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Commodities Look Set to Rocket Higher

Wednesday, September 7, 2011, 11:38 AM

I've been asked to comment on the work of a few noted deflationists who are calling for a top in commodity prices here. Their argument is pretty clear cut: Because inflation is a function of available money plus credit (their definition), and because credit has fallen, deflation is what comes next. When looking about for things to deflate in price, commodities are an obvious candidate for attention because they have risen so much over the past decade.

In this view, three things have to be true:

  1. Demand for commodities has to fall below supply. After all, as long as demand exceeds supply, prices will typically rise.
  2. Money, including credit that would normally be used to buy commodities, has to shrink. That's the definition of deflation that we're analyzing here.
  3. People's preference for money has to be greater than their preference for 'things,' with commodities being very obvious 'things.' That is, faith in money has to be there or people will prefer to store their wealth elsewhere.

These are all just versions of the old supply/demand argument for commodity prices, except that our consideration also includes the important element of the Austrian economic view of demand for money.

There are several reasons why I think there are serious holes in each of these conditions. Enough to warrant a healthy degree of caution in one's certainty about what 'must' happen next to commodity prices. Full disclosure: I continue to have 75% of my total net worth locked up in gold and silver, so I am decidedly in the camp that does not believe the commodity surge has yet run its course.

A Technical Challenge

Before we tackle each of those three conditions from above, let's look at the chart for the Continuous Commodity Index (CCI) to see what it might be telling us.

First, let's examine the period after the great bust of 2008 (a liquidity-driven event) and note that commodities essentially rose during all of 2009 and then formed a classic 'bull flag' formation in early 2010.



It should be noted that calls of commodity "topping" were also made at this time by several prominent deflationists. However, a topping pattern and a bull flag are very different beasts. So I was quite content to keep my calls for more commodity price increases intact at this time, even though they spent six months trending lower in this consolidating pattern, because the chart looked quite bullish to me. 

And I was watching the near-daily Fed injections of thin-air money into the system, reading about surging Chinese demand, and tracking our negative interest rates at the same time -- all features that are supportive of higher commodity prices.

Note also in the above chart that the RSI on top was in neutral territory and rising (green line above) and that the momentum indicator (MACD) was also rising (green line below), both of which are typically bullish patterns. None of this was at all consistent with topping. It doesn't rule a top out, naturally, in trading and markets anything can happen, but these are not the usual signs one expects at a top.

Now let's expand the chart out and see what happened next:

First, we might observe a 43% run-up in commodity prices over the next eight months following the bull flag we just dissected. Note that it is almost uninterrupted during the period from July 2010 to April 2011.

Second, we might ask ourselves what sort of a pattern we currently have in the commodity index chart. Rather eerily, because one rarely sees such a perfect repeat of patterns, what we see is another almost identical bull flag complete with rising RSI and MACD readings.

On the basis of these technical readings, I would be extremely cautious in making a call for commodities to spike down from here. Instead the chart is pretty clearly calling for another run to the upside. Again, this might not happen, and commodities could always fall from here, but a bet made in that direction is fighting a pretty powerful chart.  

Now let's turn to the fundamental reasons that support the idea of a bullish commodities chart.

Condition #1: Supply Exceeds Demand

A key component of the deflation argument is that with credit shrinking, demand will drop, leaving excess market supply that resolves with lower commodity prices. Housing in much of the Western world, for example, fits this definition nicely. Too much was built while prices ran too high, and the bursting of that bubble is now resolving itself through lower prices.

Commodities have a long and storied history of boom/bust/boom, with supply and demand alternately racing past each other as the lag times for developing new supply assure too much at some point and too little at others.

What's new in this story today is the emergence of a couple of new economic powerhouses with billions of citizens as new participants at the resource table.

India is one of them, and the recent 'bad news' out of there was that the Indian economy only grew at 7.7% in the most recent quarter:

August 30, 2011

India's economy grew 7.7% in the three months from April to June, compared with the same period of 2010.

It was India's weakest growth for six quarters, but still better than had been expected.

The manufacturing sector grew 7.2%, an improvement from the previous quarter, but well below the 10.6% in the second quarter of 2010.

While the 7.2% growth in the manufacturing sector was downplayed in most articles in comparison to the prior 10.6% growth, it is useful to remember that a 7.2% rate of growth translates into a full doubling over just ten years' time. In other words, in ten years, India's manufacturing sector -- the one that consumes lots and lots of natural resources -- will be consuming twice as much of everything as it does now.

It is this massive rate of growth that is eating into the world's remaining resources and creating competition for most basic natural resources.

As big as India is, and as fast as its rate of economic expansion is, it is dwarfed by China on both counts:

SINGAPORE/BEIJING (Reuters) - UBS cut its 2011 and 2012 growth forecasts for China on Thursday to reflect weaker growth prospects in developed economies, saying the central bank may relax policy if the world's second-largest economy falters.

UBS now expects 2011 gross domestic product growth of 9 percent, down from its earlier projection of 9.3 percent. For 2012, it sees GDP growth of 8.3 percent, down from its previous forecast of 9 percent, it said in a report.

