKER. THIS CHOICE CHOP HAS EXCELLENT PROPERTIES, MANAGEMENT AND EVEN SOME MONEY. A LONG TERMER BUT A LIKABLE ONE. THE PIG SAYS TUCK SOME AWAY. FOR A RAINY DAY.
AAA.V....POTASH OR BUST....A PIG LONG TERM FAVORITE HAD NEWS TODAY THAT WAS A BIT LUKE WARMLY RECEIVED BY THE MARKET. NEVERTHELESS, THE POWERS WITH EYES ON THE PRIZE ARE WATCHING (AND ACCUMULATING) INTENTLY. THE PIG SAYS THE SMART MONEY IS WAITING FOR BUYOUT/JV ANNOUNCEMENT TO COME. PATIENCE IS A VIRTUE AND A "P" WORD. COME TO THINK OF IT SO IS POTASH..............
THE PIGS "RUMOURS DU JOUR"......
THE PIG DOES NOT HAVE MUCH OF A KNOWLEDGE BASE FOR OTC STOCKS THEREFORE AVOIDS THEM. THATS NOT TO SAY THERE ARE NOT TRADING OPPORTUNIIES WITH THEM. IN THE LAST FEW DAYS SOME SUGGESTIONS FROM THE PIGS READERS FOR A COUPLE OF OTC SYMBOLS THAT ARE "READY TO BUST". LOTS OF RUMOURS OF DEALS ETC PENDING ON THEM BOTH. DO YOUR OWN DD AS ALWAYS...........BUT THEY COULD BE GOOD GAINERS.....AND THANKS FOR THE TIPS ! KEEP THEM COMING....
GLER
QASP
THE PIGS WEBSITE OF THE WEEK......
Absolute Return Partners Trashes Commodity ETFs and Warns of Bubble
MineFund.com
Published 5/7/2010
ST. LOUIS (MineFund.com) -- Absolute Return’s Niels Jensen took a billy club to commodities generally and exchange traded commodities (ETCs) specifically in the firm’s May newsletter.
Entitled “The Commodities Con”, the Jensen authored letter launched a strong attack on the run up in commodities that has pushed many metals toward or through their 2008 peaks. He cites three specific risks to commodities in the near term:
* Financial demand is growing much faster than industrial demand;
* The Chinese have aggressively stockpiled over the past 12-15 months;
* Most investors do not understand the complex nature of commodity investments.
It is hardly a novel thesis, but it reflects the bearish consensus against commodities. What was unique was the extent of the assault on ETCs.
Jensen is quite right that financial investors (code for speculators) have pumped up commodity prices. But it’s largely a function of the vast oceans of loose credit and free money that has been pumped into financial markets, and the condition of the US economy. There is a remarkably strong relationship (93%) between US inflation and US unemployment, and broad commodity indices. They are not buying commodities for the intrinsic value, but for their reciprocation.
Jensen goes on to say that as a result of the growth in ETCs, commodities have become financial rather than “real” assets.
Jensen wants commodities to be yeoman assets - priced by the sweat of the miner’s brow and the savings of the industrious Shenzhen housewife.
Commodities have not become financial assets, but have instead reverted to their traditional role as quintessential “hard assets” in the face of determined efforts by several governments to melt if not dissolve traditional financial assets.
Jensen accuses investors of not knowing they have become the market. That’s ridiculous.
Like any asset, investors know that there is no divine providence underwriting commodities. And it is similarly ridiculous to suggest that “real” commodity prices can only be formed in one-to-one supply and demand relationships; which is Jensen’s inference.
It’s a very poor understanding of the enormous commodity value chain which has “financial” considerations spliced into every segment of every market. By Jensen’s purist definition, “real commodity prices” shouldn’t carry any financial overheads either - no debt, no insurance, no hedging; nothing ‘artificial’ please.
Perhaps he would also like to chastise buyers of platinum jewellery as less worthy than buyers of platinum catalysts? Vanity assets vs real assets?
Just because an investor bids up a commodity price in the course of avoiding taking physical delivery doesn’t render that portion of the price or trend any less valid. Where is it written that commodities cannot be used as a liquid asset, substituting for conventional cash if necessary?
Jensen is also guilty of conflating OTC commodity derivatives with ETCs. The former have a very different function since they are largely linked with “wholesale” activity whereas ETCs are more suited to the retail and conventional institutional (hedge funds, investment banks) side of the market.
To say that prices are “distorted” by hard asset seeking investors is preposterous. And yet he does it with an especially bad example: “because commodity markets are tiny compared to the size of financial markets, prices are easily distorted. In this respect, it is worth paying particular attention to the behaviour of the largest nation on earth – China. The bull market in commodities is intimately linked to the growth story of China; hence commodity investors are well advised to listen to the signs of policy change emanating from the political leadership in China.”
That results in a full-blown contradiction. Chinese infrastructure spending is being slashed. Ergo lead, zinc, copper and nickel are going to get walloped. Hold on, but isn’t infrastructure “real”? At least you can say a resulting price tumble would be “real”.
