The following is an excerpt from Pivotal Events - February 22, 2007.

Signs Of The Times:
"After Subprime: Lax Lending Lurks Elsewhere"    WSJ, February 20

The article reviewed some research by UBS that notes that the downturn in the sub-prime mortgage market was "marked by an unexpectedly large number of early defaults", by which borrowers stop paying shortly after getting their mortgages.

The article continues with the increasing frequency of "soft fraud" whereby "someone takes a mortgage, buys a home, avoids payments and lives rent-free until the marshals come".

The day earlier, Reuters carried a review by Barclays Capital. This polled 250 institutions on their views on commodities. Positions on commodities or, as it was phrased, "assets under management in commodity products" could reach $120-$150 billion by end-2008.

Of those polled about this, 52% said that investment would reach this level, while 36% indicated it would exceed $150 billion.

To our way of thinking, this seems that some 86% of institutional money managers are very bullish on commodities with, expressed in a different way, a majority of planning to reach an allocation of 10% commodities.

Last June, HSCBC noted that institution commodity exposure would be about US $100 billion by the end of 2006, which compared to $10 billion at the end of 2003.

The high for the benchmark index - the CRB - was 366 on May 11, and the cyclical low was 182 in October, 2002.

At the end of 2003 when institutions held some $10 billion, the index had increased to 240. The point to be made is that when commodities were at their last cyclical low, the position was less than $10 billion. And closer to the cyclical peak, institutions own over $100 billion and are intending to own over $150 billion. "Come on in, it feels good - all the lemmings are doing it!"

Although the action must be disappointing since the halcyon days of June, especially with the occasional expensive rollover, the tout is still on. This reminds of the establishment's chronic bear raid on gold. This continued well after the real price began a cyclical bull market in November, 2000.

It seems to take a long time for the establishment to become disenchanted with the last investment fashion. This long-term pattern shows up in our study of life insurance companies since the 1860s.

This was sent out in June and can be reviewed through the following link: http://www.institutionaladvisors.com/pdf/060616-ACTUARIALLY-DRIVEN_INVESTORS.pdf

At the top of bond markets, they tend to be fully positioned in high-grade bonds; near the peak of a boom, they tend to be long hard assets, stocks, and low-grade bonds.

Then, typically, when strong convictions are fully employed, a long period of chagrin follows. We have not noticed any rationalizations that the institutional direct entry into commodities will reduce the big swings hitherto inherent to commodities.

Applied to equities, this reasoning prevailed from around 1966 to 1969 when institutions were distinctively taking larger positions in stocks.

The tout was that the research capabilities of the institutions would caution against over-commitment at cyclical peaks. This, in turn, would provide the ability to buy going into cyclical bottoms.

Now this all sounded quite practical, but along came the special reasons about "this time it's different". One was championed by the towering influence of Paul Samuelson who had, in the mid-1960s, declared that through very wise manipulations the business cycle had been eliminated.

"No more recessions" was the tout from interventionist economists and Wall Street strategists extrapolated the new venture into equities by institutions into a "shortage of equities"!

This prevailed through to the end of the 1960s while the DJIA, deflated by the CPI, set its high in 1966, from which it plunged 75% to a dismal low in 1982.

Obviously, this was accompanied by the usual recriminations when a fashionable asset goes bad.

This time around on the new institutional infatuation, the "new" policy theory has been "Helicopter Ben" and the theory that the business cycle has been eliminated is summed up in one word - China.

This provides, once again, that there is no risk of a reversal of fortune - that's despite mounting carnage in housing and sub-prime mortgages.

The investment policy history of financial institutions suggests that the next big event will be a lengthy disgorgement of commodities within a climate of boardroom chagrin.

By : Bob Hoye

Institutional Advisors

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