Commodity prices could crash for this reason

Jun 17, 2009

In this issue:
» 'Buy American', and now 'Buy China'
» Obama warns Wall Street
» Recession not to end so soon, warn Roubini and Shilling
» The best investment of our time
» ...and more!

Oil price: Will the rally continue?
Data Source: CNNfn
Oil on the New York Mercantile Exchange breached US$ 71 a barrel last week and currently hovers around that very level. This is a seven month high for the commodity, which is up almost 100% since its lows of mid-February 2009. This sharp surge in oil prices have been helped by an improvement in risk appetite around the world, weak dollar, you would have imagined, China buying.

So, is this rally for real considering that the underlying consumption for oil has not risen much during this period?

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We believe this rally in oil prices (like the blind surge in stock prices) stands on shaky ground. Our view is so because the rise has been driven a lot by just the 'hope' of a global recovery and stockpiling, more than anything else. You see, with the dollar getting weak against major currencies, and the US already having problems of a burgeoning deficit, it is getting difficult for China to continue to park its incremental forex reserves in US bonds.

So what do the Chinese do with this extra cash? Buy commodities...of any kind, including oil. And this is exactly what they have been doing all this while.

As international reports suggest, most of the Chinese purchases of commodities in recent weeks have gone towards creating stockpiles rather than to satisfy current demand. This means that once the stockpiling is done, the huge Chinese buying is unlikely to continue, and that in turn would mean that commodity prices may be unable to sustain their recent advance.

There is no denying the fact that we remain bullish on commodities for the long term given the demand that is likely to come from the rising population of India and China and their aspiration for better quality of lives. Also, given that oil prices have an inverse relationship with the US dollar*, a depreciating dollar in the future would provide the leg-up to oil prices to rise.

But we see the current rally as irrational.

* Because oil is priced in dollars, when the value of the dollar falls it makes oil cheaper in other currencies - simultaneously boosting consumption outside the US and motivating non-US producers to raise prices to make up for the purchasing power they've lost in the currency conversion.

China does not seem to be aware of the adage - 'practice what you preach'. Just a few months back, the country had strongly opposed the 'Buy American' policy proposed by the US as a clause in its bailout package. But now China is the one looking to implement the 'Buy China' policy as its economy battles to overcome the dampening effects of the global financial crisis. Obviously such a move will not go down well with its trading partners as it has all the makings of protectionism.

In an edict released jointly by nine government departments, China has said that government procurement must use only Chinese products or services unless they were not available within the country or could not be bought on reasonable commercial or legal terms. China's exports industry is already under severe duress and there is heavy dependence on the domestic industry now to pull the country out of the slump.

While the economy has started showing some signs of a recovery fuelled by the stimulus packages, unemployment and fears of layoffs still persist. In resorting to protectionism, China may alleviate its problems in the medium term, but in the long term such a move will only tarnish its image in global trade.

In a recent speech, Obama chided Wall Street for criticizing the US government's policies to stem the recessionary tide. He said, "Wall Street seems to maybe have a shorter memory about how close we were to the abyss than I would have expected."

Now, while Obama maintains a grim view on the unemployment scenario (which he feels will touch the 10% mark on the back of losses in the financial sector), he still maintains that the engines of the US economy have started to turn. And as his team work towards stricter financial sector regulations so as to avert future crises, Obama has a view - "Derivatives are a huge potential risk to the system. We are going to make sure that they have to register, that they are regulated, that you have clearinghouses."

After nearly three decades of de-regulation, a wide spectrum of financial services in the US would once again be brought under strict legislations. These would not just control the unregulated bodies but also make the executives responsible for their decisions. For example, it is expected that Obama will propose the establishment of a new watchdog agency that would aim to protect consumers from deceptive or dangerous mortgages, credit cards and other financial products.

The broader purpose is to craft a framework of financial regulations influenced by the lessons learnt from the current crisis. A welcome move indeed!

But while Obama may say that the engines of the US economy have started to turn, two eminent economists, Nouriel Roubini and Gary Shilling continue to remain negative on the US economy despite all the talk of 'green shoots' and an early revival.