Jensen does a covering maneuver by pointing out that China stockpiled commodities at a ferocious pace last year (see chart). It’s certainly not news, and the market has been desperately calling a catastrophic end to Chinese stockpiling for more than a year! The better explanation is one that RBC pointed out a year ago: “China is stockpiling commodities such as copper and iron ore as part of a reallocation of its sovereign wealth amid concern that the value of its dollar assets may decline”.
Not only did stockpiling provide diversification, but the Chinese knew a bargain when it stared them in the face. What better opportunism than to buy raw materials essential to sustained long-term growth at multi-year lows? However, in Jensen’s world, Chinese contributions to commodity pricing should apparently be discounted if not disqualified.
To be fair, Jensen does acknowledge this hard asset strategy as well as a geopolitical one. However, that doesn’t negate his earlier claim that commodities are afflicted by a “financial” malady. And he reinforces it with a chart showing a 72% correlation between the CRB Commodity Index and Shanghai stock index - since 2006! Talk about cherry picking your period to make a point!
We can agree that the risk for commodities being overpriced right now is high, but that doesn’t invalidate the reasons for arriving at this point. Where’s the con?
Well, as it turns out, Jensen is accusing ETCs of conning investors. He highlights the underperformance of the United States Oil Fund (USO) relative to WTI crude.
The ETF has underperformed the benchmark WTI spot price – against which it is pegged – by a whopping 68% since January 2009! Investors have been conned into believing that if they invest in USO, they effectively buy the WTI oil price. In reality they buy an ETF which is so far off the mark that it is almost criminal. And USO is by no means the only ETF which has consistently underperformed, although it is probably one of the worst of its kind. Nobody cared to explain to hopeful investors about a subtlety called contango.
It’s an excellent point, although we have to note that Jensen admits to investing in commodity derivatives - and rolling them! Gasp! Such ‘financial’ activity...
His warning is necessary and useful:
[With a persistent contango] Not only do you suffer from a negative roll yield every time the market is in contango but, as a passive investor, you are a sitting duck for more active investors keen to take you out. It is simply too easy for professional traders to jump in front of these large passively managed funds every time they need to roll their positions. Many ETPs have clearly defined – and publicly stated – trading patterns which are only too easy to take advantage of.
Obviously, the theoretical solution to the problem is to invest in the spot market rather than the futures market; however, this is not easily accomplished in most commodity markets. If you buy spot, you need to be prepared to store the physical commodity. This is relatively easy when it comes to non-perishable commodities such as metals but industrial metals would require storage space beyond what most investors have access to. Therefore, typically, only precious metals are traded spot, whereas most other commodities are bought in the futures markets.
Many ETF sponsors are aware of the problem and have taken various initiatives to address it, for example by making trading patterns more opaque by spreading out the rollover trades. However, based on the performance of many commodity ETFs, such initiatives have only been partly successful (please note: this is not a problem for ETFs operating in spot markets such as stock index linked ETFs).
The problem does not affect the leading precious metals ETCs which are priced at spot rather than in futures. Jensen warns investors in some gold ETCs to be sure there is physical product behind the fund.
Jensen’s solutions for indirect commodity investors:
* Invest only in commodities when they are in backwardation (not recommended as it may keep you out of the market for long periods of time);
* Treat ETPs as short term trading instruments, not long-term holdings, which will eliminate much of the problem associated with contango (may be an appropriate strategy for some investors although it has its limitations); or
* Invest through active managers who can handle this highly complex problem on your behalf.
ST. LOUIS (MineFund.com) -- Absolute Return’s Niels Jensen took a billy club to commodities generally and exchange traded commodities (ETCs) specifically in the firm’s May newsletter.
Entitled “The Commodities Con”, the Jensen authored letter launched a strong attack on the run up in commodities that has pushed many metals toward or through their 2008 peaks. He cites three specific risks to commodities in the near term:
* Financial demand is growing much faster than industrial demand;
* The Chinese have aggressively stockpiled over the past 12-15 months;
* Most investors do not understand the complex nature of commodity investments.
It is hardly a novel thesis, but it reflects the bearish consensus against commodities. What was unique was the extent of the assault on ETCs.
Jensen is quite right that financial investors (code for speculators) have pumped up commodity prices. But it’s largely a function of the vast oceans of loose credit and free money that has been pumped into financial markets, and the condition of the US economy. There is a remarkably strong relationship (93%) between US inflation and US unemployment, and broad commodity indices. They are not buying commodities for the intrinsic value, but for their reciprocation.
Jensen goes on to say that as a result of the growth in ETCs, commodities have become financial rather than “real” assets.
Jensen wants commodities to be yeoman assets - priced by the sweat of the miner’s brow and the savings of the industrious Shenzhen housewife.
Commodities have not become financial assets, but have instead reverted to their traditional role as quintessential “hard assets” in the face of determined efforts by several governments to melt if not dissolve traditional financial assets.
Jensen accuses investors of not knowing they have become the market. That’s ridiculous.
Like any asset, investors know that there is no divine providence underwriting commodities. And it is similarly ridiculous to suggest that “real” commodity prices can only be formed in one-to-one supply and demand relationships; which is Jensen’s inference.
