Farmageddon

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” – Ludwig von Mises.

“I bought an ant farm. I don’t know where I’m going to get a tractor that small.” – Steven Wright.

The Oxford English Dictionary contains multiple definitions of the word ‘commodity’. One of the more benign and pleasing: “..a thing of use or advantage to mankind.. useful products, material advantages, elements of wealth.” That variant is less commonly used – perhaps because our new and fragile world order looks disdainfully upon real things when financial assets seem so much more sophisticated. More widely used is the following, perhaps a little more pejorative, definition: “A kind of thing produced for use or sale, an article of commerce, an object of trade.. goods, merchandise, wares.. Now especially food or raw materials, as objects of trade.”

These definitions are mutually contradictory. Something that has advantage to mankind, almost of necessity, has an element of scarcity to it. There is something to “an object of trade,” and doubtless to the prevailing perception of “commodities” as now broadly understood in the financial markets, that implies something grubbily practical but unlimitedly fungible, like the proverbial widget. And the “commodities” complex is a broad church, encompassing classic real money substitutes (gold, silver, more latterly perhaps platinum and palladium) as well as foodstuffs (soybeans, corn, wheat, sugar, coffee..) and those energy raw materials (oil, corn again, sugar again, natural gas..) whose price rises are proving so problematic to central bankers theoretically committed to inflationary stability when we all know that the jig is well and truly up. The central bankers have lost control in an unhinged world, and we know it. The prices of gold, silver, platinum, palladium, oil and wheat – the list is not meant to be exhaustive - certainly know it.

Scarcity is where the action is. It was previously assumed, for example, that investment banks – by dint of competitive remuneration moats - possessed some rare access to a mother lode of ‘alpha’ generation that could be tapped, at a price, by paying clients. We now know, from the baneful evidence of a list of market participants too numerous to mention, that investment banks have been trapped by their own hubristic sophistication, and that their ‘alpha’ generation was built on a sandbank of broken financial modelling and leverage. Or as John P. Hussman puts it, in the light of valuation black comedies from the likes of Credit Suisse and others,

“One wonders how companies [but he means banks] can have much sense about the risks of their counterparties when they cannot reliably quantify their own.. I continue to believe that there is substantial risk of audit delays and “qualified” opinions in the upcoming reports of financial companies. It is difficult to see how analysts and some financial news anchors can seriously be looking for the market to have “discounted the bad news” when companies are still at a loss to quantify their news at all. It is equally difficult to see how financials can “come clean” with their losses when those losses generally have not yet occurred because the major wave of mortgage resets that started in October (are) probably only now beginning to produce delinquencies. It’s impossible to know yet which mortgages and how much will end in foreclosure.”

So everybody knows that the banks, with just one or two mysterious exceptions, haven’t just stumbled onto subprime landmines, they have been positively tapdancing upon them – see the chart on the attached PDF. This is admittedly old news, and while banks’ share price charts have typically exhibited a ‘top left (of the screen) to bottom right’ tendency, that does not automatically guarantee anything other than purely optical cheapness – Citigroup recently cut its dividend to the order of 40%; and banking earnings going forward, in the context of sagging property markets, the effective closure of vast swathes of the structured credit markets, and imminent consumer spending retrenchment, look like doing a workable impression of the Bataan Death March.

So much for financial assets and the frailty of the financial system. Bloomberg’s Andy Mukherjee (“Food is a great asset – minus the fund manager”) suggests, by contrast, that “as a hedge against a possible US recession, and [offering] direct exposure to rising urbanization and wealth in Asia, (food) is an asset class that’s tailor-made for the present times.” This is not exactly new news. But the extent of further gains by the soft commodities complex – deemed limited by the sceptics, if agricultural commodity prices are not indeed overdue for substantial correction – should be considered in the context of the extent of further conceivable losses by financial assets. Our thesis, essentially, is as follows: yes, grains and other food raw materials prices have soared beyond the expectation of most commentators over recent months, and a pullback may well be overdue. But in the context of a global financial crisis that is some way from resolution, in the context of the ongoing manipulation of foodstuffs’ economic fundamentals by governmental promotion of food crops as alternative fuel, and in the longer term context of mammoth Asian demand, on which side of this trade would you prefer to sit ?

Mr. Mukherjee raises an interesting point. Agricultural commodity prices are booming. But he cites a Merrill Lynch report indicating that many actively managed funds focused on agriculture are failing to outperform passive indices. Since this is par for the course across all asset classes anyway, this should come as no particular surprise. But just as commodities markets are now rising because of insufficient expenditure upon basic infrastructure during the previous extended bear market, so the fund management community is comparably short of the raw material in investment expertise required to deliver the goods in value-added terms. As futures markets are particularly prone to manipulation and marked volatility, the current wave of commodities fund managers may largely be handing their putative “alpha” to the savvier locals within the commodities pits. Wall Street is only now waking up to the commodities boom – commodities desks are, presumably, the only growth opportunities within a financial sector otherwise stealthily removing human material from the balance sheet. And Wall Street has been maintaining oil research teams for some time now, but that doesn’t seem to have done anything to improve their price forecasting abilities, which can best be described as vilely incompetent. Either way the conclusion seems clear: ETFs 1, Wall Street 0.

There is yet another definition of commodity: “Profit, gain.” Notwithstanding the fact that the commodities trade is altogether more crowded than it used to be, that usage still seems – particularly relative to financial assets – highly appropriate now. Inflationary pressures are on the rise. 10 year Gilt yields have recently turned a corner, from lows of around 4.40% to above 4.70%. They probably have some way further to rise, given the cost of the Northern Rock bailout, and the outlook for diminished corporate (and personal) tax revenues amidst a recessionary slowdown. US Treasury yields have shown a similar reversal, albeit from lower, panic-induced levels. Western governments / central banks are facing a showdown of credibility in their ability to rescue their banking systems by means of aggressive monetary easing without triggering an uncomfortable upsurge in inflation. Commodities in a general sense, and the likes of precious metals and agricultural foodstuffs in a very specific sense, are robust hedges against currency [specifically US dollar] weakness even without the uplift from anticipated Asian demand. Any pullbacks by commodities look like being superb buying opportunities. The fact that so many investors seem to be waiting for them could mean that those pullbacks prove somewhat elusive.


Download Farmageddon.pdf