Roubini is of a view that the US economy will not recover until the end of this year, and even then growth will remain meek and vulnerable to higher interest rates and commodity prices. "In addition to green shoots there are also yellow weeds," said Roubini, pointing out to the growing divergence between business sentiment surveys, which have been improving in recent months, and industrial production in the US, which is down sharply and receded another 1.1% in May.

Leading American financial analyst and commentator, Gary Shilling too has similar views, expressing that it is normal to have at least one up quarter in real GDP in the midst of recession, and having a bear market rally accompanying it. Thus according to him, the odds are that this is just a short up move in the middle of a recession and that recession will probably last another year. His reasons for the same include the huge pile up of housing inventory in the US, consumers who are on a saving spree and are consequently spending much less, and a whole gamut of financial problems that are yet to be solved.

"Buy land, they're not making it anymore," goes the famous saying by the American author and humorist, Mark Twain. Based on this simple reasoning, ace investors George Soros and Jim Rogers are betting big on agricultural land for the long-term. "I'm convinced that farmland is going to be one of the best investments of our time," says Rogers.

Based on the fundamentals of scarcity, these investing gurus feel that in the long run, the strain on arable land is expected to be huge. The world population is expected to rise by around 50%, from the current 6 bn levels to about 9 bn over the next forty odd years. Another rationale is the fact that the decline in the price of grains has not brought down the cost of the land that was used to grow it.

The benchmark BSE-Sensex ended the day lower by almost 435 points (2.9%). Midcap and smallcap stocks also had a harrowing day of trade today as their respective indices on the BSE ended down by 3.9% and 3.7% respectively. Most other Asian indices, other than China and Japan, closed in the red. The mood in Europe too is no different with all major indices in the region trading weak currently.

 Today's investing mantra
"If you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker " but not your partner." - Warren Buffett

P.S.: The 5 Minute Wrapup has completed one year of enriching you with our views, opinions and analysis of the events we see happening and the thoughts we see floating in the world around us. We thank you for your patronage and hope to serve you even better in the times to come! We'll be delighted if you can share your thoughts and feedback on The 5 Minute WrapUp with us so that we can make it more useful for you going forward.

P.P.S.: With an aim to serve our audience better, we have initiated a new series directed to women investors. The series is titled - Women's Weekly - and will be a conduit through which we will provide our views and recommendations on how should women go about managing their finances and invest for a better financial future. Click here to read the first article of this series."

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10 Responses to "Commodity prices could crash for this reason"

R S Bhat

Jul 3, 2009

Dear Sir,

The 5 minute wrap up is very good. Please adjust right margin so that entire contents can be read.

Thanking you,

Yours sincerely,

R S Bhat



Jun 18, 2009

Excellent compilation of news and views. Keep us posted on upcoming events like report on oil-reserves data, report on WPI or report on un-employment.



Jun 18, 2009

Commodity prices, house prices, stock prices, car prices, everything will crash and crash it will.

Food, fuel and bills wont crash however, they will only rise.


Ankit Paul

Jun 17, 2009

Great Feeds......... Keep it up...........



Jun 17, 2009

nice 2 read and thought provoking articles


virk kuldip singh

Jun 17, 2009

dear editor

your efforts to put the latest in the money markets in the international markets is praiseworthy job. please keep it up



Jun 17, 2009

I am surprised to see that EM is planning to bring out a separate weekly meant for women investors. When it comes to financial concepts and management, should you be creating a dividing line between man and woman? Financial publications must be genderless, meant equally for men and women.



Jun 17, 2009

i will agree with you.



Jun 17, 2009

Your 5 minutes summary is an excellent brief of various main events, summarised like a tablet!!. Everyday I eagerly wait for your mail to hit my mailbox. i dont miss reading your 5 minute summary. Its nothing but a juice concentrate. keep up the good work. look forward to reading more enhanced version of this. I think you should increase this from 5 minutes to 10 minutes as your way of presenting this is much better...

Many thanks. all the best and continue this good work

Most interested reader



Jun 17, 2009

gold low target

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