Is the "Commodities as Anti-Dollar" Trade Back?

Commodities had a nice day Wednesday, with oil in particular spiking up. Although the trigger appeared to be the Fed rate cut, one has to wonder at the seemingly disproportionate price reaction, particularly given deteriorating fundamentals and hence falling demand.

One reason for the sudden enthusiasm for commodities is that, as in the frenzied days of last spring and early summer, hard assets can serve as an anti-dollar trade. And the dollar is looking pretty richly valued right now.

From the Financial Times:

Commodities prices rose sharply on Wednesday, with oil trading above $69 a barrel, as the dollar retreated after the Federal Reserve lowered US interest rates half a percentage point to 1 per cent.

The Reuters-Jefferies CRB index, a global benchmark for commodities, rose almost 6 per cent propelled by a surge in energy, metals and agricultural raw materials.

The price of several commodities, ranging from wheat to oil and from nickel to sugar, rose 10 per cent on the day. But traders warned that sentiment was weak and the gains could be shortlived amid worries about a global economic slowdown.

“Demand for physical commodities is tanking in many parts of the world, with US oil consumption contracting at the sharpest rate since 1980,” said Francisco Blanch, commodities strategist at Merrill Lynch in London.

In the oil market, Nymex December West Texas Intermediate jumped $4.77 to $67.50 a barrel after hitting a session high of $69.24, while ICE December Brent rose $5.18 to $65.47 a barrel after reaching a high of $67.12.

Dollar weakness and gains for equity markets outweighed the impact of the latest US weekly inventories data which painted a mixed picture. US crude stocks rose by 0.5m barrels, below the consensus forecast for a 1.4m barrel increase. But total US demand averaged 18.88m barrels a day over the past four weeks, down 7.8 per cent compared with the same period a year ago.

US petrol stocks fell 1.5m barrels, confounding the consensus forecast for an increase of 1.2m barrels. However, petrol demand remains weak, averaging 8.93m barrels a day over the past four weeks, down 3.4 per cent compared with the same period a year ago.

Nymex November RBOB unleaded gasoline rose 10.8 cents to $1.5628 a gallon.

US refinery utilisation rose 0.5 percentage points to 85.3 per cent, recovering towards the 88.8 per cent reached in late August just before the arrival of hurricane Gustav.

The market was also bolstered by further signs that the world will struggle to build enough oil production capacity over the next 20 years to compensate for steep declines in output in mature oil fields such as those in the North Sea, Mexico or Alaska…

James Steel of HSBC cautioned that next week’s US elections could weigh on gold prices if the new president was granted a “honeymoon” period by investors or if the dollar rallied after a new administration entered the White House.

Caroline Baum of Bloomberg throws cold water on the oil bull thesis:

Three months ago, the world was running out of oil…

Now there’s too much oil, prodding OPEC to cut production targets for the first time in two years…

World markets greeted the news of reduced oil supply by pushing prices down further. Crude oil fell $3.69 a barrel Friday to $64.15. Yesterday, oil dropped another 93 cents to $63.22, a 17-month low.

How quickly things change. Or do they?

All speculative bubbles have a kernel of truth behind them to justify their existence. This time around it was China and India. These emerging Asian giants were gobbling up all the commodities the world could produce to fuel their rapid industrialization.

It wasn’t that the story was untrue; it was old. Growing global demand probably was the reason for the gradual rise in oil prices from $20 a barrel to $40 earlier in the decade, and even to $60 by mid-2005.

It was the moon shot to $147 that took on a life, and a litany, of its own. Emerging nations didn’t start gobbling up crude, coal and copper all of a sudden in the middle of 2007.

Yet analysts on TV and in print told us with a straight face that the doubling in oil prices from July 2007 to July 2008 was a result of fundamental demand, not speculative buying or investors, including pension funds, “diversifying” into “alternative investments” in search of “uncorrelated returns.” (It sounds a lot better than admitting you got suckered into buying what was going up and are now stuck with a pile of stuff that no one wants.)

“It happens in every market,” says Michael Aronstein, president of Marketfield Asset Management in New York. “Once it goes up an enormous amount, creating unfathomable wealth for the fortunate participants, someone makes an ex-post case as to why we are only at a beginning and it’s not too late to get in.”

This advice is “generally formulated by someone who has a vested interest in selling the stuff,” he says…

The silliness that accompanies speculative bubbles isn’t to be outdone by what passes for economic analysis. It’s just over three months since commodities began their sharp, swift descent, and already the nonsense is starting: Lower oil prices are going to boost consumer demand.

