Commodity Prices, Growth And Inflation / The Daily Reckoning

verfasst von - Elli -, 15.03.2003, 14:52

-->Commodity Prices, Growth And Inflation

The Daily Reckoning

Paris, France

Friday, 14 March 2003

--------------------

*** Readers are cross with us...

*** Dow up big time - 269...gold down big time, too - more
than $10

*** War...war...war...dead soldiers...and more!

--------------------

Et tu, dear reader?

Daily Reckoning readers are canceling their subscriptions.
Not exactly in droves...but at least a large enough number
to cause us to take notice. We write today with more
disturbing thoughts...and brace ourselves.

Readers are cross with us because they don't like our
attitude toward the war against Iraq...they do not think we
take the matter seriously enough...they don't like the
comments we hear on the street or at dinner parties and
pass along to you...they don't think we have any business
having opinions about politics...and they especially don't
like the fact that these opinions pullulate in what they
regard as the devil's own den - Paris, France.

"Dear Editor," begins one letter, politely."U seem to be
overlooking a few Natural facts concerning the U.S.
Economy...Confuscious says: He who has the biggest Gun,
makes the rules...the difference between right and wrong is
an opinion and since the U.S. has the biggest gun then the
U.S. opinion is the only one that counts."

Another correspondent describes our humble notes as
"drivel"...

"Leftist politics," says yet another (never before have we
been so accused...!)

"You better come home...your brains have been taken over by
socialists..."

"Hopefully, America will drop a few smart bombs on you on
their way to the middle east..."

Strange and dangerous things are happening, dear reader. In
the past, Americans have gone to war reluctantly; now they
seem to look forward to it. The rest of the world - which
seemed to go to war so readily in the past - seems
overwhelmingly opposed.

What both sides have in common is dollars...which is what
attracted our interest in the first place. The dollar rose
sharply yesterday...and the price of gold dropped more than
$10.

Stocks took off. Investors panicked, just as we worried
they might, but in the wrong direction! The Dow rose an
astonishing 269.

The Dow depends on the economy. And the economy depends on
the dollar...and on the rest of the world's confidence in
it. At least in the near-term, the dollar's value seems
linked to the war effort. In the long term, we think the
dollar is doomed...as all paper currencies sooner or later
disappear to worthlessness. (For key reasons why, see our
special report:

How To Seek Profits From The Dollar Breakdown
http://www.agora-inc.com/reports/RCKN/Everbank)

The short term may produce surprising twists and turns. War
news now seems to drive investor sentiments. One day, bad
news sends the dollar and Dow down...the next, a rumor
causes them to soar.

Like it or not, we have a war to reckon with.

Faith in the currency is faith in the future...and faith in
the economy and the system behind it. Three years ago,
Americans had almost unlimited faith in their stock market.
Here at the Daily Reckoning, we mocked the bubble; U.S.
stock prices rested on illusions and lies, we pointed out.
Many readers didn't want to hear it.

They wrote to complain and cancel.

Now they cancel when we scratch their almost unlimited
faith in U.S. military superiority, the dollar, and
American consumer capitalism. Stocks peaked out 3 years
ago. The bull market in confidence has migrated from stocks
to arms...from the comedy of markets to the tragedy of
politics. People welcome war talk as they once welcomed
statements from their brokers; they seem to think that U.S.
military might can not only protect the homeland...but
protect its dollar and its economy, too.

Will the end of the war cause the dollar to rise? Will
taking out Saddam make the world a better place? Those
canceling their subscriptions seem to know the answer; to
them it is as obvious that the war against Iraq will be
successful as it was once obvious that stock prices would
always go up.

How they can know what will happen tomorrow is anyone's
guess. We wish we could do it - but we have never mastered
the secret. So, we fall back on the dusty tomes of history
for examples...and a tattered old bunch of rules and
principles for guidance. We don't buy stocks when they are
high; we say please and thank you; and we wait for the
other guy to strike first.

But these are strange and foreboding times. And even this
modest position is regarded by many people as if it were
treason.

"We Americans take action," a reader reminded us."We don't
waste our time with a lot of talk like the French."

But the preference for action over reflection is probably
episodic, not genetic. In the Napoleonic era, the French
favored action."Audacity, more audacity, always audacity,"
Danton urged the generals in 1792. In just a few years, the
bodies of audacious French soldiers were spread all over
Europe, following the trail of Napoleon's many wars.

