From one anonymous to another: Please realize hedge funds can hoard commodities, thus taking inventories down without a real increase in industrial demand. Not all funds maintain position on paper and roll over profits from one contract to the next.

Let’s see what happens when stops get triggered, then we’ll see just how much hot money was in the commodity markets and how much inventory was hidden from the market.

Only time will tell.

I have to second (or is it fourth now?) the opinion that oil prices simply aren’t going to fall that much. Yes, we will probably see a bunch of industrial materials experience a price decline.

But even assuming the Saudis can expand production more, (and who else but they can do so?), a lot of the oil that we see pumping is not feasible at lower prices.

Hell, the stuff in Canada isn’t even oil, despite what the media reports, it’s bitumen. Not only is extracting it extremely detrimental to the environment, but it’s bloody expensive.

Essentially every new field that comes on line these days is extremely heavy crude, meaning that it can only be sucked from the ground with blood, toil, tears, and sweat. Absent the prices we’ve seen, and these operations will stop.

Which means supply will plummet, and prices will just go back up again. So it’s doubtful we could see more than a temporary decrease.

And what’s so often forgotten is that our agricultural machine is ridiculously dependent on petroleum. That’s the price we pay for employing practically no one in the bulk of our agricultural sector(obviously I’m excluding, say, lettuce picking). ConAgra needs it for creating fertilizer, they need it for running tractors and combines and plants and trucks to take produce to market. And even those organic lettuce heads and chilean sea bass need to be shipped or flown to San Francisco or New York.

So agricultural prices are partly driven by increased demand in BRIC and the rest of the 3rd World and partly driven by the exceedingly high cost ofthe primary input into the system, oil.

To recap then, even during a recession, we will see price supports for oil, because we will quickly find ourselves surpassing the supply of light crude, and thus forcing prices back up until we can process Alberta or Wyoming or the Niger Delta.

Meanwhile, even if recession does dampen a certain amount of demand in the developing world, let us not forget that , unlike other commodities, people need to eat food. So they’ll cut back on consumption to make up for the difference. Between demand pressure, and the fact that oil prices will remain high, agricultural products aren’t going to fall by much either.

The US was not able to reflate till 1933-1934, after massive bank failures, liquidity hoarding, and the Dow failing by 90%. Oh, and after the creation of the FDIC (June 1933).

The US could also devalue its dollar then (it left the gold standard then too) because the UK had in 1931. We were following their currency debasement, not leading it. I am not sure we can trash the dollar now without creating a systemic event and/or precipitating recessions or at least very serious slowdowns in India and China. That would take a lot of froth out of commodities prices.

If we get liquidity hoarding, (and I say if and it is a big if I hope we avoid, but we are seeing it among banks now, and I doubt things will improve much until we get market clearing in housing and people are certain how bad the losses are) all bets are off. The Fed did increase the monetary base in 1930, which is all it controls, but money supply shrank anyhow due to people pulling their money out of banks due to well justified fear of failure.

One reason the Fed had to rescue Bear is that if the public at large saw what a mess it is to have your accounts in a bankrupt firm, you’d see a lot of withdrawals from big brokers (places that were pure brokers with no trading businesses like Schwab, Fidelity, and Vanguard would benefit, but some people might divert a big chunk of their withdrawals to banks).

I doubt we will see anything even remotely like 1930, but one largish failure, be it a securities firm or a WaMu, could lead to a tremendous amount of dysfunctional behavior.

And my informed buddies tell me the European banks are in every bit as bad shape as the US ones. When that realization hits, we’ll see another spell of worry that will somehow redound to the US.

Whether they want to admit it or not, both the Fed and Congress are operating in Japan mode: prevent the losses from being realized. That serves to prevent the bottom from being reached, which in turn discourages private domestic capital and sovereign wealth funds from stepping in. The US government simply does not have the resources to prop up the banking system and the housing market.

And we aren’t Japan. Even though Japan’s bubble was arguably bigger than ours (I say arguably because I have yet to see an estimate of the economic value of the notional $45 trillion plus CDS market, which is trouble waiting to happen), they had several assets we lack. Number one was a very high level of savings; they could handle their crisis internally. Number two is a very cohesive culture and a willingness to share pain to preserve stability. Number three is that the financial system was highly concentrated (four big securities firms, maybe ten “city banks”, three long term credit banks), so the authorities could get their arms around the problem. Number four, no complicated instruments (save perhaps stock warrants) that were beyond the authorities’ understanding. Number five is that the bureaucrats (MOF, the BoJ, MITI), really were the best and the brightest in the country (meaning the politicians for the most part didn’t attempt to interfere).