Whoa! The price of oil (and other raw materials) is falling because of a cutback in demand, both actual and expected. Expressed as a graph, the demand curve for oil has shifted back, to the left. Consumers demand less energy (gasoline, heating oil) at any given price than they did before.

To say that lower prices will stimulate demand, a widely held misconception, confuses a movement along the demand curve (lower price, higher quantity) with a shift back in the curve (lower price, lower quantity).

Why this is such a hard concept to understand, I’m not sure. People imbue oil prices with all kinds of mystical powers. They see a falling price and treat it as a cause, not an effect.

That oil prices are falling in the face of OPEC’s announced production cuts — a reduction in supply would tend to raise the price, not lower it — suggests that demand is falling even faster than OPEC can reduce supply.

That won’t boost demand, but who knows? Maybe it will help recapitalize the banks!

Reader Michael also passed this thought along:

I almost forgot about nat gas…its bounced back with oil, but that’s got $4 written all over it…we can’t export the stuff yet we increased drilling to a level not seen since 83. These producers saw $20+nat gas overseas, and figured that’s where we were headed…but the demand picture is obviously different here…That’s why tboone and mcclendon were spending money on commercials, pleaing for people to create some sort of demand that would soak up this massive supply that will hit the mkt over the next few months.

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  1. Anonymous

    I’m not convinced we’re out of the woods re: oil and supply issues. This in the FT:

    “World will struggle to meet oil demand

    By Carola Hoyos and Javier Blas

    Output from the world’s oilfields is declining faster than previously thought, the first authoritative public study of the biggest fields shows.

    Without extra investment to raise production, the natural annual rate of output decline is 9.1 per cent, the International Energy Agency says in its annual report, the World Energy Outlook, a draft of which has been obtained by the Financial Times.

    The findings suggest the world will struggle to produce enough oil to make up for steep declines in existing fields, such as those in the North Sea, Russia and Alaska, and meet long-term de-mand. The effort will become even more acute as prices fall and investment decisions are delayed.

    The IEA, the oil watchdog, forecasts that China, India and other developing countries’ demand will require investments of $360bn (£230bn) each year until 2030. The agency says even with investment, the annual rate of output decline is 6.4 per cent.”


  2. doc holiday

    The bigger news is taxpayer bailout for Harley-Davidson! I assume Dairy Queen International is next and then on to The Large Hadron Collider and then perhaps cat food companies like Menu Foods?

    >We have used (the Fed facility) as one of our CP sources," Harley-Davidson spokesman Bob Klein said Wednesday in a phone interview. "It’s an additional source of diversification," he added, noting that traditional commercial paper sources remain available to the financing unit.

    The Milwaukee, Wis., company, which has been hard hit by slumping sales and tightening credit conditions, first accessed the facility on Monday, when the Fed began buying commercial paper from companies to help bring down rates and lure investors back to the market. Klein, who didn’t comment on terms or amounts, said the company expects to continue using the Fed’s facility.

    Harley-Davidson shares, which have lost nearly half their value this year, were up 13% at $24.19 in afternoon trading Wednesday.

    Two weeks ago, when Harley-Davidson announced a 37% decline in third-quarter earnings, Chief Financial Officer Tom Bergmann said the company expected to be eligible for the Fed program. That, Bergmann said, gave the company confidence that its financial services unit would have continued access to the commercial paper market, an important source of funding for the day-to-day needs of companies.

  3. Yves Smith

    The IEA survey was a very dubious exercise, a mere 25 or so analysts, limited time frame, merely made inquiries of oil producing nations. Do you think any oil producing nation, particularly ones with heavy or sulphurous crude that is economical to refine only when oil prices are high, would find it in its interest to say supplies are robust? There was NO independent verification. This was a garbage-in, garbage-out exercise. Now its findings may indeed be prove to correct, but I would not give much credence to the survey.

    We commented on this survey back in May in “International Energy Agency to Try to Gather Supply Data It Won’t Get (And Other Oil Information Gaps)”:

    Why am I so deeply cynical? Because, as the article points out, the IEA simply can’t get the information it needs to make forecasts with any reasonable degree of accuracy. Now if the IEA admitted the fact that you could drive a truck through its estimates, I’d have a lot more respect for this exercise. As a management consultant/sometimes special situations analyst, I frequently have to deal with data about markets where the information is very soft. The definitive tone of the IEA’s reporting (see their April report, courtesy reader Bjornar) seems to overrepresent the integrity of the underlying work.

