Tuesday, April 29, 2008

BCA: "...Commodity Equities are "Bullet Proof"

When the Bank Credit Analyst proclaims something, contrarians should take note. And so, today, as the BCA said "Buy, buy, buy..." just before the entire complex of commodity-correlated risky-asset plays was getting shallacked. This includes Gold , which, as I write this is sitting at a four-month low, enroute to what appears to be a somewhat larger correction, presumably spurred by the worse-than-expected decline in US home prices and yesterday's continuing rise in the stock of unsold homes to rather alarming levels. Ooops. To be entirely fair to their junior analysts, they were particularly highlighting the spread opportunities between spot prices and performance of underlying related equities and long-dated futures, the latter presumably reflecting still-skeptical investors that are discounting underlying demand erosion once the housing shit, currently encountering the fan-blades in the USA, Spain, and Great Britain, reverses course and disperses globally. The beauty of "futures" is that no one need make any difficult decisions so long as prices are moving in one direction: The Right One! However, when prices move in the opposite direction (technical term: The Wrong Way), both, investors' convictions (if they have any), and their credit-lines (if they also have any) are put to the test. What happens when price-action causes conviction to collide head-on with margin-call in the game of buy-sell-hold rock-paper-scissors?? Speculative liquidation is rarely far behind...


Anonymous said...

BCA ain't what it was before they shortened their name - and you had to go down to the library to read it.


"Cassandra" said...

Ain't indeed!

BTW Charles,I greatly enjoyed your last two posts, particularly your investment manifesto. And "Congratulations!" are an order on your upcoming union, and many regrets at not being able to celebrate there.

The last such Mediterranean nuptial fete that I attended has become the stuff of legends (for me), as they are recounted to me by third-parties since my own recollection of things occuring after sunset are seemingly now-lost forever, excepting a vague recollection of a Jameson's-induced (or was it Grant's?) pact "to shoot me" if I ever became "like THAT!. Unfortunately, I am unable to recall what "that" was, and so, like Closeau, am forever looking over my shoulder for Kato...

Mencius Moldbug said...

Strangely enough, most analysts seem to think mold is trading down with other "safe-haven assets" such as Treasuries, based on the recent mild "whew of relief" that has Barron's sporting a bull on its cover. I'm not sure I buy this category, but if I buy the category I definitely don't buy the trend. There have been other such whews in the recent past - all temporary.

The problem with associating the shit-fan interaction, which is definitely (I like MM's comment about "trading the recovery before the recession happens") on its way, with commodity prices excluding gold (eg, the gold-oil ratio has moved quite vertiginously in favor of the latter), is that IMHO it assumes a simplistic hot-cold model of commodity price inflation which does not fit the facts at present.

Commodity prices are not rising because the global economy is "overheating." Commodity prices, as measured in Western currencies, are rising because there is a hemorrhage of Western currencies flowing from the West to a set of commodity buyers whose demand for basic commodities is very sensitive to their wealth - as measured in Western currencies, or at least non-Western ones pegged to Western ones.

For this effect to stop or reverse, its cause has to stop or reverse. To stop appreciation in the price of basic commodities, you need an economic event which either (a) substantially reduces Western commodity demand, or (b) stops or reverses the trend of increasing non-Western commodity demand.

How much will a Western recession achieve either of these goals? Will it produce any substantial reduction in the flow of Western monetary instruments to China, for example?

As I've pointed out repeatedly, China, whose political stability is not impressive and which has no intention of allowing a recession, could easily decouple itself from a drop in Western demand simply by slowing or halting its peg crawl. To overcome this effect would take a consumption drop of 10% a year or so - in the amount spent on Chinese goods. Ie, manufactured goods.

A 10% drop in demand is not a recession, it is a disaster. Washington will accept any amount of price inflation before it lets an event like this happen. Perhaps it should happen, but I don't think it will.

So I urge you to rethink your assumption, whether intuitive or model-powered, that Western financial carnage or even a Western recession implies a drop in commodities prices. Certainly today's prices, or at least tomorrow's futures have a lot of speculative prediction baked in, and this prediction could be too high. On the other hand, it could also be too low. Wouldn't be the first time.

"Cassandra" said...


I thank you for your concern and would suggest we are not far apart for in your big picture view, such swoons as I might occasionally prophesize are, in fact, tactical, at least until we emabrk upon, as we both agree, more Volckeresque response. That said the mid-seventies correction in similarly desired things that made noise when you dropped them were on the order of 40 to 50%. In my experience, markets (however one-way they appear) have a curious habit of shaking the tree to see what falls, and at the moment, it is the risky-asset longs in energy, iron-ore, fertilizer etc. that are perched up high. That said, I wouldn't want to leave a short position out there while I hitched a rocket to Mars, and hopefully, back...

David Pearson said...


Some perspective: for the past five years, there have been moments when an acceleration in inflation caused the gold price to fall. The premise behind the correction was always the same: "now the Fed will HAVE to get tough on inflation, so its time to exit gold."

Of course, you know how the story turned out.

The reaction of gold to a spike in inflation is a remnant of belief in the Volkerian resolve of the Fed. That remnant is frayed, bleached, and crumbling. How many more inflation-spike corrections will we see in gold before the trade goes the opposite way? We're overdue, and I would not be surprised to have it happen at this juncture.

Mencius Moldbug said...


I will argue with you about economic fundamentals (or political ones) all day. But when it comes to trading intuition, I know my limits!

Charles Butler said...

Thanks lad (on both counts). We can sympathise. Northern drinking and southern feasts are mutual anti-matter. But we'll be saving the inevitable bone shards and severed extremities as treasured mementoes.