That all means that (per the competing and contradictory proposals re what to do), the process of dealing with the credit mess is sure to become highly politicized, which will probably lead to ineffective to bad remedies. Look at the stimulus bill: just about every legitimate economist had nothing nice to say about it. Doing nothing and saving the firepower for something useful would probably have been a better move. But no, DC had to Throw Money At The Problem.

I don’t disagree with what you are saying, and I am featuring these bearish posts on commodities in part to counter the extreme bullish conventional wisdom. Even if it is directionally correct, near term commodities look overbought.

You are right that the outcomes are bimodal, and to such an extreme that it makes it difficult to know what to do. If the Fed succeeds in preventing a deep recession, the cost will be stagflation, which in the end will be dealt with via a Volckereque deep recession. There is no way not to pay the piper here; the matter is when (and yes, commodities will likely remain higher than their past levels due to fundamental changes in demand/supply, but the inflation premium will be wrung out).

As much as I believe the ag inflation is here to stay, the slaughter of herds and very high meat prices will relieve some of the pressure on grains. Remember, it takes ten grain calories to produce one meat calorie. Bad harvests are a factor (and there is a nasty wheat fungus wiping out crops in Africa) but the biggest factor in the rise in ag prices is people in emerging economies eating more meat, eggs, and dairy products. A move back down the food chain in eating patterns would alleviate that (my hopes are not high here, Americans in particular are very addicted to their meat).

I have been watching the credit markets pretty closely, and of late have become pessimistic about the Fed’s ability to prime the pump enough to prevent asset deflation. As I have said elsewhere, it is due to the fact that we are early in the housing correction. It took 15 quarters in our last housing recession (around the time of the S&L crisis) and a similar amount of time in the “big five” post WWII banking crises studies by Carmen Reinhart and Kenneth Rogoff; in all, housing bubbles played a big role. And they all took place pre 1995, before the financial system was so tightly coupled. The fact that Bear had to be effectively liquidated this early in the process is a bad omen.

The dollar also constrains what the Fed can do, and it doesn’t seem to acknowledge that. We are dependent on foreign credit. Keep depreciating the dollar, our partners will abandon their pegs because their amount of domestic inflation will become unacceptable politically. No more dollar peg means a big drop in buying of Treasuries and a spike up in interest rates. We get our Volckeresque recession by accident, not design.

That scenario is hugely destabilizing to international trade, and has the strong potential to drag emerging markets into a recession too. Hence, lower commodity prices.

Interest rates are low because monetary policy is much less effective given the nature of the problems in the banking sector.

Also, given the weight of the over the counter derivatives market place and a still large overhang of securitised debt above the banking system the federal reserve cannot afford to let the economy move into a severe recession. Insolvency would become an even more pronounced factor and interest rate policy even less effective.

Unless the financial system is stabilised, the probability of a depression and deflation are nevertheless very high.

On the other hand if moves to stabilise the financial system are successful, part of this success will be through maintaining a large broad money supply base. There will therefore be an abundance of money supply.

If we cannot let economic conditions deteriotate even though the fundamentals strongly suggest weakness, the other side if we reach it is indeed stagflation.

Prior to the crisis the relationship between money supply growth and the productive potential of the US (and other) economy was well out of alignment. That much of this misalingment was concentrated in property and other securitised debt products held indirectly via the banking system is a major reason why we are seeing the initial reversion in the banking system.

Andrew Teasdale

The TAMRIS Consultancy

You believe anything that comes from Cheney’s lips? The Saudis say they don’t see inventory tightness and are holding pat on production; Cheney says there are strains because he wants them to pump more.

Neither is trustworthy…..

Breeder populations of pigs (sows) are being taken to slaughter throughout US, Canada,England, Asia as we I write this due to the high cost of feed, can’t afford to keep them around. This will also be true for fryer (chicken) operations as it gets to expensive to keep the parnet and grandparnet populations at large levels due to huge imput cost increases. Cattle herds will definitely suffer the same fate, the shortterm for all the above will be lower meat price’s but as the inventory is worked off and the lower level of production begins to show up in slaughter rates meat prices will jump. I have expected higher margin rates for AG commodities for sometime but the discount between modern life and the food supply continues and will until large shortages appear in the markets then the outrage will begin, I guess.