The Edible Portfolio

Commodities have made a big push front and center in the last couple of years – and we aren’t just talking about the always-popular topics of oil and gold. With the birth of the ethanol craze, more and more commodities are coming to the forefront – particularly corn, wheat and soybeans.

“It’s pretty ironic that the modern commodities markets owe their success to the original grain markets that started it all,” writes Kevin Kerr in today’s guest essay.

“Back only a couple of decades ago, there was no such thing as an energy futures market or a stock market index. In fact, the grain markets were the first organized futures contracts when many of the exchanges started trading. As the markets developed, grains took a bit of a backseat and the financial and energy commodities seemed to take the lead.

“Now with the emergence of the electronic trading market and the ethanol boom, grain futures are soaring. The global demand for agricultural and soft commodities is so significant that these markets are not only important, they are vital for price discovery once again.”

Eric Fry
September 20, 2007

Keep reading today’s guest essay here:

The Edible Portfolio

More news from Short Fuse in Los Angeles…

————–

Views from the Fuse:

As Gilda Radner would say: “It’s always something.” And right now it’s everything.

Our friend Byron King points out that since the Fed cut rates on Tuesday:

“Oil over $82 per barrel and rising.

“Gold over $734 and rising.

“Canadian dollar at US parity. (Tar sands aren’t so cheap anymore, huh?)

“Euro over $1.40 and rising.”

This is the seventh straight session that crude has hit a record high – this time on news of refinery shutdowns and equipment malfunctions in Texas and California. Also supporting the price of crude is a “mixed” report from the Energy Department’s Energy Information Administration. The report shows that inventories have declined due to the disturbance Hurricane Humberto made to shipping and refinery operations along the Gulf Coast.

As the price of oil rises, the greenback is falling – so far, in fact, that it has reached a new all-time low against the euro (EUR). MarketWatch reports:

“‘Fueled by a break in the euro just above the $1.40 mark for the first time ever, the gold market took off like a Pamplona bull,’ said Jon Nadler, analyst at Kitco Bullion Dealers.”

As of 11:59 AM (EST), gold futures were up $15.10 to $744.60 an ounce, a price not seen in 27 years. Gold has held at over $700 for more than a few days only once before – and that time, the price went up to $850.

If history repeats itself, the yellow metal could still have a ways to go – and there is a way to own gold with ‘zero-downside’ risk.

Gary Dorsch, at SafeHaven.com, says we’ve entered the “Twilight Zone” of the economic cycle:

“Nowadays, there are numerous signposts indicating that inflation in the United States is getting out of control. The US M3 money supply is 14% higher than a year ago, its fastest growth rate in 35-years, the US Dollar Index is plunging to 15-year lows, gold is surging toward $725/oz, a 28-year high, crude oil is cruising above $80/barrel, wheat prices have doubled to $8.75/bushel, an all-time high, and the Baltic Dry Freight Index has zoomed 300% higher to stratospheric levels.

“It’s like entering ‘a fifth dimension beyond that which is known to man, that lies between the pit of man’s fears and the summit of his knowledge.’ It is an area called ‘The Twilight Zone’, Mr [Rod] Serling explained. Could it be – the fifth dimension that lies ahead is hyper Inflation, and the re-ignition of the ‘Commodity Super Cycle?’ Money is still pouring into commodity indexes to diversify portfolios, amid recent financial market turmoil, reaching $120 billion at the end of the second quarter, up 50% from a year earlier.

“Food and energy prices are sharply higher from a year ago, and this time, the surge in these ‘volatile components’ of inflation is not a flash in the pan. But remember, you’re in the ‘Twilight Zone,’ where perception is more important than reality, and emotions often trump logic. Putting it another way, ‘there is nothing so disastrous as a rational investment policy, in an irrational world,’ explained JM Keynes.”

And the rally in agriculture prices is still on…and likely to continue for a while, reports Resource Trader Alert’s Kevin Kerr. “If you think agriculture prices are high now, at these record levels, think again. With early frost in the plains, we have new worries on our hands.”

“However,” continues our Maniac Trader, “snow isn’t quite here yet, so the more pressing concern is disease.

“This April, and then again in the summer I went to visit farms across the country. Hopes were high for a solid gigantic crop of corn, beans, and wheat. Little by little, that dream is fading. My sources in Minnesota and Agriculture online report that, ‘not only have the hot and dry conditions and hail affected corn yields in Minnesota this year, these conditions have also favored development of ear rots.’

“Meanwhile, soybeans have problems of their own…as early defoliation and death of soybeans in patches have been reported recently.”

Kevin’s Resource Trader Alert subscribers have had a pretty good September so far…they’ve closed half a position in wheat for 146% gains in seven days…closed second half of soybean oil for 125% gains in 19 days, and most recently, sold half of December gold spread for 100% gain in about eight months.

It is the sensation that you get when you get older. It comes from parachuting out of a plane, Doug explains. For a very long time, you have the impression that you are just floating in air. And then, suddenly, you see the ground rushing up at you.

When you are a child, a week is a very long time. Now, a week goes by for us like a cross-town bus. We stand on the curb, reading the headlines in the Financial Times, and it is goes by; we hardly notice.