    And while the survey-in-progress will attempt to remedy some of these shortcomings, it’s clear there will still be quite a lot of guesswork in the final product due to the lack of cooperation of pretty much all of the interested parties save perhaps the US and North Sea producers

    The post discusses many more shortcomings of the survey.

  4. Edwardo

    Peak OIl is a genuine phenomenon, and while I will admit that the price of oil was distorted when the commodity bubble was in full force, don’t think for a minute that the respite that is occurring now will persist for very long.


    China and India’s thirst for oil is immense, even in the midst of the present severe global economic contraction. As such, the floor under prices is not far below present levels. I’m not saying we won’t see 50$ dollars for a barrel of oil, but it is far from certain in my view. And may last for all of an hour if it does happen.

  5. Yves Smith


    Chinese + Indian consumption + 1/4 EU + US.

    A small amount of demand destruction in the US and Europe will offset increases in Chinese and Indian demand. And a global recession will also reduce Chinese and Indian demand growth considerable.

    Plus in 7 years, China starts to have a demographic time bomb thanks to its one child policy. Population growth will halt and perhaps go into decline.

  6. Anonymous

    This from the IEA:


    IEA Statement on Unauthorised Press Coverage of World Energy Outlook 2008

    The Financial Times carried a cover page article this morning and a second article on page 4 allegedly reporting on the findings of the forthcoming WEO 2008. This article was drafted without any consultation with the IEA. It appears to be based on an early version of a draft from several months ago that was subsequently revised and updated. The numbers in the article can be misleading and should not be quoted or considered to be official IEA results. We are dismayed that such a comprehensive and important IEA report was made public without our input and verification.

    The IEA will present the final and accurate results of the World Energy Outlook 2008 officially as planned at a press conference in London on 12 November. At that time, we will be happy to discuss the results and their implications for the global energy and climate in full detail.

  7. john bougearel

    it is hard to substantiate todays $6 spike in crude oil as disproportionate relative to itself. The average true range for crude oil was 552 ticks, right smack dab in the middle of the average true range for CL of 470 ticks to 637 ticks since Sept 2.

    Even with a shift to the left on the demand curve, normal oscillations for crude oil given the volatility increase could well see crude priced well into the mid 80’s from its recent low at 61 this week.

    On another note in favor of higher prices, one unverified but credible source noted that in the COT report, commercials are net long again crude oil.

    In other words, airlines and other industries are net long in the 60’s which tells us they are hedging their future energy needs down here. This signals they are buying protection against price spikes regardless of how depressed the economy becomes.

  8. doc holiday

    Maybe a little related? Maybe not, but here:

    Fears mount in Japan over complex yen products

    The products, which are known as power reverse dual currency notes (PRDC), were sold to Japanese households as simple products offering higher yields than regular savings but the bonds were in reality hugely complex structures “with 15 moving parts and multiple points of pain”, derivatives experts at RBS in Tokyo said.

    The products combine exposure to foreign exchange, interest rate differentials and domestic inflation and have formed a small but potent part of the so-called yen carry trade – the borrowing of yen to invest in currencies offering higher interest rates – a gambit thought to have financed huge amounts of global risk-taking in recent years.

  9. john bougearel


    your earlier crude oil report this week noted 12% demand destruction has already occurred.

    “supply is higher than demand by around 2m barrels a day” noted Algeria’s minister

    And worse, “OPEC’s problem is they don’t know how much demand is falling” said UBS’ Jan Stuart.

    Crude oil prices may bottom ahead of deteriorating fundamentals, but one thing is for certain, until those fundamentals bottom, the long term secular bull in crude oil is dead in the water and will leave it bound in a wide trading range approximately from $55 to $95

  10. Anonymous

    Needing oil to transport staples, its by-products to package and grow crops, as the US$ is now losing value I would say the bottom is in. (commodities sector)

    It’s all in the dollar. Just ask Taiwan how they feel about US debt.

  11. Bo Peng

    Yes, Yves, USD is the new carry trade currency as the real interest rates goes negative and long-term inflation is assured (as soon as the Great Unwind finishes). Commodities bubble of the last year had nothing to do with supply/demand. Going forward, as the credit freeze thaws and leverage creeps back, commodities is really the only place to go.

    I’m not saying it’d be straight up from here on since I can’t tell when the Great Unwind will end. But I figure it can’t go on for more than another month or so, if not finished already.