Then came the Franco-Prussian war - and still the French
were men of action. It was the French who went on the
attack, not the Prussians. And once again, their lovely
corpses were soon scattered all the way from Paris to the
Belgian border. In short order, the Prussians had
surrounded the French capital; Parisians had to eat cats,
dogs and rats before finally surrendering.

What did the French learn from this? The doctrine of 'élan'
- or fighting spirit - rose in the French military."Let
us go even to excess and that perhaps will not be far
enough," wrote Col. de Grandmaison, mad as a hatter."In
the offensive, imprudence is the best of assurances..."

At the beginning of WWI, the French got a chance to try to
this new tactic. The aging Mr. Junot, with whom we dined a
few months ago, recalled his own uncle:

"He was mounted, with his sword drawn...and he attacked the
German machine guns!"

"Never have machine-gunners had such a heyday," writes
Alistair Horne in his history of the period."The French
stubble-fields became transformed into gay carpets of red
and blue. Splendid cuirassiers in glittering breastplates
of another age hurled their horses hopelessly at the
machine guns that were slaughter to the infantry. It was
horrible, and horribly predictable...that superb, insane
courage of 1914..."

Within the first year of war, France lost more men than the
U.S. lost in both WWI and WWII. The French began to
think... and talk...

One day, Americans will, too. Of course, that could be many
years from now...

*** More from George Soros, writing in the Financial Times:

"I see a parallel between the Bush administration's pursuit
of American supremacy and a boom-bust process or bubble in
the stock market. Bubbles do not grow out of thin air. They
have a solid basis in reality, but reality is distorted by
misconception. In this case, the dominant position of the
U.S. is the reality, the pursuit of supremacy the
misconception. Reality can reinforce the misconception, but
eventually the gap between reality and its false
interpretation becomes unsustainable. During the self-
reinforcing phase, the misconception may be tested and
reinforced. This widens the gap leading to an eventual
reversal. The later it comes, the more devastating the
consequences.

"This course of events seems inexorable, but a boom-bust
process can be aborted at any stage and few of them reach
the extremes of the recent stock market bubble. The sooner
the process is aborted, the better. This is how I view the
Bush administration's pursuit of American supremacy.

"President George W. Bush came into office with a coherent
strategy based on market fundamentalism and military power.
But before September 11, 2001, he lacked a clear mandate or
a well-defined enemy. The terrorist attack changed all
that. Terrorism is the ideal enemy. It is invisible and
therefore never disappears. An enemy that poses a genuine
and recognised threat can effectively hold a nation
together. That is particularly useful when the prevailing
ideology is based on the unabashed pursuit of self-
interest. Mr Bush's administration deliberately fosters
fear because it helps to keep the nation lined up behind
the president. We have come a long way from Franklin D.
Roosevelt's dictum that we have nothing to fear but fear
itself."

*** Enron...Worldcom...Fannie Mae!? Yes, St. Louis Fed
governor William Poole mentioned all three in the same
breath. Could Fannie Mae and Freddie Mac, which together
own or guarantee 45% of the U.S. residential debt market -
$3.1 trillion of it - go broke? Well, they could. We'll
have to wait and see if they do.

*** Welcome to the future: A candidate for president of
Argentina proposed linking the peso neither to the dollar
nor to the euro, but to gold.


The Daily Reckoning PRESENTS: Can commodity prices continue
to rise while economic recovery continues to elude
countries around the globe? Yes, says Andrew Kashdan, who
sees a resurgent inflation, not a resurgent economy, as the
key to what could be a long-term bull market in the
resource sector.


COMMODITY PRICES, GROWTH AND INFLATION
By Andrew Kashdan

The U.S. economy, formerly the growth engine of the world,
has been sputtering recently. That's causing most
economists to push back their targets for the strong, self-
sustaining recovery that was supposed to have started
already...according to the earlier forecasts of these same
economists. Europe and Japan are hardly in a position to
take up the slack. So the question for us is,"Can
commodity prices continue to rise in this environment?" To
offer a preview: Yes.

Over the long term, it is clear that during periods of
strong economic growth, commodity prices tend to rise, and
during periods of weakness, prices tend to fall. But the
CRB Index of commodity prices tracks nominal GDP more
closely than it does real GDP. This fact is not too
surprising, given that the CRB simply measures the nominal
price of a basket of commodities. In other words, inflation
may be more pertinent to the recent commodity price trend
than GDP growth, per se.