(Source

Again, while the emphasis in this article is on weakening growth, we should also be sure to note the absolute rate of growth here. 

Global slump? What global slump? China is slated to grow its already huge economy by 9% this year (2011). If that rate of growth were sustained, China would double its economy in just eight years. Twice as much of everything would be consumed in just eight years.

When you are talking about 1.3 billion people doubling their intake of economic goods and services in just eight years, you are talking about the fastest absolute increase in demand placed on natural resources ever seen in world history. Faster and faster and faster; more and more and more.

What sorts of news items might we expect to accompany such a proposition? Perhaps some like these:

China's corn demand mindblowing

August 17, 2011

China's struggle to meet the growing demands of its middle class is fueling a sudden surge in demand for corn, sending vast ripples across the U.S. farm belt and potentially upending the grain's trade flows around the world.

China's need for corn -- which forms the basis of sweeteners, starch and alcohol as well as feed for livestock -- was on stark display in July when the nation ordered 21 million bushels of U.S. corn in one hit, more than the U.S. government thought the country would buy in a year. 

Corn prices, which have nearly doubled over the past year, climbed another 1% Tuesday. 

BEIJING, Aug. 15 (UPI) -- China's dependence on imported oil grew to 55.2 percent in the first five months of this year up from 55 percent last year, reports state-run news agency Xinhua, citing figures from China's Ministry of Industry and Information Technology.

In 2009, however, China's dependence on imported oil rose to 33 percent.

(Source

China's Natural Gas Consumption Climbs 32 percent

Industrial Info Resources reports China's apparent natural consumption reached 11.1 billion cubic meters in July 2011, an increase of 32 percent from July 2010 and a 3 percent increase from June 2011, according to data issued by the General Customs Administration of China (GCAC).



As consumption increased, the import volume of natural gas also jumped from 15 percent to 25 percent over the same time period.

Securing uranium supplies still essential to China’s energy security

China has 14 operational nuclear reactors and according to the World Nuclear Association, 77 more reactors are either planned or under construction with aim toward increasing nuclear capacity to 80 GWe by 2020, 200 by 2030 and 400 GWe by 2050.

However, the nation’s domestic uranium resources don’t even come close to the amount needed to fuel such an expansion. To secure uranium reserves, China has been aggressively moving to sign supply contracts and joint venture mining agreements as well as to purchase uranium mines overseas.

By 2020, China is expected to account for 20 percent of global uranium demand, according to Resource Capital Research.

There are loads of similar articles covering China's aggressive expansion into Africa's resource plays, energy deals across the globe, and arable land where it is available. We're seeing exactly what you would expect from a major economy expanding like crazy:  a rapidly growing, or, shall we say, exponentially increasing hunger for natural resources.

Perhaps a slump in the Western economies will suddenly flood the world with enough resources to cause a commodity crash, but perhaps not.

A Paradigm Shift

The supply-and-demand argument rests on the time-tested notion that with increased demand, new supplies are brought to market. This has more or less always been true, although astronomical prices will not get you a passenger pigeon and rising prices seem unable to drag more giant Bluefin Tuna from the seas. The point there is that the usual supply and demand argument falls apart in the presence of limits.

Jeremy Grantham, who previewed my book last fall and provided a blurb for its jacket cover, has been all over the news lately talking about a profound structural shift in natural resources:

Grantham concludes that the world has undergone a permanent "paradigm shift" in which the number of people on planet Earth has finally and permanently outstripped the planet's ability to support us.

Specifically, Grantham says, the phenomenon of ever-more humans using a finite supply of natural resources cannot continue forever--and the prices of metals, hydrocarbons (oil), and food are now beginning to reflect that.

In other words, Grantham says, it is different this time.

Grantham believes that the trend of the last 100 years, in which the prices of almost all major commodities have steadily declined, is permanently over. And from here on in, humans will be competing more--and paying more--for ever-scarcer resources.

From a societal standpoint, the news is far worse. Grantham believes that the planet can only sustainably support about 1.5 billion humans, versus the 7 billion on Earth right now (heading to 10-12 billion). For all of history except the last 200 years, the human population has been controlled via the limits of the food supply. Grantham thinks that, eventually, the same force will come into play again.



(Source)

Instead of oil being in a spiked-top formation ready to fall back to its prior range of $20-$30 a barrel, Grantham argues that oil has shifted to a new price level. I have argued the same thing, not by using price charts, but through the fundamental analysis of oil supply in the context of Peak Oil coupled with an understanding of the marginal cost of producing a new barrel.

If it costs $70 - $80 to produce a new barrel of oil, the price cannot fall much below that for very long. 

So on the first deflationist point that supply of commodities will soon greatly exceed demand, I have to conclude that until and unless we see China's and India's economies fall off a cliff, the impact of bringing an additional 2.5 billion consumers to the global buffet of natural resources will provide ample pressure to prevent a sustained crash in prices. Perhaps we'll experience a short-term correction, especially if the Fed is stingy with its still-unannounced QE III program, but a long-term crash seems highly unlikely.