  12. Chris

    I really think the story here is far more complex than can be captured with economic models. Petroleum geology is really tricky and the notion of drill here and now and a bountiful supply will be forhcoming is hogwash. I’m sure most would agree.

    If I’m wrong (which occurs rather often), then I ask why are we mining oil in Alberta and drilling offshore in excess of 6000 meters to access the stuff?

    In my belief, there is a very limited supply of economically usable oil and one can anticipate expensive oil as the norm in a non-recession environment.

    The days of 100 to 1 energy return on energy invested are gone.

    When (if?) the economy reloads, it will again come up against this expensive oil which will mitigate growth. Indeed, that’s the story with many commodities.

    Yves, population growth is only a partial story here. It is the rise of the middle class throughout the world, the consumers of the Tata Nano etc., that will push us up against this geological reality.

    The unfortunate thing with all of this is that so called peak oil has become a sideshow and that has reduced our capacity to think about energy alternatives.

    Also, it’s not just fossil fuel supply that’s an issue. The electricity grid, aging oil infrastructure (refining, drilling rigs, etc.), artificial price controls (eg. Venezuela, Saudi Arabia, etc.) add up to a dysfunctional world wide energy picture that’s going from bad to very worse.

    No one can predict the short term future of crude, but going forward it would not surprise me to see oil become expensive again. It would also not surprise me to see governments limit trading in the stuff. Perhaps something like the Iranian/Thai model will take over. Oil is just that important.

  13. Anonymous


    Bo Peng has got it right.

    The trade went back on about 2:00PM Tuesday when the currency markets starting moving. Fertilizer, energy, materials etc.

    Even Lakshmi Mittal got off the mat, although he was a laggard Wednesday.

    Lets see how long it lasts but copper is back to October 21st levels after incessant chatter from people who had never discussed it prior to it hitting $2.00 lb.



  14. Anonymous

    From: Bugs Bunny
    To: The World

    There is always a speculative component to all trades. In this case under consideration: commodities. Yves possesses a mistress of gloom and doom perspective that attempts to spear even the most negative and apocalyptic of investments.

    Can one be negative about EVERYTHING?

    We’re in a deflationary environment. Capital injections are needed because no one has any CASH.

    I wonder at this juncture, where the spare cash would arise to
    inflate commodities.

    Yves forgets WE ARE IN A CREDIT CRISIS.


    Over time, Gold and Oil will reclaim their former thrones.
    I’ll bite the bullet and go with 2-3 years. They represent tangible, measurable scarcity.

  15. FairEconomist

    Now the entire world is going to try to imitate the Japanese system of lots of money and – in many cases – negative real interest rates. Since there’s nowhere to carry trade to, speculating in commodities becomes a great deal even if prices are excessive, because as long as they’re not *too* excessive it’s a better return than the artificially low interest rates. So yes, commodities are going to be seriously inflated by the money supply increases the Fed has finally started.

  16. bg

    "And the dollar is looking pretty richly valued right now."

    That is the same as saying the S&P500 P-E is low. Neither is predictive of medium term direction, as both earnings will continue to fall, and less safe haven currencies will be under pressure.

    the only thing the dollar might be rich against are assets that won't deflate. I just can't come up with any. Definitely not commodities.

  17. bg

    Bo Peng,

    I am not an expert on the carry trade, so would love to hear from people who are. It is my belief that the carry trade requires three things: Abundant credit, a low interest rate country of origin for that credit, and asset inflation in different countries from the source country.

    I think you only get one out of three today, and thus the carry trade should be much smaller. Margin calls started the exodus, and I doubt it is complete.

  18. bg

    fair economist:

    “speculating in commodities becomes a great deal even if prices are excessive, because as long as they’re not *too* excessive it’s a better return than the artificially low interest rates”

    This implies that there is enough money pumped into the system that it has to leak into some bubble somewhere, and it might as well be commodities. I am not sure you can make this case anymore when asset deflation is needed across the board, and risk (as measured by margin calls and volatility) is massively skewing the risk-reward ratio. It is overly simplistic to believe that overheated asset inflation is the natural outcome of all money supply infusions.

  19. Yves Smith


    Have you looked at the dollar versus, oh, say for starters, the euro, sterling, AUD, NZD? Treasuries are in massive bubble, and dollar and Treasuries tend to trade together.

  20. baychev

    demand for oil may be tanking, but the supply of dollars seems to only increase, so let’s consider the demand/supply curves of both the comodity and the medium of exchange.

