It is time for a fun bubble in commodities
John Dizard wishes for a commodities rally to brighten the frozen wasteland that is the economy
Ihave been inspired by recent thoughtful comments from Lawrence Summers and Paul Krugman, the economists, on the permanent liquidity trap, zero lower-bound constraint, global depression and endless expanse of frozen wasteland that stretches before us. It is time for another fun bubble. A commodities boom, one where everybody sells bonds and buys metals, grains and the “energy complex” with or without ever setting eyes on the stuff in warehouses, silos, or storage tanks.
This is not to dismiss the deflation that has set in on southern Europe, which may be a chronic condition for countries with declining working-age populations. Nor do I believe the US budget deal, or the regulators’ eliding of the Volcker rule, or the endless fixes for healthcare finance have solved any of our long-term structural problems. I said “commodities boom”, not “sustainable long-term global expansion” or “world peace”.
The commodities rally, boom, or whatever you want to call it has probably already started. It is accompanied by noticeably higher inflation risk premia that are being priced into government bond yields. Those do not support the view that the developed world as a whole is now at risk of falling into a deflationary spiral.
It is always possible to have price rises that are linked to supply or transportation disruptions, in particular commodities. The fluctuating spreads between the US West Texas Intermediate oil price and the Brent North Sea price are a good example; many of the weekly swings could be explained by pipeline constraints, Norwegian offshore platform shutdowns and other identifiable events driving the “basis” trades.
The current broader upswing in commodities seems different. For example, US Henry Hub natural gas futures prices are up more than 120 per cent from their 2012 low, despite the much-reported “miracle” of endless low-cost shale gas supplies.
Then there is the “backwardation” in the copper futures curve. Futures prices are in backwardation when the price of a commodity offered for immediate delivery is higher than the price for delivery at later times. A move to backwardation, or an increase in the backwardation of a futures curve, is generally taken as an increase in real demand for the commodity.
Now of course there are times when this phenomenon is just commodities sellside talk. Temporary and local backwardations can be over-interpreted by those who have too much of the commodity on hand, or who have commissions at stake. That turned out to be the case with the brief copper futures backwardations that popped up in early 2012. Those were explainable by short-term glitches in the supply chain. Yet the current copper backwardation stretches out along the futures curve. That suggests that a lot of market participants believe, collectively, that the excess of demand over supply will be sustained.
There are some other encouraging signs for the depressed commodities longs. Major US banks are closing down or selling off their commodities trading and warehousing operations. The regulators and Congress have been pushing for this, and now the banks’ boards of directors are fed up with the endless fines and compliance problems, misaligned compensation schemes and trading losses. Any time the banks are falling over themselves to get out of a trade, you should consider getting in.
Also, there is a dawning realisation on the part of US macroeconomists that there may be less slack in the labour market than meets the eye. We can all agree that the high rate of people giving up on job searches is a social tragedy. Yet the increasing difficulty employers have in filling vacancies for skilled workers should also get our attention. The outlook for wages and earnings is quite strong for those who are employed, which means there will be less resistance to increases in commodities prices.
I do not believe in contrarianism for its own sake. Even if your analysis is right, and the crowd is wrong, you can wait for far too long before your position comes into the money. It is also a good idea to be sceptical of many commodities-based alternatives to the overbought bond market. You do not, though, have to squint hard to see the rally already taking shape.