Condition #2: Money Plus Credit Shrinks

The second key deflationist assumption is that the supply of money plus credit will decrease. Central to this argument is the idea that it's insufficient to track the money supply alone and that it's essential to include the expansion (and/or contraction) of credit as well. This makes sense on the surface, because credit allows people to buy things and buying can translate into price pressures. More credit means more buying pressure; less equals the opposite.

But I have a number of difficulties with this view over the long-term. (Hey, credit has to be paid back at some point, right? So it's roughly neutral over the long haul.) This explanation is especially problematic for me when it is used in an overly broad way by lumping all credit market debt into a single spot and then saying, "There. Look. It's fallen. Credit is down, and that's deflationary."

The trouble I have with this view is that not all credit has the same impact on demand. Some credit leads to demand that directly impacts the CPI (inflation), and some does not. When we are talking about inflation, what most people care about is the price of things they use or consume (cars, food, gasoline, health care, houses, etc.), rather than financial instruments or paper assets (stocks, bonds, derivatives, etc.)

Let's put it this way: If you give someone a billion in dollars in credit, it matters significantly whether they go out and buy ten thousand silos of corn or one twentieth of the next ten-year Treasury bond auction. In the latter case, nothing much happens to everyone else's inflationary experience, but in the former case, the price of corn goes up.  A lot.

In other words, credit extended within and among the financial community mainly flows within and among the paper assets of the world, while non-financial credit goes to consumers, businesses, and governments that use the credit to buy real things. 

[Note: One aspect of financial credit takes us to the world of shadow banking, where financial institutions and purely financially oriented participants buy and trade financial instruments generally just within and among themselves, often with tremendous leverage.]

Whether credit-default swaps (CDS), traded within and among the shadowy world of purely financially motivated entities, are trending up or down in price has almost zero impact on the price of molybdenum or corn. Therefore it is important for us to separate credit into its financial and non-financial components. 

On this basis, if we look at total credit market debt broken out into its two main components (financial and non-financial), we see that instead of credit falling in general, it has fallen only in the financial world, but has climbed by an amount almost exactly offsetting it in the non-financial sectors:

Yes, financial-sector debt has fallen by $3 trillion, and that is a drag on total credit market debt, but as explained above, we wouldn't expect this to have much of an impact on inflation for anything other than paper assets. Non-financial debt, on the other hand...

...has rather steadily climbed uninterrupted before, during, and after the Great Recession. Credit market debt within the physically consumptive portion of the economy has climbed by nearly $3 trillion, almost perfectly offsetting the non-financial decline. But the offset is just an interesting observation that really tells us nothing about the inflationary or deflationary effect of credit expansion/contraction on the things that are tracked in the CPI.

So on the basis of credit alone, I find the deflationary argument to be weak. There's been $3 trillion of new credit created in the consumptive portion of the economy since the start of the financial crisis in 2008, and it's almost entirely thanks to government borrowing. Not too shabby.

Money, Money, Money

Turning to money itself, the deflationary argument becomes a lot more difficult to sustain. Money is measured by the Federal Reserve in various ways that are called the "M's." M1 is the narrowest version, representing cash in and out of the banking system and demand accounts (savings and checking) at the bank. Just look at M1 lately:



The increase in M1 since the start of the financial crisis (red box) is the same as the entire accumulated supply of money that existed in 1992 (green box). That is, as much M1 money has been created in the past three years as was created from the founding of this country through 1992.

It's really hard to square up that data with a deflationary argument. I have to assume that at least part of the reason for the big increase in M1 is people like you and me taking cash out of the bank, necessitating the printing and distribution of more cash.  

M2 represents a slightly broader definition of money:

M2 includes a broader set of financial assets held principally by households. M2 consists of M1 plus: (1) savings deposits (which include money market deposit accounts, or MMDAs); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds (MMMFs).

(Source)

A chart of M2 reveals a steadily increasing rate of money creation that has been especially intense over the past few months:



There is absolutely nothing deflationary in the M2 chart. It is exactly what we would expect to see from a culture that placed a man at the monetary helm on the basis of his promise (Jackson Hole, 2002) to run the printing presses if deflation came knocking.

Because M2 includes time deposits, which are generally locked up (in CDs and such) and therefore not immediately available for use, and it excludes institutional money funds (that might be used to buy things), it might not be the best indicator of money that can trot out of an account and create inflationary pressures.

For a better measure, I prefer MZM, or money of zero maturity, which includes institutional money funds and excludes time deposits. Here's a chart of MZM:



Yes, there was a little wobble downwards in MZM right after the end of the last recession, but over the past two years (red dotted lines), we note that a trillion dollars in new MZM has entered circulation (blue dotted lines). Again we might note that it took all of US history until 1982 to create the first trillion of MZM money stock, but only two years for the most recent trillion.

But what about people's preference for money? In Part II: Why Commodities Are the New Safe Haven, we delve into the big changes afoot there, as well, which will assuredly influence the future direction of commodity prices. For those looking to preserve the purchasing power of their wealth, it's important to understand the growing momentum in the global mindshift away from paper assets towards more tangible stores of value.

Click here to access Part II of this article (free executive summary; enrollment required for full access).

