Comments on naked capitalism: Hamilton: Negative Real Interest Rates Feeding Com...

I think exchange traded funds are really to blame ...

2008-04-28T19:03:00.000-04:00

I think exchange traded funds are really to blame here. Check out this article laying out the same argument.

http://econdynamism.blogspot.com/2008/04/can-housing-deflation-pop-commodities.html

The Yield Curve and the Mineral BubbleThe Hidden P...

2008-04-06T06:57:00.000-04:00

The Yield Curve and the Mineral Bubble

The Hidden Parameter in Interest Rates

Executive summary:

There is a strong link between the evolution of the market price of minerals and the shape of the yield curve.

The idea is that given the shape of the yield curve the marginal cost of extraction of minerals becomes irrelevant to their market price as miners stop maximizing their output under constraint of the marginal cost of extraction.

Profit maximization would have them trying to retain their minerals rather than extract them.

The Hidden Parameter:

The price of minerals has grown unabated since the Federal Reserve has started increasing short term rates above 2.5%.

All of the minerals have grown together, which cannot be explained by the growth of the marginal price of extraction alone: no price increases have caused the price of any mineral to stop its growth as a result of an increased investment in exploration.

This correlated increase in the price of minerals must be caused by a global parameter.

Harvard Economics Professor Jeffrey Frankel made the hypothesis that a decrease in real interest rates ("real" rates exclude inflation) increases the demand for storable commodities.

However during the increase of short term rates from 1% under the chairmanship of Alan Greenspan, inflation didn’t grow as fast as short term rates still minerals kept growing.

Moreover any storage outside the ground would not be economically viable as the cost of storage would be added to the interest rates under this assumption the only storable commodity would be minerals.

My hypothesis is different:

Financial decisions are about choices:

If you consider the minerals as short term assets, you come to the conclusion that miners, confronted with an inverted yield curve would, as a group, prefer to hoard their minerals in the ground where storage cost is almost free rather than sell them and invest the proceeds in long term assets.

How else would we understand that the cost of oil was multiplied by 5 over such a short period with a low depletion of the proven reserves?

How else would we understand that all the minerals saw their cost rising at the same period with a next to perfect correlation?

How else would you explain the fact that the rise of minerals started shortly after the rise from 2.5% of short term interest rates by the Federal Reserve?

At the same time the yield curve was under the influence of the famous Greenspan Conundrum, which caused the inversion of the yield curve.

Should the yield curve on the U.S. dollar return to normal, as it did on Monday March 13, after the Bear Stearn bailout, the miners would stop hoarding their reserves in the ground and the prices should go down in the direction of their marginal cost of extraction.

Should the yield curve stay normal or steep for a protracted period of time the price of commodities would reach their marginal price of extraction.

According to my hypothesis, that price must be much lower than the expectation of all market participants.

Because most of the hedge funds holding are outside the ground, they are not constrained by the marginal cost of extraction, should the price of mineral go down, we should see some overshooting, in particular with minerals with low industrial use: gold and silver.

The correlation between the shape of the yield curve and the price of commodities is only one of the many overlooked signals that are embedded in the yield curve.

Among others, it can give a precise timing of a possible systemic collapse through a Keynes' Liquidity Trap.

My model of the yield curve never gave a signal of a systemic collapse during the recent credit crisis: it has always forecasted that the Federal Reserve had sufficient room to rescue the market and the economy.

Shalom Hamou
Independent Yield Curve Special Advisor
shalem.ashalem@gmail.com

TAF is all about the equilibrium of manure being m...

2008-03-08T23:28:00.000-05:00

TAF is all about the equilibrium of manure being mark-to-market

Now that The Fed is accepting manure as collateral...

2008-03-08T19:33:00.000-05:00

Now that The Fed is accepting manure as collateral, there will be a virtual gold rush to Texas from Wall Sreet!

Yee Haw!

In Texas, a significant issue is disposal of animal manures because Texas leads the nation with roughly 220 billion pounds of animal manures produced per year. Texas A&M University estimated the year 2000 manure production per animal

The rise of a global economy is stressing all of o...

2008-03-08T15:52:00.000-05:00

The rise of a global economy is stressing all of our natural resources: water, arable land, minerals, energy, etc. Even so, many commodity traders are wedded to the idea of "the long-run equilibrium."

The fact is that no one has any idea of what the equilibrium price of almost any commodity is. For some, it may actually be much higher than the current "inflated" prices, and the equilibrium price may be going up over time.

For example, the world is running out of phosphate rock. This is a critical resource for agriculture, and there simply isn't going to be enough to go around. Not only that, but the amount available will go down every year. Potash is also in depletion, though not as far advanced as phosphate. Fertilizer shortages are already happening, which is going to reduce yields, at the same time that global population is increasing. The idea that farmers will just go out and plant more to offset yield declines and demand increases is just fantasy. The price of food is going to continue to go up, even though it is probably higher now than it "should" be.

Global oil production (in "all liquids") for the past 3 years is absolutely flat (a 0.02% increase from 2005 to 2007, with a slight drop in 2006). Global demand, on the other hand, has been growing over 3%/year. A flat supply with exponential demand growth is going to cause exponential increases in price.

Some of the more common metals, such as copper and iron, might respond to increased price with increased supply. But for many of the earth's most essential resources, it will take a huge capital investment just to slow the rate of depletion.

Interesting and useful so far as it goes. But aren...

2008-03-08T10:09:00.000-05:00

Interesting and useful so far as it goes.

But aren't both of you considering what are in fact global commodities in a domestic context (fed)?

You may be perfectly correct. On the other hand, the balance of the globe sometimes diverges from our way of seeing things.