  21. Yves Smith

    Bugs Bunny,

    I do not see why suggesting that the oil/commodities as anti-dollar trade, which was a pronounced feature of late 2007-early 2008 might be back is gloom and doom. As the FT pointed out, demand for many commodities is down, the dollar weakened, and commodities went up. Dollar related action seems a reasonable culprit to suggest.

    So if one is empirical, that equates to gloom and doom?

  22. Anonymous

    The oil issue is such an obviously complex topic as it is a product in universal demand by people who earn income in various currencies, compounded by inadequate knowledge about current capacity and ultimate supply. Can we please stop with the arrogance that we each *know* what’s going on? As if Caroline really knows that the demand curve has shifted back. As if anyone could. Listen, I have no idea whether it has or hasn’t, my only point is the arrogance with which she expresses herself is enough to mock her, whether or not she is ultimately “proven” to have guessed corrected. No one in the entire world is certain about either demand (will per capita consumption in the rest of the world catch up with the US? will it be because the rest of the world expands or the US contracts?) or supply (is global peak oil real?). So, please, dispense with telling me you *know* what’s going on. To every pundit and every commenter, just tell me your best guess and let’s just agree to move on, OK?

  23. Anonymous

    Someday it will become aparent to all that commodities are the only real assets. Fiat currencies, paper stocks and bonds, CDOs, swaps, ABCP, etc, are no different than toilet tissue when confidence disappears from the population. Little is said about confidence but it is a very large part of consumer led recessions. We have entered a consumer led recession.

    Commodities will adjust upward as inflation renders fiat paper more common. Deflation is the only scenario that could hold down commodities and the Fed/CBs are not willing to tolerate deflation.

    As confidence erodes further and governments print more fiat currency commodities will continue to rise against paper.

  24. FairEconomist

    bg: We’re due for asset deflation in real terms, but asset deflation in nominal terms depends on how much inflation occurs. The entire world is now trying to hold real interest rates far below market clearing rates, and that’s producing the credit crisis. Having realized this won’t go away on its own the Fed is trying to clear things by printing money. If they print enough to clear we will get massive inflation, starting in commodities.

    An additional problem is that if commidities are not overvalued, then the newly printed money will go straight into commodities because the zero or better real return already outweighs negative real treasure rates. Moderate printing might reflate the commidity bubble without significant credit relief.

  25. Richard Kline

    So FairEconomist at 0200, I share the perspectives of your comment in all its dimensions. It is clear that the decision has been made to zirp the world. Depression is depressing; debt can’t be zapped: get your zirp on, chillun, and a happy face.

    That makes commodities a real mid-term play. Whatever their real value, the only thing that matters is for their speculative value to stay ahead of liquifying currencies. And it must be borne in mind that the colossal plunge in commodity prices we see presently is as artificially induced as the ashphyxiating spike in such prices of six months past. The Great Credit Unwind is whipping numbers back and forth like the tail of a snake with it’s head inside the head of a higher predator. We are not going to keep $60 oil unless trade collapses completely, which is unlikely for any length of time. We saw the ‘stupid spike’ earlier; the next speculative increase will be flatter and played shorter to the vest.

  26. Independent Accountant

    I have said the dollar and dollar denominated bonds are overvalued for about a year. I think almost anything is a better long-term investment than dollars, stocks included. During the German 1918-23 inflation, if one had bought a diversified portfolio of German stocks in 1918 and held them throughout the entire period, he would have would up with about 30% of his initial value in gold terms. You figure out what happend to mark holders when the mark was revalued in 1923 after 12 zeros were lopped off. That's why no matter what the S&P 500 does, I say hold.
    Of course the Germans who understood what was going on, bought US $ or British pounds and borrowed marks to do it. Paying off their mark borrowings every three months and kept repeating the process. By 1923, these few people became fabulously wealthy. The dollar and British pound were then gold-backed. Coincidence, I don't think so.

  27. Richard Kline

    In parallel to your comment of 0304 re: Fed printing, I am reasonably confident that the pressures exerted by zirp will go _sideways_ in unanticipated ways, and do little or nothing at all to stimulate mid-term investment in real production which stimulates economic recovery. Neg rates make it unprofitable to lend money, period. The powers that be don’t get this, but their successors in office will get to sort it out. Speculation is the only vehicle for Big Money to reproduce itself. Commmodities have been and will be a major vehicle for such speculation because demand from them has a solid _real_ floor; demand destruction only builds down so far as long as economic activity continues at all.

