situation is developing the global markets which threatens to undo the recovery
of the past two years. The price spikes in fuel and especially agriculture
prices is the Achilles' heel of the recovery and may well serve as its death
knell before the year is through.
surge in commodity prices since last summer is garnering headline attention
as fears of a surge in consumer price inflation increase. Agricultural prices
have jumped in recent months and grocery store prices are forecast to
increase across the board by summer. Developing countries have born the brunt
of the commodities surge, with the poorest countries paying an estimated 20
percent more for food in 2010 than in 2009. Wheat prices at the Chicago Board
of Trade are up by more than 75 percent in the past year; corn prices have
gained almost 90 percent.
central banks of both China and the U.S. have taken a big share of blame for
the global food price inflation. Many experts have accused the U.S. Federal
Reserve of stimulating an inflationary outbreak by embarking on its $600
billion Treasury security purchase plan. China's own $586 billion stimulus
plan has had arguably a greater impact on food price inflation in that
country considering that China's economy is only a third the size of the U.S.
economy. The Fed's quantitative easing initiative, which is expected to
continue until June, clearly has had a benign impact on equity prices and
arguably has helped corporations shore up their balance sheets and raise cash
levels to their current highs. It has, however, had a rather malignant
spillover effect in another area of the financial market.
spillover effect of the Fed's Treasury purchasing program can be seen in the
huge amounts of money that have been funneled into commodities. Oil and
agricultural commodity prices in particular have been beneficiaries of the Fed's
QE campaign. This has increased prices for a broad array of consumer goods as
well as boosting transportation costs.
biggest victims of the concerted central bank stimulus campaigns have been
the poor in the emerging nations. Rising food prices in the Middle East
region have already led to a revolution and one dictator has already toppled
as a result. Moreover, global food prices have pushed 44 million people into
extreme poverty, according to the World Bank.
turbulence in the Middle East is making matters worse by spiking the oil
price even more. The Kress 120-year "revolutionary cycle" is in its
final descending phase and this is why we can expect to see more
revolutionary activity between now and 2014. The strong deflationary undercurrents
that accompany this cycle are responsible for creating the economic chaos
which is the dominant factor behind political revolt and popular uprisings.
With the Middle East a revolutionary powder keg, the oil price has never been
more vulnerable to factors other than those of the financial market.
chief Bernanke has the unenviable task of balancing a domestic economy
plagued by low consumer demand against his loose money policy. In the first
two years following the credit crisis, Bernanke's loose monetary policy
served him well. Commodity prices were depressed along with equity prices and
this gave the Fed plenty of room to re-inflate with worrying about
immediate-term consequences. Two years of steadily rising commodity prices
have eroded the Fed's cushion, however, and the end game is surely in sight.
Any additional commodity rice increases will threaten the global market
recovery and will exert profound pressure against the Asian and emerging
market economies. It won't do any favors for the still weak U.S. economy,
Bernanke has expressed his determination to continue the second quantitative
easing (QE2) campaign, which commenced in November 2010, until June this
year. This means at least three more months of potential spillover into the
commodity price uptrend. Hedge funds are taking full advantage of this
copious increase in liquidity and what we're seeing here is essentially Act 2
of the drama that unfolded in the months before the credit crash in 2008. At
that time, a fund-driven rally in the oil price put tremendous pressure on
the already weakened financial market and added fuel to the credit fire. The
oil market eventually succumbed to that raging inferno, but not before
causing tremendous economic damage.
situation that appears to be repeating here is the same theme we saw in the
months leading up to the credit crisis. Oil and gas stocks accounted for much
of the stock market's gains during 2007 and although the market did
effectively ignore the rising crude oil price for a while, the relentless
rally in oil eventually turned out to be the proverbial straw that broke the
Bernanke's conundrum is truly of the catch-22 variety: either he'll be forced
to ease off the monetary accelerator to prevent prices from rising too much,
in which case the forces of long wave deflation (i.e. the long-term Kress
cycles) will push hard against the financial system and eventually create
another systemic crisis. Or if he decides to keep pumping the increase in
commodity prices (particularly oil) will put all kinds of pressure on the
still fragile economic recovery. Under this scenario, there would most likely
be a sharp spike in retail prices across the board, particularly for
gasoline. This in turn would be followed by a deflationary crash.
may wonder how a fuel price spike would create deflation? The reason is that
higher oil prices eventually result in reduced consumer spending, which in
turn puts downward pressure on prices, i.e. deflation. Another point worth
mentioning is that in the last 40 years, with the exception of 1986,
year-over-year rises in oil prices of 80% or more have always been followed
by recession (see chart below). So no matter which way Mr. Bernanke turns, he
is confronted with the specter of deflation.
likely won't be a concern until later this year or early next year,
particularly after the 6-year cycle peaks in October. For now we'll continue
to look for opportunities on the relative strength and momentum front among
individual mining stocks and ETFs. But we need to be aware that the days of
easy profits and extremely low volatility are likely over. For the rest of
2011 investors would do well to assume a market environment similar to that
of 2007, which had its ups and downs but was characterized by increasing
turbulence as the year progressed.
lately, the gold price hadn't benefited from the Fed's second QE campaign
quite as much as oil and agricultural prices. It has nonetheless managed to
catch up to the oil price recently. There are two components behind the gold
price uptrend that are especially significant from an interim standpoint,
namely the fear component and the currency component. Fear has been a major
factor behind gold's surge in recent years, particularly following the credit
crisis. A weak dollar has also helped fuel the gold bull market, and to that
end the Fed's loose money policy has benefited gold in a residual fashion.
the Fed's easing program has also hindered gold's progress since last
November. The easy money fueled a surge higher in stock prices, which
resulted in a diminution of investors' fears. This in turn led to a
temporarily diminished demand for gold investments. With market volatility on
the rise once again in response to Middle East troubles, fear is returning to
the market and will help gold gain additional traction.
Editor, The Daily
Durban Deep/XAU Report