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46 Comments

KugsCheese's picture
KugsCheese
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Debt and Inflation

Nationaldebt just tweeted "NationalDebt: $14,694,862,366,160.97 (+) #nationaldebt" so the US is over the new debt limit again.  Did anyone notice this?

Also, did anyone read the ISM Non-Manufacturing Report for August?   Prices increased 7%!  Clearly commodity inflation is spilling over to the supply channel now in the product pipe.  Services are 90% of GDP but no news on this!

pslater's picture
pslater
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Great Article - But

Chris, as usual a job well done.  I would offer that the massive increases in the various 'M's' is the result of the Central Bankers of the world trying to stave off deflation.  As such, we are confronted with the half of the problem you articulated in your article - rising commodity prices.  This is a logical byproduct of the desire to own 'things' rather than currencies.  Unfortunately, the other side of the coin points solidly toward deflation for which, IMHO, the following is the end all;  we are in a balance sheet recession which will shortly turn into a depression.

Simply put, the asset side of the national balance sheet has been decimated while the liabilities have not been reduced meaningfully.  This has resulted in real estate prices collapsing while, oddly, the mortgages that funded this real estate still sit on the ledgers of the banking system at par.  Put another way, the amount of income that can be generated by the remaining level of assets is no longer able to support the liabilities.  This will remain the case until the liabilites are reduced to match the current level of the assets.  However, if/when this happens, the global banking system will be proven insolvent.  Therefore, TPTB will do EVERYTHING and ANYTHING in their power to insure this doesn't happen

As evidence of the deflation argument, I offer the continued decline in real estate prices and the fact that the 10 year Treasury bond traded at a yield of well below 2.0% most of yesterday.  This happened just more than 60 days AFTER the end of the Fed's open market operations designed to LOWER interest rates.  Since the end of QE2 on June 30, 2011, the price on TLT (the iShares 20+ yr. Treasury ETF) has risen from about $93 to $112 today while the yield has fallen from around 3.5% to under 2%.

I would argue that the environment we are is is solidly deflationary overlaid with the specter of currency and/or sovreign defaults which is pushing commodity prices higher.  Like you, I expect commodity prices to continue rising as alternatives to currencies and for the demand issues you identified.

JAG's picture
JAG
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Dr.M, What happened to "The

Dr.M,

What happened to "The Coming Rout" that you were warning about all summer?

Have you really switched gears again so quickly?

plato1965's picture
plato1965
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   An absolute stunner..

An absolute stunner.. think it should be reserved for the subscribers only for at least 3 months .. 

The separation of credit money and "physical" t=0 money... crucial.. and the analysis of how that impacts the commodity space...

and *within* the commodities...   *cough*

Separates the inflation/deflation boys from the men.. !  

Arthur Robey's picture
Arthur Robey
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Thank you for your analysis

Thank you for your analysis and insights, Dr. Martenson.

It would seem that my models need major surgery.

I thought that the thin air money was ending up in the financial sector and just spinning it's wheels. Meanwhile, back at the Ranch, the markets were being starved of cash and this caused the  increases in instability and price.

However, this graph shows a decrease in financial debt, destroying the model completely.

And this graph shows a (spectacular) amount of money going feral.

So my new model is that the money is being handed out at the ATM's.

How about this? The financial sector is deleveraging and dumping this toxic asset (the dollar) onto Joe Bag-of-donuts.

But hang on there. The top graph shows the Debt carried by the financial sector. Perhaps they are syphoning off some of the flow of dollars to deleverage and then passing the rest off to the public. Perhaps we should consider what ratio is being kept in the financial sector.

Perhaps not. It is all too esoteric.

What should Joe do? I think Joe should be sly and pass the counterfeit notes on to his friends for real goods. (While keeping a dollar tucked into his shoe.)

Arthur Robey's picture
Arthur Robey
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Nacent economist.

Looking at the two graphs again I see that the financial sector debt is 14 trillion and the M1 money supply is about 2.1 trillion. About seven times the size. I guess that the greater part of the printed money is being held back by the financial institutes.

What does that mean? That the prime function of the FED money machine is to monetize the pretend assets on the financial institutions, (Failed mortgages).

OMG! I am begining to sound like an economist. I must stop before it is too late.

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geminijackson3
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ChrisMartenson.... You know

ChrisMartenson....

You know what you are?  I will tell you what you are.  You are the [expletive deleted] man!!!! 

Finally... someone explains the DIFFERENCE between financial credit and non-financial credit to solve the mystery between increasing commodity prices in the context of deflationary credit (nobody I've asked has ever been able to explain this, because they themselves had no idea). This missing piece is finally solved for me... phew!
Damnthematrix's picture
Damnthematrix
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need to keep finger on the pulse...!

KugsCheese wrote:

Nationaldebt just tweeted "NationalDebt: $14,694,862,366,160.97 (+) #nationaldebt" so the US is over the new debt limit again.  Did anyone notice this?

I posted about this in Daily Digest 8/3.........