Autumn weather has come to London. It is still warm, but the sky is clouded over and the leaves have turned yellow. What happened to spring and summer, we wonder? We can’t quite remember them.

Last night, we went to dinner at a small apartment with our two daughters…boyfriends…girlfriends…friends of the family…and people who seemed to walk in off the street. “Ai yi yi,” we said to ourselves. “They’re growing up so quickly. For a long time, they were children. We thought they’d be children forever. But now…a kind of ground rush has taken over…everything is happening so fast. “

The two girls are not little girls anymore; they’re grown women. They’re adults, with grown-up manners and grown-up problems. We tried to remember them as they were when they were five or six. The memory must be there somewhere…but we couldn’t find it…we couldn’t quite remember what they were like. We now know them only as they are.

Why does this matter to Dear Readers? Well, we wonder if there isn’t a kind of ‘ground rush’ in the economy too. For a very long time, everything remains more or less the same – floating in air. Stocks rising gently. Credit flowing by like a jet stream. The dollar slipping down softly.

Then, when you begin to think that these comfy trends are permanent, suddenly, everything changes. All that ‘flation’ in the system explodes…prices soar…or collapse. Markets are hit – as though by people whose parachutes had failed to open. And then, you can’t quite recall what it was like before…you are dazed at first…and then the reality of ‘ground rush’ focuses your attention so vividly that you can’t think of anything else. You lose perspective. What is becomes so much more important than what used to be.

Ben Bernanke opened up an auxiliary parachute on Tuesday. It lifted investors’ spirits. But will it really stop the fall? Will it greatly prolong this period of floating in air? We’ll have to wait to see.

But it appears to us that the direction of the economy…and the markets…remains the same.

“The decline in house prices stands to create future dislocations, like the credit crisis we have just seen,” said Yale economist Robert Shiller to the U.S. Senate’s joint economic committee.

Applications for building permits fell to a 12-year-low. They’re now at their lowest level since June 1995. And consumer prices actually fell last month – led by the price of gasoline. Government reports tell us that the inflation rate has gone down, from 2.2% to 2.1%.

As inflation eased off, it gave the Fed time to turn its forces from fighting inflation to fighting the other kind of “flation.”

Alan Greenspan, whom you all know by reputation, told the Financial Times this week that he thought house prices in the United States might fall by more than 10%. House prices more than doubled in the last 10 years. A 10% correction seems like a minor adjustment. But it would have grave consequences, says Shiller.

The Center for Responsible Lending predicts that foreclosures on subprime loans will lead to a total loss of $164 billion worth of home equity. Financial institutions are said to be facing losses of more than $300 billion from mortgage financing. But the real losses will be suffered by ordinary homeowners. The total value of residential real estate, in the United States, is about $21 trillion. A 15% loss would be the equivalent of a $3 trillion loss in household wealth. Things aren’t looking so good for the average homeowner.

That would be a whole lot of ‘flation’ taken out of the system…and a hard landing for the millions of people who’ve been floating in air for the last 20 years.

Poor Mervyn King. The man is the head of the Bank of England. He was just trying to do the right thing. When the credit crisis began this summer he, alone among central bankers, stood firm. No bailouts, said he. If we rescue reckless lenders and imprudent speculators, he opined, it could “sow the seeds of a future financial crisis.”

But integrity in a central banker is like honesty in a politician or chastity in a prostitute – the quality is completely at odds with his profession. Economists talk about the “moral hazard” of allowing investors to do the wrong thing and get away with it. But the hazard is greatest for central bankers themselves. Not since Paul Volcker has any central banker been able to stand up straight. Instead, they bow to pressure – from politicians, the public, the media, and the squirrelly economics profession itself. This has led to what some economists refer to as an “asymetrical response” from the financial authorities. When the going is good…they are reluctant to tighten up on credit. But when the going is not so good…they ease up quickly.

Mr. King resisted pressure for a few weeks. Then, when the tabloids began running photos of depositors lining up to get their money back from troubled mortgage lender Northern Rock, he buckled. He turned to the cameras and offered to help out. “You need money…” he almost said. “Just come see me.”

“I’ve seen this movie before,” said Angelo Mozilo, boss of Countrywide Financial, “and it always ends in some form of recession.”

Does it? Real estate prices have gone down before – sometimes sharply – in the United States. But the declines were always confined to certain regions. Now, for the first time ever, real estate prices are falling nationwide.

If they fall 10% or more – as Alan Greenspan suggests – it will take more than $2 trillion out of the nation’s wealth. Of course, it was never real wealth anyway…as we pointed out many times. It was just ‘on paper.’

Still, many Americans spent the money anyway…borrowing against the inflated value of their own homes in order to get cash. Now, the value may disappear. But the debt will still be there. What happens next depends on what prefix you put before the ‘flation.’ If it is ‘in’ interest rates tend to rise…then, the cost of servicing the debt pushes the hapless debtor into the poorhouse. If it is ‘de’ …then he loses his job…his house falls in value, along with his stocks…and he is out of luck. Either way…the result is a slump (eventually).

Until tomorrow,

Bill Bonner
The Daily Reckoning