Commodities | - Part 5

A Perfect Storm for Inflation?

It should be pretty interesting to see how everyone reacts if and when sharply higher inflation finally does show up here in the U.S. The economic statistic that, since 2008, has been like the boy who cried wolf will probably have many more doubters than believers right up until the point when it’s too late to do anything about it (that was pretty much the story with the boy and the wolf and, of course, the sheep).

Anyway, they talk about the possibility of a tightening labor market playing a role in higher inflation (a key factor to really get broad-based inflation going) in this clip from CNBC.

That surge in agricultural goods last week took a lot of people by surprise and it’s shown in table form below from a data set that is maintained for the investment website.

Like most commodities, there’s a lot of ground to make up from last year’s drubbing for such products as corn, wheat, and soybeans, but they’re off to a great start this year so far.

It might be a good idea to cut out that extra cup of Joe in the morning as coffee prices just reached a two-year high. Now this is interesting … according to my data, the coffee price surged 77 % in 2010 but then fell 6%, 37%, and 23% in 2011, 2012, and 2013, respectively. Now it’s up 78% so far in 2014.

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Some highlights from former Federal Reserve Chairman Alan Greenspan’s commentary at The American on why all financial bubbles are not bad and how the world might avoid what increasingly appears to be an inevitable next financial crisis.

Bubbles, the root of the 2008 crisis and earlier ones, for reasons I will discuss later, have become more prevalent. All bubbles deflate, by definition. But most deflate without debilitating economic consequences. On the fateful day of October 19, 1987, for example, the Dow Jones Industrial average plunged 23 percent, the all-time daily record. I defy anyone to find economic disruption in the GDP figures following that date. I believe there was none. Similarly, in the dot-com boom, capital losses, as in 1987, were huge. But the owners of the toxic assets were mainly pension funds, households, and mutual funds; all suffered very large capital losses, but few ever got to the point where they defaulted on debt. And it turns out that the only two times in recent history in which we experienced real contagion in the financial markets were in late 2008, when, as AEI’s Peter Wallison has documented, there was a very destructive subprime mortgage crisis, the toxic assets of which, of course, were highly leveraged. And in 1929 we experienced a leveraged broker loan crisis. The result was contagious defaults.

The question before policymakers is how to avoid such breakdowns in the future. As far as I can see, the only way to address such issues is to recognize that euphoria-driven bubbles are an inherent consequence of human nature over which we have little or no control. Successful financial policy, in my experience, ironically spawns the emergence of bubbles. There was never anything resembling financial euphoria, or the bubbles it creates, in the old Soviet Union, nor is there in today’s North Korea. At the Federal Reserve during my tenure, we often joked that our greatest fear was that policy might be too successful. Achieving an underlying stable rate of growth and low inflation appears to have been a necessary and sufficient condition for the emergence of a bubble. We would conclude with mock seriousness that optimum monetary policy for bubble prevention was to create destabilizing inflation.

Can bubbles be prevented from rising once markets are in the grip of euphoria? At the Fed, we tried to defuse the nascent dot-com bubble of 1994. We failed…

He goes on at some length, but, I lost interest after the mid-1990s bubble-fighter reference.

The message appears to be: “It wasn’t my fault, we were too successful at the Fed, you can’t control animal spirits, and we’ll always have bubbles”.

The Enduring Value of Gold

Somehow, it doesn’t seem likely that anyone will stumble upon $10 million worth of Bitcoins, say, about 150 years from now, similar to a California couple recently finding tin cans full of gold coins buried in their back yard.

When these coins were buried, gold was, literally, money.

The paper currency that the North and South printed around that time both ended up being worthless as the nation went through the entire 19th century with near-zero inflation while having all sorts of technological advances and strong economic growth.

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WGC Gold Demand Trends for 2013

The chart below, appearing on the first page of today’s release by the World Gold Council of their Gold Demand Trends – Full year 2013 tells you just about everything you need to know about what happened in the gold market last year, save for the important point that nearly all the ETF sales were in the West and most of the jewelry purchases were in the East.

Records were set for the combined total of jewelry demand and bar/coin demand while another record was set for the lack of demand for the relatively new ETF category that, basically, began in 2004 in the left-most portion of the chart.

WGC Gold Demand Trends 2013

Overall demand fell 15 percent and, since the gold price is set in the West, this goes a long way in explaining why prices plunged last year. But, cost-sensitive buyers in Asia stepped up their buying as boatloads of physical bullion made their way from London and New York vaults to Switzerland and then into mainland China, never to return to the global market.

It should be interesting to see what this chart looks like in a year or two and to see who the rubes really were in 2013 – Asian investors who bought the metal as prices were falling or investors in the West who never really liked the metal, never actually owned any of it (because they held it in ETFs), and thought they were getting out while the gettin’ was good.

My bet’s on the latter…

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Learn from Buba

This is a pretty remarkable commentary about the opaqueness of the physical gold market considering that the story appears in the Financial Times (alternate link here).

I mean, it’s one thing for someone like Glenn Beck to be looking askance at the difficulty that Germany has had over the last year in repatriating a small portion of its gold reserves from the vault of the New York Fed in the video below, but it’s quite another for one of the world’s most respected financial news organizations to be doing the same thing.

From the Financial Times:

In the “armchair farmer” fraud you are told: “Look, this is your pig, in the sty.” It works until everyone wants physical delivery of their pig, which is why Buba’s move last year caused such a stir. After all nobody knows whether there are really 260m ounces of gold in Fort Knox, because the US government won’t let auditors inside.

“Won’t let the auditors inside”? That sounds a lot like Mr. Beck.

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