Deja Vu All Over Again: Total US Debt Passes Debt Ceiling... In Under One Month Since Extension Tyler Durden 09/02/2011   Remember when one month ago the US, to much pomp and circumstance, not to mention one downgrade,  announced a grand bargain raising the debt ceiling from $14.294 trillion to something much higher, with a stop gap intermediate ceiling of $14.694 trillion, or $400 billion more.   Well, as of today, or less than a month since the expansion, total US debt is at $14.697 trillion.   Yep - the total debt is again over the ceiling, which means the US debt increased by $400 billion in one month. Score one for fiscal prudence. And while the total debt subject to the limit is still slightly less, at $14.652, one week of Treasury auctions and will be time for Moody's to justify again why the US is a quadruple A credit.   http://fms.treas.gov/dts/index.html

SagerXX's picture
SagerXX
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Arthur Robey wrote: OMG! I

Arthur Robey wrote:

OMG! I am begining to sound like an economist. I must stop before it is too late.

I think Big Pharma has a pill for that. {wry grin}

Thanks for this breakdown Dr. Chris. Helping me once again to better understand the sitch. Viva -- Sager

wroth5's picture
wroth5
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What to buy?

Stocks of commodity companies?

joemanc's picture
joemanc
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Outstanding

Hi Chris,

This was an outstanding report. Although one word I did not see you use is Stagflation. Because to me, we have a stagnant economy with rising prices.

As an example of price inflation, the other day, I poked around to see what the local heating oil prices were, and it occurred to me that if these prices were to hold through the winter, then this will be the costliest year ever for those of us heating with oil.

hucklejohn's picture
hucklejohn
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Gold

I have been comparing the performance of gold with everything else over the last three years.  I discovered something which to me was extraordinary:  Over the last three years gold has outperformed every stock, every bond fund, every mutual fund, & every index I can think of -- except for silver.  (No doubt I missed many comparisons.)  I give a special mention to gold vs. commodities ($CCI):  For 2009 & 2010 gold & $CCI performed similarly.  However, so far in 2011 in gold has outperformed $CCI.   All currencies are being debased.  I see precious metals as the only refuge for preserving purchasing power given the continual debasing of all currencies around the world.      

KugsCheese's picture
KugsCheese
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Arthur Robey wrote: Looking

Arthur Robey wrote:

Looking at the two graphs again I see that the financial sector debt is 14 trillion and the M1 money supply is about 2.1 trillion. About seven times the size. I guess that the greater part of the printed money is being held back by the financial institutes.

What does that mean? That the prime function of the FED money machine is to monetize the pretend assets on the financial institutions, (Failed mortgages).

OMG! I am begining to sound like an economist. I must stop before it is too late.

John Williams showed recently that the spike in M1 and M2 is due to entities moving out of M3.   He stated that this is sign of forthcoming credit freeze ala 2008, ie moving into more moveable money.

Johnny Oxygen's picture
Johnny Oxygen
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Thank You

Really great analysis Chris.

Thanks so much.

isildur22's picture
isildur22
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Re: What to buy?

I have followed Jeremy Grantham and his company, GMO, and am thinking of investing in the fund it manages under Wells Fargo.  He seems like one of the few wealth managers who worries about peak everything and cares about the environment. If you'd rather have some money working for something instead of parked in gold, you might do the same.  He's also an ethical gentleman in a business sector with too few of them.  Here's a good NYT piece on him:

http://www.nytimes.com/2011/08/14/magazine/can-jeremy-grantham-profit-fr...

There are also a couple of audio presentations in podcast form on iTunes, just him talking about his investment strategy and fielding questions. Search for his name in the podcast directory.

Zach - Kunming, China

JAG's picture
JAG
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M3 and Paper Derivitives

Dr. M,

What about M3, as calculated by Shadowstats.com

Here are Mr. Williams' thoughts on M3:

While M3 is not the perfect money measure, it is the broadest and best practical measure that currently is available, although no longer from the Federal Reserve.

...and I explain my preference — indeed the necessity — for using the broadest money measure available as an indicator of future inflation. While money supply measures M2 and M3 have a fairly strong correlation, the broader M3 provides the most comprehensive picture of what is happening to money in the system.

Link

Why didn't you include the broadest measure of money supply in your argument? Perhaps it lacks the visual punch that your charts provide, but at first glance it does seem to correlate well with price inflation over the last decade. 

And what about this statement from you:

In other words, credit extended within and among the financial community mainly flows within and among the paper assets of the world, while non-financial credit goes to consumers, businesses, and governments that use the credit to buy real things.

...

Whether credit-default swaps (CDS), traded within and among the shadowy world of purely financially motivated entities, are trending up or down in price has almost zero impact on the price of molybdenum or corn.

Are you really claiming that investment banks have no influence on consumer prices? That the paper derivitive markets have no effect on the pricing of real things? 

I mean, compare the price action of the food commodities that are traded in the paper market to those that are not, and you will see that financial community is very much a player in rising prices. And the housing bubble is a great example of how the derivitive markets influence the price of real things.

The whole inflation/deflation debate is really akin to the fable of the blindmen and the elephant. Everyone's experience and interpretation of the market (the elephant) is accurate, yet incomplete. In an attempt to explain what we perceive is occuring (or will occur) in the market, we create elaborate rationalizations, when the truth is much simpler: everything that happens in the market is driven by the pursiut of profit, Period.