    This is what happened with Japan’s zirp; we got the carry trade rather than productive investment in Japan. If the world goes zirp, the race to find speculative opportunities will crank up to warp speed from the full flank ahead of the present. And, BTW, a by-product of that is the suffocation of real investment. . . . This is what happens when we let trained economists run the global macroeconomy: they put their blinders on, run their maze, push their expected lever, and wait for the pellet to descend unto them. *grrrrr*

  28. Anonymous

    reverse dual currency notes (PRDC)

    bonds were in reality hugely complex structures “with 15 moving parts and multiple points of pain”, derivatives experts at RBS in Tokyo said.


  29. bg

    FairEconomist and Yves,

    I agree that sufficient money supply can cause inflation, so in the margin of course governments can inflate away asset deflation. But they cannot will away generational imbalances. Capital is running to the sidelines for good reason, and overshoot is likely.

    I think Norielle is on the other side of the debate as Jim Hamilton, but both outclass me by 2 standard deviations.

    I am always a little amused by the ‘bubble in treasuries’ argument. Thats like talking about the ‘euphoria of bomb shelters’.

    Nobody’s running to the dollar. They are running from everything else. In the long run is a different story.

  30. Anonymous

    “Although the trigger appeared to be the Fed rate cut, one has to wonder at the seemingly disproportionate price reaction, particularly given deteriorating fundamentals and hence falling demand.”

    From the start, the Fed rate cuts have been ill advised, feeding a speculative froth that has created and nurtured synthetic asset markets dominated by “traders”. At the same time, the market interest rates have moved in the opposite direction, confirming the role the Fed has played in destroying the fundamental valuation yardstick of competitive price discovery that fair markets provid.

    The cost to the taxpayer, non-speculative and fixed income investors has been the most under reported casualty of this episode of Fed malfeasance.

    It is time for Bernanke to go.

  31. Anonymous

    I would not like to predict the future path of commodity prices as there are a number of determining factors.
    Firstly the problem with letters of trade perhaps further hinted at by Danny Blanchflower (Member, Monetary Policy Committee, Bank of England) in his speech at Kent University yesterday when he said. “Trade credit is unavailable for financing freight which has traditionally been written at the LIBOR.”. This is likely to depress commodity selling prices while increasing commodity purchase prices as freight is rationed. The consequence of this may be depressed production below demand levels. This would suggest to me that in the next 6 months commodity prices will pick up significantly.

    Secondly we have the dollar, commodity pairing trade, where as the dollar rises , commodity prices fall. Paul Kedrosky as a good article today on what the prospects for the dollar will be. “Of course, as more money comes flooding into the dollar the better it does, and the better it does the more money comes in, and the more hot money (read: hedge funds) follows it. Such upward spirals are illusory”. This might suggest any significant downdraught in the dollar may cause commodity prices to shoot up. This may be why the treasury is keen to set up swaps with emerging economies to limit the dollars rise.

    Thirdly in contrast demand is likely to drop off and no more so perhaps in the short term than China. Yesterday we heard about the rumoured scrap metal merchant who was kidnapped in china. While there are some inconsistencies in the story it does show a problem with pricing and demand of US and European scrap metal. I have a suspicion this may be more about pricing in that they might just as well renegade on the current deal and wait for the next delivery which will be significantly cheaper.

    The fourth consideration and perhaps one which will have a long term effect especially with foods is the ability of the producer to hedge their prices. No farmer or producer wants volatility in prices because it makes planning difficult, therefore they take out insurance against price changes. In a volatile market the cost of that hedging becomes prohibitive which either means prices will rise to include the cost or no hedging will take place and some businesses will run the risk of failing. As businesses fail so production will drop and prices will rise. Which ever way you look at it prices will rise until a better pricing mechanism or market comes along.

  32. FairEconomist

    @ Richard Kline:

    I agree the inflation will go to speculative purposes and not real investment. If you look in the real sense, there’s no real wealth being invested; nobody’s making net deposits at these interest rates and the government isn’t using tax dollars for investments. The world governments seem to be falling for a bad money illusion. Printing a little money can do a lot of real good by averting deflation; but they seem to think printing more does even more real good when actually excess money does real *harm* via the distortions of inflation.

    The really bad planning shows in in the Fed M0 statistics which have been relatively flat for the past year and suddenly popped up 10% in one month. And we wonder why things seem like they’re thrashing around? Consistency of policy is a real value for central banks and we’re certainly missing that.

