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The commodity crush By Richard Croft February 29, 2008 – Now we know. And we have it from no less an authority than the winner of the 2001 Nobel prize for economics, Joseph E. Stiglitz. We can heap most of the blame for the current US credit crisis, stock market volatility, commodity boom, and housing market collapse on the former Chairman of the US Federal Reserve Board, Alan Greenspan. And his successor, Ben Bernanke, also must share some of the guilt, says Stiglitz. In a Feb. 26 interview on Bloomberg television, Stiglitz announced that the current crisis had its origins during the heady Greenspan years following the tech bubble (which, according to Stiglitz and others, Greenspan was also responsible for!). Greenspan not only was “asleep at the wheel, he actively looked the other way,” said Stiglitz in laying the blame for the US housing bubble at the former Fed chairman’s doorstep. During the 2000-02 US recession, the Fed cut its policy rate to the lowest level in 30 years in an effort to stave off what it perceived as the imminent threat of a deflationary collapse of the kind that kept Japan in the doldrums for a decade. Whether such a deflation was imminent or not is open to question (I argued at the time that it wasn’t imminent). Nevertheless, the deep interest rate cuts had the desired simulative effect - resulting in an orgy of easy credit. It’s an effect that Stiglitz and others argue has led in a straight line right to the financial crisis we face today. Stiglitz has a point. In economics, the line of cause and effect is usually pretty easy to see. What’s more difficult to see is how the Fed or any of the other major central banks could have acted in any way other than they did. And here’s where analysts like Stiglitz — and others who have a particular left-wing political drum to beat — run up against the 20/20 rule. Never heard of that one? That’s the rule that says unequivocally that hindsight is always 20/20. Foresight is blinkered, with a patch over one eye and cataracts in the other. Poor old Alan — blamed for all the bursting bubbles. But also grudgingly noted for presiding over some of the longest periods of low-inflation growth in American history. In the larger scheme of things bursting bubbles, recessions, bear markets are probably inevitable. Even the redoubtable Mr. Greenspan recently admitted that he “wouldn’t be surprised if this recession is deeper than the last two shallow recessions.” He added that the economy is at stall speed, saying, “When you’re at stall speed, anything that goes wrong takes you lower.” Well, let’s not shed any tears for Alan. He’s now a high-priced economics consultant in the private sector with PR that you couldn’t buy for a million bucks. Instead, let’s sympathize a little with the current Fed Chairman, Ben Bernanke. Right now, Mr. Bernanke is presiding over a U.S. economy that’s inexorably gearing down, while inflation is stubbornly gearing up. The U.S. economy grew at a minuscule 0.6% annualized in the fourth quarter of 2007. But as of the end of January, the consumer price index was rising at an annualized rate of 4.3%. Most recently, US wholesale prices rose at an annualized 7.5% in January, the fastest rate since October 1981. The Fed has signalled that it is likely to continue easing in coming months in an effort to cushion the economy. And that raises the spectre of “stagflation,” a condition of stagnant growth combined with rising inflation. Whether it’s a cause or an effect of inflation, or a consequence of the slumping U.S. dollar, commodity prices have been on tear. Gold touched a record high at the end of February. Industrial metals rose to their highest levels in about two years. Oil jumped to a new record above US$103 per barrel. Soft commodities, like wheat, soared to eye- popping levels, with nearby wheat contracts recently closing at $22.40 a bushel on the Minneapolis Grain Exchange. To put that into perspective, wheat traded at about $5 per bushel just one year ago. Although Canada is in much better shape fiscally and economically than the US, the performance of our economy and markets is largely dependent on what happens in the US, our largest trading partner by far. So although we may well avoid recession in Canada, as we did in 2000-02, our stock markets will feel the pain. Right now, though, the commodity surge is easing some of that pain. Stocks of commodity-related companies have rallied considerably. To the end of February, the S&P/TSX Materials Index is up 13.8% in the year to date and ahead a blistering 41% over the past 12 months. Compare that with a loss of 1.8% in the year to date for the S&P/TSX Composite and an advance of about 4% for the 12-month period. By contrast, the big U.S. indexes, which aren’t as resource-rich as the TSX, are in the dumps right now. The Dow Jones Industrial Average is down 7.5% year to date, and is just about breaking even for 12 months. The S&P 500 Composite has slumped 9.8% year to date and is down 4.9% for 12 months. And the Nasdaq Composite is down 14.7% year to date, for a 12-month loss of 5.8%. So is it time to invest in commodities? Therein lies the problem. The very great danger of investing after a spike in prices is that you’ll be whipsawed out of the market. Gold, oil, wheat, metals, and soft commodities have surged to records in just the past few months. The time to invest was a year ago. Now it’s probably too late, as speculators and hedgers crowd the markets and short positions start to build. Precious metals probably have some life left, and gold could go a lot higher as the US dollar falls — some analysts are predicting a $1,200-per-ounce peak, I’m still questioning anything above US$1,000. Meaning that the really big move is probably already behind it. The time to catch the wave is when it first starts to build, not when it’s cresting. And right now, with very few exceptions, like forest products, the wave on commodities is cresting. Investors whose portfolios have not been constructed and maintained with an asset mix that builds in downside protection will be feeling some anxiety these days. That anxiety will last for the next few months at least. Those with a well-designed portfolio already in place should avoid the temptation to “invest by headline news” — instead, let your portfolio do its job.
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