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leweke1
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Reduce Inflation Impact of Financial Dithering?

JAG...I see what you are saying about derivative markets having some impact on real goods costs, but I speculate that perhaps only in relatively few areas (and relatively limited dollar quantities) do they really create money velocity friction in the consumer markets as compared to increasing dollars of direct spending. 

zabolots's picture
zabolots
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I disagree with your credit analysis

You state: "Whether credit-default swaps (CDS), traded within and among the shadowy world of purely financially motivated entities, are trending up or down in price has almost zero impact on the price of molybdenum or corn. Therefore it is important for us to separate credit into its financial and non-financial components."

It has been documented in the past that financial players are using credit to play in the commodities markets. There is also hoarding going on with sovereigns:

http://www.mlive.com/business/detroit/index.ssf/2011/07/report_goldman_s...

http://247wallst.com/2009/01/22/ships-as-floati/

http://online.wsj.com/article/SB1000142405274870436610457625486055558873...

You also state that non-financial credit has not fallen. If I recall coorectly, the only consumer credit that has expanded has  been student loans (which can't be expunged in bankruptcy, how nice) and possibly auto loans (which have become the new subprime credit driver).

It all boils down to whether or not the Fed ultimately prints enough to offset all the bad debt that can't be paid. Political pressure is already causing them to hold off on QE3 in my opinion. While there are currently no legal restrictions that would prevent them from doing so, I believe that ultimately their power will be taken away from them and they won't be able to keep up with the flood of defaulting debt.

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Zabolots

As a new posting member... welcome.  I think you make some good points regarding credit... surely it can have some effect on commodities through speculative channels.. the question is how significant? 

When you speak of the FED, saying, "While there are currently no legal restrictions that would prevent them from doing so, I believe that ultimately their power will be taken away from them and they won't be able to keep up with the flood of defaulting debt."

What do you mean by this?  How do you imagine the FED's power will be taken from them before the system crashes and burns in some kind of inflationary criticality?  I don't get it.  Ron Paul 2012? 

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Inflation and Money

As Friedman showed

M \cdot V = P \cdot Q, where M is money supply, V is money velocity, P is Price Level, and Q is the Real Value of Final Expenditures

so we see that the price level P = (M x V) / Q therefore P is a function of both M and V.  V is of most interest right now because a lot of the increase in M has went to slow V as money is locked up in Commodities and such which throttled inflation somewhat due to less money chasing real products.   But commodity inflation is causing input costs to rise now as evidenced by CORE CPI increasing towards 3%.  One has to conclude that Q is then decreasing.  Yes, we are becoming poorer because we make less REAL STUFF.   But if commodity prices collapse, where will that money go?   We could see V unleashed which would cause good old money chasing product inflation.  Comments?

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V is the stealth killer...

V will increase.... and it will be hailed/spun initially as evidence of recovery.  This will cause the sheeple to even farther down the rathole of denial, led by the mass media.  But this velocity will not be about recovery.. it will be driven by a loss of confidence in the dollar.  In this way, people who know little of what is really happening under the covers in our economy will be able to reassure helplessly paranoid doomers like me and you that all is well... didn't you know that retail sales have been increasing sharply of late?

By the way, speaking of fuel for inflation,  Doug Casey mentioned the foreign held dollars, same as Chris, in his subscription email today;

The End of the Dollar Standard

"Central banks won't be the only players. The millions of people around the world who use the dollar as their second currency will join in. And for most of them, "the dollar" doesn't mean Treasury bills, it means $20 bills, $50 bills, and $100 bills. The collapse in the foreign-exchange value of the dollar sparked by foreign central banks unloading their excess holdings will undermine everyone's confidence in the dollar's usefulness as a store of value. Private foreign investors will flee the dollar, further reducing its foreign-exchange value. And most of that privately held cash will flow back to the US as more fuel for price inflation. The dollar standard will be dead.

The consequences will be of historic proportions."

Of the many ponzi rabbit holes you can go down.. I find this idea of dollars held abroad (called, confusingly, Eurodollars) particularly intriguing, and little talked about, since the Fed decided it best for us back in 2006 to stop wasting so much money measuring it's growth.... yeah, sure;

http://inflationdata.com/inflation/inflation_articles/m3_money_supply.asp 

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Commodities Rising

Chicken layer pellets are a commodity I guess, now $14/50 lb bag around here compared to $12 last year.  I should have bought ahead last year and saved 14%!

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Some Thoughts

Woodman wrote:

Chicken layer pellets are a commodity I guess, now $14/50 lb bag around here compared to $12 last year.  I should have bought ahead last year and saved 14%!

I wonder:

How long do the pellets store for? Does buying in bulk and storing for a couple of years or three in cool, dry place make sense?

What did people feed layer hens back in the old days? Or did they make do with fewer eggs?

Do people feed egg shells back to chickens?

Poet

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http://www.cnbc.com/id/444528

http://www.cnbc.com/id/44452871

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inflation

Woodman wrote:

Chicken layer pellets are a commodity I guess, now $14/50 lb bag around here compared to $12 last year.  I should have bought ahead last year and saved 14%!