    The one agent that’s pursuing a relatively productive course is the Europeans, who have kept interest rates moderate. In their case, they’ve held back from printing and they are risking deflation; but I think they will step in if that really takes hold. But reputedly they’re losing their nerve and are about to do a major rate cut. In any case, if they do hold to their course, the US and Japanese policies will blow absolutely massive carry trade bubbles into Europe. The most disturbing part about the threatened universal ZIRP policy is that destructive as that carry trade bubble would be, it would still be better than the ZIRP-driven 100% speculative bubble into commodities or whatever because the carry bubble would go into housing or green energy and at least those investments wouldn’t be *completely* wasted.

    @bg: You don’t agree with us that asset prices can easily decrease in real terms while increasing in nominal terms?

  33. Anonymous

    financial analysts of banks are borderline criminals. At the peak of the internet bubble, they continued to tell me to buy telco stocks, sometime later the stock collapsed to never recover. Same with oil: at the peak this summer they told us oil would rise above $200 but the opposite happened. and the sad thing is the media continue to quote all the bankers making these quotes, I am sure banks profit from these claims, either by selling to stupid clients or maybe even worse: already secretly speculating on the opposite trend

  34. Matt Dubuque

    Matt Dubuque

    Porsche, which made 3 times as much money in the derivatives market last year (and which pocketed billions of dollars from the Volkswagen affair this week) is currently hedging its portfolio carefully anticipating a possible STELLAR rise of the dollar to $1.80 vs. the Euro, per the article below in today’s FT.

    The notion that the greenback could reach such a level against the Euro will be met with widespread scorn and derision in the blogosphere and New York Times, whose apparent estimation of their expertise on such subjects seems to know no bounds.

    However, sober Europeans are less smug.

    Matt Dubuque

    Porsche intentions baffle markets

    Published: October 29 2008 19:58 | Last updated: October 29 2008 19:58

    When Porsche speaks the market moves. A statement on Sunday brought a quadrupling of Volkswagen’s shares and another early on Tuesday morning brought a near-halving from that elevated level. But to what end?

    Almost nobody is certain what Porsche’s intentions are. Its overall strategic aim remains, however, clear: to gain control of VW, Europe’s largest carmaker.
    Its announcement on Sunday that it held 42.6 per cent in VW directly and 31.5 per cent indirectly through options was meant to highlight how close it was to its goal. At 75 per cent – only 0.9 per cent away – it can implement a domination agreement and get its hands on VW’s large cash flows.

    But Porsche’s use of derivatives has long had criticisms from investors and analysts who worried that its options trading could get out of control. When it disclosed a year ago that it made three times as much money from VW options – €3.6bn ($4.6bn) – as from making cars, an analyst at Sanford Bernstein described Porsche’s finance director as “more of an options trader than a CFO” and added “investors would prefer him to be the latter not the former”.

    Even before VW, Porsche had made vast profits from options, this time in currency hedging, which led to annual profits of €250m.

    That growing dependency on derivatives has led many hedge funds, burned by the huge rise in VW’s share price, to speculate wildly that Porsche was forced to put out the statement at the weekend to ensure its financial health. In particular, hedge funds claim it may have been exposed to big options positions.

    Porsche refutes the allegations vehemently. Frank Gaube, its head of investor relations, said: “We have not manipulated the market. To say we released a statement because of option positions refers to share price manipulation and we refute it totally.”

    He says that Porsche put out its weekend release to show investors that there was a free float of only 5.8 per cent, rather than the 45 per cent some had been assuming. “What we wanted to say at the weekend is that one should expect that the banks with which we have these cash-settled options normally cover themselves by buying the shares and that the market should realise the free float was lower than it thought,” he adds.

    He similarly dismisses arguments that Porsche had run into trouble on its currency hedging. It is fully hedged against the dollar until 2013 and has argued in the past that the US currency could go as high as $1.80. The current level of about $1.25 has led some to believe Porsche could now be in difficulty. But Mr Gaube says Porsche does not hold just one option but layers of options that fall away gradually if the dollar strengthens. He adds it could cost them some money but not much. A €10bn credit line that it drew down earlier this year is “needed for VW” and is not invested in options, says Mr Gaube.

    More mystery surrounds Wednesday’s announcement that it could settle up to 5 per cent in hedging transactions to support liquidity in VW shares. Mr Gaube says Porsche has only settled “substantially below 1 per cent” and hopes to remain under 5 per cent. He is unclear as to how Porsche will decide how many options to close but says it regards a share price of even €300 as “unreasonable”.

