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Tuesday September 19, 2006 - 09:42:37 GMT
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The commodities game: There’s nothing new here

Key News
• China's policy to boost its consumer spending is beginning to bear fruit, central bank governor Zhou Xiaochuan said. Consumption has expanded at rates of around 12-14 pct this year, about half to two-thirds the pace of investment and export growth. (AFX)
• Just how much will the US housing market decline impact the US consumer. Not nearly as much as expected, says Morgan Stanley’s Richard Berner: the deceleration in housing wealth will have at most one-fifth the impact on consumer spending that some fear. Some, including former Fed Chairman Greenspan, believe that 50 cents of every additional dollar of home equity extraction has financed consumer outlays. Empirical studies, however, suggest that a $1 decline in real housing wealth would trim spending by at most 11 cents, and some suggest that the effect would be half that magnitude. (MS)
• Key Reports (WSJ):
7:45a.m. ICSC Store Sales Index. For Sept 16 Wk. Previous: -0.3%.
8:30a.m. Aug Housing Starts. Previous: -2.5%.
8:30a.m. Aug Producer Price Index. Previous: +0.1%.
8:30a.m. Aug Producer Price Index, Ex-Food & Energy. Previous: -0.3%.
8:55a.m. Redbook Retail Sales Index. For Sept 16. Previous: Unch.
5:00p.m. ABC/Wash Post Consumer Conf. For Sept 17. Previous: -13.


“Yet commodities as a financial asset are as bubble-prone as any other investment. As is always the case in every bubble I have lived through, denial is deepest when asset values go to excess. That’s very much the case today. After three years of extraordinary outperformance, denial over the possibility of a sustained downside adjustment in commodity prices is very much in evidence -- underscoring the time-honored sociology of an asset class that has gone to excess. Meanwhile, China and US-housing-related fundamentals are going the other way -- setting up increasingly tender commodity markets for unpleasant downside surprises on the demand side of the global economy.”

Stephen Roach

FX Trading – The commodities game: There’s nothing new here

Lately, and we plead guilty, there is much talk about a big break in commodities i.e. metals and energy as the grains haven’t quite played along anyway—which could go to the argument that global food production has become so efficient, maybe grain and other food prices will remain stable or low for a very long time, but that’s an issue for another day. The break in commodities hinges on growth. And growth hinges on the US consumer and China; more specifically, how quickly the Chinese can fire up domestic demand. According to Central Bank Governor Zhou Xiaochuan, as noted in Key News above, Chinese consumer demand is growing nicely.

But, we must think in relativity and time frames when it comes to leveraged markets, for as Mr. John Maynard Keyens once said, “Markets can remain irrational longer than you can remain solvent.”

So despite longer term optimism that Chinese consumer demand will continue to explode higher and the US consumer will remain solvent longer than most analysts expect, we have to believe there is still much in the way of spec in the commodities. The question—how much speculative juice needs to be washed away before it’s over?


We noticed one of the major commodities players has been sent to the penalty box, the Journal reported this morning:

“Here in this bustling new energy frontier, Mr. Hunter headed the energy desk for a Connecticut hedge fund called Amaranth Advisors. At the end of August, trading natural gas, he was up approximately $2 billion for the year. Then Mr. Hunter lost roughly $5 billion, in about a week.

“His losses savaged returns for Amaranth, dragging its assets under management down to $4.5 billion from $9 billion at the start of September. In disclosing the losses to investors in a letter yesterday, the fund said it was ‘aggressively reducing’ its natural-gas bets, though Mr. Hunter remains at the fund.”

The story also mentioned that Mr. Hunter was 32-years young. The question: How many more 20- and early 30-something hubris-filled Masters of the Universe running a lot more money than they ever should, making bets they do not understand, will come home to roost?


“His reaction to the first losses was, characteristically, to ignore the market. ‘One would go crazy if one were to listen to the mood swings of the market,’ he [John the trader] said. What he meant by that statement was that the ‘noise’ was mean reverting, and would likely be offset by ‘noise’ in the opposite direction. That was the translation in plain English of what Henry [John’s quant trading assistant] explained to him. But the ‘noise’ kept adding up in the same direction.

“As in a biblical cycle, it took seven years to make John a hero and just seven days to make him an idiot. John is now a pariah; he is out of a job and his telephone calls are not returned. Many of his friends were in the same situation. How? With all the information available to him, his perfect track record (and therefore, in his eyes, an above average intelligence and skill-set) and the benefit of sophisticated mathematics, how could he have failed? Is it perhaps possible that he forgot about the shadowy figure of randomness?”

Nassim Taleb, Fooled by Randomness

The point: There could be a lot more spec in the commodities game than we realize even if optimistic growth forecasts prove true.

Jack Crooks, Black Swan Capital Black Swan Subscription-based Service


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