This year I'm selling my 1lb jars of honey for $10.  In 2009 it was $8.  I'm sold out.  :-)  ... dons

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Inflation at the grocery

Last year we were buying 5 pound bags of unbleached flour for $1.25.  Over the winter I watched with alarm as the price went up with each passing month.  Earlier this summer, the price for the same thing was $2.22, a 78% increase over less than a year.

To ameliorate the increase, we switched to buying 25 pound bags at $8.88 a few weeks ago.  To my shock, yesterday that same 25 pound bag was marked $11.88.  A 34% increase.

I know the Fed doesn't consider inflation in food prices a big deal, but I think they're ignoring it at their peril.

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chicken feed

Free range them as much as possible,  they'll eat less.  Add fodder from your own yard.  Cuttings from other plants thrown into their run helps too.  Storing feed is hard.  It seems to come with bugs that get a hold on if you store it.  We found these containers that are water and air proof pretty much and the food does better stored in them than in the paper bags it comes in.  But, we have not had luck stporing food more than 6 months wihtout it becoming buggy and often moldy.

As for shells,  yes we refeed shells but only after they have been mashed up in other foods past the point of recognizbility.  If you don't you'll teach your hens that shells are and contain food and they'll soon start eating eggs, an utter disaster if it gets hold of your flock!  I am currently battling it and we've gone from a dozen eggs a day to 4!  Because some one is eating them.

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honey

since my bees took off I just bought honey and yes it was $10 .  

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Full Moon wrote:  since my

Full Moon wrote:

since my bees took off I just bought honey and yes it was $10 .  

Sorry your bees left.  Try again.  It's fun and educational.  ... dons

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Out of interest, Chris,

Out of interest, Chris, could you name these "noted deflationists" and provide links to where they are calling for a top in commodity prices? Also, are these noted deflationists happy with the conditions that you've chosen to define and knock down? It seems that, for completeness and fairness, you should do this as a minimum.

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food commodities

Good tips land on feeding chickens; I do free range my chickens and with all garden leftovers this time of year their processed feed consumption is way down.  I suppose the government factors in that kind of substitution though to calculate official inflation as much lower than it really is.  

After reading the link in Chris's report about China's growing corn demand I'm glad I spent those late nights blanching and freezing up so much of what I grew; my freezer is full of enough for all winter. 

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Love your apiarist!

I love my local bee guy.  2 gallons of fresh local "premium" bee spit- $60 delivered.  Paradise indeed....Aloha, Steve.

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Credit:

I believe one of the assumptions to reconsider has to do with credit. The article implies debt has to be paid back (credit -> debt ->money) and is therefore neutral and thus does not, over the long haul, effect money. Debt does not have to be paid back. There are many remedies to debt and pay back is only one. Default like is happening in Greece is one. Foreclosure of an 'underwater ' home is another. Bankruptcy of credit cards and other personal debt is another. Just running away (moving out of town) from debt is another if the person cannot be found and forced to pay. Death is yet another. IMHO at the present time considering the housing market and the second loan market, there will be a great deal of debt that will not be paid back. And thus the money and credit side of equation side goes down. This of course does not mean that the affordability of commodities will go down. To the rich, "Who Cares?" they can afford what they need. To the masses, they will not be able to afford things because they have used up all their available credit and their income is less. Even in hyperinflation (money with low value), wages are always behind prices so we see commodity inflation and affordability depression.

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How and where to buy?

Thanks for the great info. I have already bought gold and silver, but... how do you buy other commodities like oil, corn, sugar, wheat , cotton etc.  Is there an ETF you can buy that will track the price?  I am not interested in buying stocks of companies since I don't know if they will be there tomorrow or in a year from now.  And I am not interested in futures.  How do we buy commodities that are liquid like a gold or silver ETF that will simply track the price and you can buy and  then sell it when you wish?  Does anyone know please??

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Eric Sprott interview

Eric Sprott interview.
 

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Essential #4, The other way to reduce credit...

Chris, I think you probably have a better handle on the recent financial gyrations than I do, and I'm glad to see you accepting Grantham's general idea, but you seem to miss it's real significance.   It's both a paradigm shift for physical and financial expectations AND a paradigm shift for the design of our economic model itself.    My evidence of it is the 10 year commodity price trend, that to me leaps out dramatically, like a "smoking gun".  

Commodities, as a group, have been inflating at nominally 20%/yr since 2001, when inflation for other things was quite low or nonexistent.  That means... *something makes resources different* from everything else.

I have an article in the recent New European Economy on that, focusing on why a global resource system would display parallel elevated exponential increases in prices, for the whole spectrum of basic food and fuel resources at once.   It's what you'd expect for a supply system responding to increasing demand, which was once able to relieve stress on one resource by exchanging another.  

The whole system would become relatively rigid and unresponsive to increasing demand, with each sector unable to find surplus capacity at once.   At that point the whole system acts as if “freezing up” as a growth economy, in effect, corners the world resource supply capacity.  With nowhere to go, resource allocation needs to be done by shedding excess demand by raising the price.  