    What is left is huge paper gains for Porsche: on the 31 per cent where it has disclosed how much it paid for VW shares it has made €42bn at yesterday’s close on an investment of €5.8bn; for the further 11 per cent in equity analysts estimate it could be at least €10bn.

    What remains is the strategic rationale for buying into VW, which was to ensure Porsche’s relationship with its biggest supplier stays intact.

    Matt Dubuque

  35. Matt Dubuque

    To be clear, Porsche is hedging against a SURGE in the dollar to $1.80. It is currently around $1.25.

    One thing you can be sure of. CNBC will NEVER run this story.

    Matt Dubuque

  36. Yves Smith


    The article is written incorrectly, A price of $1.80 per euro means the EURO, not the dollar, would be vastly stronger than the current level of $1.25 per euro.

  37. Anonymous

    look at your grain stocks or for that matter certain base metal stocks. give us your opinion on beans and oats

  38. DD


    Didn’t you recently comment on this blog that you “don’t have time to explain to Americans–who just don’t get it—that gold is going to depreciate over the next year”?

    And now comes the Porsche article…about this company hedging for 1.80 Euro/Dollar. And here you are, using it as evidence of your thesis that the USD is going to get stronger and commodities like gold are going to get weaker. Then, you get all conspiratorial on us by informing us that this is “the story THEY don’t want you to know about….”

    Only, the problem is that you don’t know how to read an exchange rate. If Euro/USD exchange rate is 1.80, then the Aussie/USD rate would be beyond parity—close to something like 1.10, maybe even 1.20. If the Aussie/USD is at these levels, gold could very well be close to $1500.

    The best part about all of this, however, is this quote from you in the very same post about the dollar getting “stronger” and “SURGING” all the way to 1.80:

    “The notion that the greenback could reach such a level against the Euro will be met with widespread scorn and derision in the blogosphere and New York Times, whose apparent estimation of their expertise on such subjects seems to know no bounds.”

    To which, I must ask:

    Whose apparent estimation of their expertise on such subjects seems to know no bounds????

  39. bg


    “@bg: You don’t agree with us that asset prices can easily decrease in real terms while increasing in
    nominal terms?”

    Of course I agree. I am just saying that inflating to overcome nominal asset deflation will require more money supply than we will probably be willing to apply. To me this is like saying you can cure cancer with a bullet to the head. It will work, but is not a practical solution, thus the cancer will likely continue.

  40. Anonymous

    Wasn’t the financial times discredited as a source upthread? Oh wait, that was an article speculating about global oil production declining precipitously and driving prices skyward (which will happen, I don’t know when). The Porsche article was about the probable resurgence of King dollar, (might happen, who knows, fundamentals suck, but so did housing’s). Mental masturbation at it’s finest.

  41. Anonymous

    The real problem isn’t the supply of money or even low or volatile investment prices. The problem is that bankers and investors are scared and won’t cough up money. So, the money that does exist already just sits in computers doing nothing.

    Instead of feeding more cash into the computers, where the money will sit and look beautiful, the government needs to figure out some combination of financial penalties, financial incentives, death threats, compromising photos of executives in bed with camels, etc. to get bankers to lend and the investors who still have cash to invest. The government also has to figure out some way to make the hedge funds more transparent and protect them against redemption calls from investors who are just wienies and don’t have any immediate need for the money.

    Trying to get the velocity of money might be brutal, but it’s probably a lot less inflationary and federal deficit-increasing than the current strategy of just printing money.

    – invisiblehand64114

  42. S

    inflation in things only works if that inflation trickles down to consumers. nominal prices can not go up if there is no debt bridge. Wages will not go up becasue of the arb. inlfation only works if interest rates accurately reflect the coming inflation. So if you can;t keep pace with investment income and your wages are not reflecting the priming, then exactly how can nominal prices go up for things other than necessities? If inflating the problem away was so easy why the need to even engage in mortgage shaving or restructuring. Wouldn;t the printing eventually just inflate it away. The problem is wages and artificial interest rates, not inflation per se.

  43. Juan

    So now everyone believes in some quantity theory of money and price, while not taking account of the form of money as though there are no limits to credit inflation, no contradiction between real and financial which can’t be overcome through expansion of the latter (even though this drives to collapse, even though the world political economy – while combined – is quite uneven)?

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