It’s a very poor understanding of the enormous commodity value chain which has “financial” considerations spliced into every segment of every market. By Jensen’s purist definition, “real commodity prices” shouldn’t carry any financial overheads either - no debt, no insurance, no hedging; nothing ‘artificial’ please.
Perhaps he would also like to chastise buyers of platinum jewellery as less worthy than buyers of platinum catalysts? Vanity assets vs real assets?
Just because an investor bids up a commodity price in the course of avoiding taking physical delivery doesn’t render that portion of the price or trend any less valid. Where is it written that commodities cannot be used as a liquid asset, substituting for conventional cash if necessary?
Jensen is also guilty of conflating OTC commodity derivatives with ETCs. The former have a very different function since they are largely linked with “wholesale” activity whereas ETCs are more suited to the retail and conventional institutional (hedge funds, investment banks) side of the market.
To say that prices are “distorted” by hard asset seeking investors is preposterous. And yet he does it with an especially bad example: “because commodity markets are tiny compared to the size of financial markets, prices are easily distorted. In this respect, it is worth paying particular attention to the behaviour of the largest nation on earth – China. The bull market in commodities is intimately linked to the growth story of China; hence commodity investors are well advised to listen to the signs of policy change emanating from the political leadership in China.”
That results in a full-blown contradiction. Chinese infrastructure spending is being slashed. Ergo lead, zinc, copper and nickel are going to get walloped. Hold on, but isn’t infrastructure “real”? At least you can say a resulting price tumble would be “real”.
Jensen does a covering maneuver by pointing out that China stockpiled commodities at a ferocious pace last year (see chart). It’s certainly not news, and the market has been desperately calling a catastrophic end to Chinese stockpiling for more than a year! The better explanation is one that RBC pointed out a year ago: “China is stockpiling commodities such as copper and iron ore as part of a reallocation of its sovereign wealth amid concern that the value of its dollar assets may decline”.
Not only did stockpiling provide diversification, but the Chinese knew a bargain when it stared them in the face. What better opportunism than to buy raw materials essential to sustained long-term growth at multi-year lows? However, in Jensen’s world, Chinese contributions to commodity pricing should apparently be discounted if not disqualified.
To be fair, Jensen does acknowledge this hard asset strategy as well as a geopolitical one. However, that doesn’t negate his earlier claim that commodities are afflicted by a “financial” malady. And he reinforces it with a chart showing a 72% correlation between the CRB Commodity Index and Shanghai stock index - since 2006! Talk about cherry picking your period to make a point!
We can agree that the risk for commodities being overpriced right now is high, but that doesn’t invalidate the reasons for arriving at this point. Where’s the con?
Well, as it turns out, Jensen is accusing ETCs of conning investors. He highlights the underperformance of the United States Oil Fund (USO) relative to WTI crude.
The ETF has underperformed the benchmark WTI spot price – against which it is pegged – by a whopping 68% since January 2009! Investors have been conned into believing that if they invest in USO, they effectively buy the WTI oil price. In reality they buy an ETF which is so far off the mark that it is almost criminal. And USO is by no means the only ETF which has consistently underperformed, although it is probably one of the worst of its kind. Nobody cared to explain to hopeful investors about a subtlety called contango.
It’s an excellent point, although we have to note that Jensen admits to investing in commodity derivatives - and rolling them! Gasp! Such ‘financial’ activity...
His warning is necessary and useful:
[With a persistent contango] Not only do you suffer from a negative roll yield every time the market is in contango but, as a passive investor, you are a sitting duck for more active investors keen to take you out. It is simply too easy for professional traders to jump in front of these large passively managed funds every time they need to roll their positions. Many ETPs have clearly defined – and publicly stated – trading patterns which are only too easy to take advantage of.
Obviously, the theoretical solution to the problem is to invest in the spot market rather than the futures market; however, this is not easily accomplished in most commodity markets. If you buy spot, you need to be prepared to store the physical commodity. This is relatively easy when it comes to non-perishable commodities such as metals but industrial metals would require storage space beyond what most investors have access to. Therefore, typically, only precious metals are traded spot, whereas most other commodities are bought in the futures markets.
Many ETF sponsors are aware of the problem and have taken various initiatives to address it, for example by making trading patterns more opaque by spreading out the rollover trades. However, based on the performance of many commodity ETFs, such initiatives have only been partly successful (please note: this is not a problem for ETFs operating in spot markets such as stock index linked ETFs).
The problem does not affect the leading precious metals ETCs which are priced at spot rather than in futures. Jensen warns investors in some gold ETCs to be sure there is physical product behind the fund.
Jensen’s solutions for indirect commodity investors:
* Invest only in commodities when they are in backwardation (not recommended as it may keep you out of the market for long periods of time);
* Treat ETPs as short term trading instruments, not long-term holdings, which will eliminate much of the problem associated with contango (may be an appropriate strategy for some investors although it has its limitations); or
* Invest through active managers who can handle this highly complex problem on your behalf.
© 2009-2010, MineFund.com
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