Other people haven't caught on quite yet, but it would says we are at the natural point of overinvesting in the earth that Keynes discussed in Chapter 16 of The General Theory, and that the remarkably clear implications for altering the theory of investment strategies now apply.    I'm pretty sure there's nothing to explain such a highly uncharacteristic and yet worldwide orderly phenomenon, other than as the natural effect of a diverse integrated growth economy reaching "peak everything", for its central resource exchange network as a whole.

If you combine Grantham's quite similar finding and mine, the picture becomes one of the world resource markets doing their normal work of scrambling to find new sources of affordable supply, but not finding enough to meet demand.  As a result the only relief valve becomes, as Keynes said, to bleed excess credit by divesting investment funds.     A decisive moment for Investing in Sustainability 

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Many choices....

joanne wrote:

Thanks for the great info. I have already bought gold and silver, but... how do you buy other commodities like oil, corn, sugar, wheat , cotton etc.  Is there an ETF you can buy that will track the price?  I am not interested in buying stocks of companies since I don't know if they will be there tomorrow or in a year from now.  And I am not interested in futures.  How do we buy commodities that are liquid like a gold or silver ETF that will simply track the price and you can buy and  then sell it when you wish?  Does anyone know please??

joanne -

Just about any on line brokerage will allow you to trade commodity ETFs.  Shop around for the best commission rate and call and ask any questions you may have.

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Momentum of money

Chris:

I have noted the  comments in the blog above.  A very astute audience.

As a retired manager of  people and things and training as a Chemical Engineer and a business manager,  I have spent many years on the study of markets and economy.  My  observation is that the  liquidity created by Ben has little or no momentum.  The banks take it as cheap money(sometimes at  zero cost-o/w at a small paid kicker) and proceed to try to find ways to loan it out.  In fact, most of it  resides in balance sheet repose as a liability against required collateral that is worth  a (major) fraction less than the real dollars given to them by old Ben. 

If they lend it out they make money, nice money on the spread.  If they let it lie in inventory it represents real improvement in the real liquidity needed to improve their real liability ratios.  And people wonder why there in no growth in the economy  with all that liquidity when the real issue is confidence and trust. I read how most well managed businesses are sitting on prettty sunstantial cash inventories; they  seem to be waiting for signs that the futjure is right for their business risks. 

How can this scenario not  promote deflation?  Your argument, admittedtly on this point only,  seems to me to be weak. 

Comment please.

Chuck

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lynford wrote:  I

lynford wrote:

I believe one of the assumptions to reconsider has to do with credit. The article implies debt has to be paid back (credit -> debt ->money) and is therefore neutral and thus does not, over the long haul, effect money. Debt does not have to be paid back. There are many remedies to debt and pay back is only one. Default like is happening in Greece is one. Foreclosure of an 'underwater ' home is another. Bankruptcy of credit cards and other personal debt is another. Just running away (moving out of town) from debt is another if the person cannot be found and forced to pay. Death is yet another. IMHO at the present time considering the housing market and the second loan market, there will be a great deal of debt that will not be paid back. And thus the money and credit side of equation side goes down. This of course does not mean that the affordability of commodities will go down. To the rich, "Who Cares?" they can afford what they need. To the masses, they will not be able to afford things because they have used up all their available credit and their income is less. Even in hyperinflation (money with low value), wages are always behind prices so we see commodity inflation and affordability depression.

Welcome Lynford.

I think the economic debacle continues because we are not allowing enough defaults to occur.  We're pretending entities like Greece or overextended homeowners can pay back their debt even thought they are not, and propping them up artificially instead of allowing defaults or foreclosures.  The artificial intervention has side effects like commodity inflation.  Perhaps we need to accept the pain then the economy can rebuild.  Tom

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thatchmo wrote: I love my

thatchmo wrote:

I love my local bee guy.  2 gallons of fresh local "premium" bee spit- $60 delivered.  Paradise indeed....Aloha, Steve.

by my rough estimate that would be about 24lbs of honey ... at my prices this year it would have been $240 ... sounds like your local guy is giving you a bargain!   hugs ... dons

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honey

dps wrote:

thatchmo wrote:

I love my local bee guy.  2 gallons of fresh local "premium" bee spit- $60 delivered.  Paradise indeed....Aloha, Steve.

by my rough estimate that would be about 24lbs of honey ... at my prices this year it would have been $240 ... sounds like your local guy is giving you a bargain!   hugs ... dons

We just got 25 lb of honey for $40.  That sounded like a good deal, but I wasn't  sure how to translate that into gallons.  Sounds like we got a screaming deal.  There are benefits from being tapped into the LDS community.

Doug

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bees must work cheap....

You're right Don- 24 lbs.  My bee guy has raised his prices $2 per gallon in the last year...And Doug- yeah, the LDS folks are a great resource for prep food items and they have that great on-line prep manual- which I can't find the link for right now.....Aloha, Steve.

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Interesting video on thi

Interesting video on this link.

http://www.cnbc.com/id/44515615

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"inflation" now and on into when?

all is clear -- u will die if u side with inflation now for the coming few years.

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Stoneleigh Responds

She has a few things to say about Chris's argument here:

http://theautomaticearth.blogspot.com/2011/10/october-3-2011-commodities-and.html

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