About Me

Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Thursday, July 30, 2015

Commodities Market

Statistically, the CRB Commodities Index is dirt cheap on an historical basis. The index is now
just slightly north of 200. Since the early 1970s, 180 - 200 on the index has marked the bottoms
on the chart. Years back, I developed a macro model to figure out an equilibrium price where
supply and demand for commodities are in reasonable balance and where  the price includes
enough  profit margin sufficient to encourage future supply to grow along with demand. Here in
2015 the fair value price is running around 350 on the index. $CRB Chart

the CRB is trading at a large discount to fair value. This suggests a goodly number of raw
commodities producers are now running in the red and can only be cash flow positive if
there are sizable depreciation and depletion allowances and / or paid - in subsidies to keep
people employed (a not uncommon practice in foreign economies). Big discounts to fair
value in the commodities markets usually occur during recession periods such as in late 2001
and 2008 - 09. Now, we have a different situation. Global demand is growing at about half
the rate it needs to grow to allow depressed operating rates to rise enough to equilibrate the
markets. The 2002 - 2008 boom in commodities prices brought along with it a large cycle of
commodities capacity expansion. Moreover, with global monetary policy accomodative
since 2009, producers have been reluctant to shut - in capacity. The problem of excess capacity
relative to demand has been clearly apparent since early 2012. On top of too much capacity in
the business, we have to add the unwinding of long positions built up in commodities by both
financial players and speculators. Long futures positions in the markets often reached 3 times
what they were at the beginning of the last boom in 2002.

Viewed over the last 40 odd years, the CRB index is sold out and in distress given rising
operating costs and notwithstanding large productivity gains. The timing of price recovery
for commodities, as cheap as they are, is hard to figure. More of the marginal producers
and more of the diehard speculators may have to be stripped out of the equation. The low
global demand growth has yet to show much acceleration and a strong US $ is also a drag
on the market. Thus, a decline in the CRB index down to the 180 level cannot be ruled before
there is improvement.

Commodities are on my watch list and I may try long positions in the DBC commodities
tracking ETF (bottom panel of chart above) when it looks like a short run uptrend may be
developing.

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