Over the past year or so, for example, the rallying CRB
Index has had little to do with GDP growth. In the last few
quarters, the Economic Cycle Research Institute (ECRI)
leading indicator of economic growth has shown clear
periods of improving or deteriorating economic growth. Yet,
commodity prices have maintained their upward trajectory
regardless of the economy's up-and-down growth prospects.
The CRB Index has advanced steadily to post a nearly 30%
gain since the beginning of the year. Meanwhile, actual and
expected rates of inflation have been heading higher, even
as the economy remains weak, and that's what is showing up
in the CRB. Inflation seems to be the message from the
commodity pits.

The Treasury's inflation-indexed bonds tell a similar tale.
The inflation rate"anticipated" by the 10-year inflation-
indexed bond has increased by about 30 basis points to
nearly 2%, in just the last few months. And you wouldn't
know it by reading the papers, or listening to our chief
inflation-fighter at the Fed, but actual inflation has been
rising, too. On a year-over-year basis, the CPI has gone
from 1.1% last June to the latest reading of 2.6%. Not
quite a repeat of the stagflationary 1970s yet, but not
deflation either. The recently released ISM prices-paid
index jumped to 65.5 from 57.5, surpassing its long-term
average of 62. And after two months of declines in the
Producer Price Index, the January PPI jumped 1.6%, boosted
by a 4.8% rise in energy prices.

One central bank, at least, has already glimpsed the near
future. The Bank of Canada raised rates another quarter-
point this week, taking the overnight rate to 3.25%, up
from 2% since the start of 2002. Canada's inflation rate is
running at 4.5%, a 12-month high, due largely to high oil
and natural-gas prices.

Net-net, the current commodity rally seems to be about
resurgent inflation, rather than resurgent economic
activity. And if Fed Governor Ben S. Bernanke has his way -
remember, he's the one who promises to crank up the
"printing press" to fight deflation - this commodity rally
has a ways to go. What is more, one aspect of the current
commodity rally is not widely appreciated: it is not just
oil that is powering the rally. Nearly all commodities are
in"rally mode" to some extent.

Curiously, the stock market is full of skeptics about the
ongoing commodities rally. Very few resource stocks have
kept pace with their related commodities. And that bizarre
divergence may present a terrific investment opportunity,
even for the most cautious of commodity bulls. If we are to
"trust" the CRB rally, numerous resource stocks are a
strong buy (and, by the way, long-term bonds are a
screaming sell). Over the last several months, the XOI, XNG
and XAU - indexes for oil, natural gas, and gold and
silver, respectively - have barely budged, despite
substantial rallies in their related commodities.

For example, let's take a look at the XNG Index of natural
gas stocks relative to the price of natural gas itself.
Natural gas prices have soared more than 260% over the past
year and a half. Amazingly, however, the XNG Index - which
consists of 15 major gas producers - has actually declined
by more than 8% over the same period! A similar divergent
pattern is seen in the oil markets. The benchmark WTI crude
oil price has nearly doubled since late 2001. Even so, the
XOI Index of oil stocks has dropped about 13%.

Likewise, the XAU Index of gold stocks peaked in May 2002,
and has dropped more than 14% since then, while gold itself
has increased by 7%."That is a real historic anomaly,"
says fund manager Paul Stuka, quoted in Barron's,"because
[gold] stocks should appreciate about two to three times
the rate of metal itself. There is something really odd
going on." Unfortunately, for some gold investors, the XAU
has suddenly found some leverage on the way down - the gold
price has dropped about 5% in the past month or so, while
the XAU has lost 12% (and the unhedged Amex Gold BUGS Index
has dropped 13%).

Clearly, all three of these equity indexes for natural gas,
oil and gold are pricing in a significant downward reversal
in the prices of their related commodities. In other words,
the indexes, especially the XNG, seem to be discounting a
worst-case scenario. That's funny; because we think we are
looking at a best-case scenario for natural gas and most
other commodities. A temporary pullback in natural gas
prices would hardly be surprising, given the spectacular
recent rallies. But we think that the natural gas bull
market is the"real deal". Therefore, we suspect that the
shares of many natural gas companies are too cheap because
they are pricing in a worst-case scenario that is highly
unlikely to occur.

The weak performance of natural gas stocks, and resource
stocks in general, relative to their related commodities
looks like a golden opportunity. Investors may be getting a
great chance to climb aboard a powerful long-term bull
market in commodities, and to do so at deeply discounted
valuations.

Given the low valuations of many resource stocks, coupled
with an inflationary threat that most investors have failed
to notice, and a favorable long-term supply and demand
outlook for raw materials, the resource stock party may be
just getting started.


Best regards,


Andrew Kashdan
for The Daily Reckoning

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• Commodity Prices, Growth And Inflation / The Daily Reckoning - - Elli -, 15.03.2003, 14:52