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Gold & the Commodity Super Cycle

Riding on the Commodity Super Cycle, the glittering Gold Market rose 32% in 2007...

"A TREND IN MOTION will stay in motion until some major outside force knocks it off its course" – and after gyrating within a sideways trading range over the past 18-months, the "Commodity Super Cycle", as measured by the Dow Jones-AIG Commodity Index (DJCI), resumed its upward course in the second half or 2007.

   Led by the agricultural, energy, and precious metal sectors, the DJCI closed at an all-time high.

   According to famed hedge-fund trader Jimmy Rogers, the 20th century saw three secular bull-markets in commodities, each spanning an average of 15-years:

  • 1906-1923
  • 1933-1955
  • 1968-1982

   The current bull market for the DJCI is now six-years old, and Mr. Rogers thinks the Commodity Super Cycle has many more years to run, albeit with some nasty corrections along the way.

Commodity Super-Cycle & China

   The latest commodities boom began at the end of 2001, when China's industrial revolution was just starting.

   China's voracious appetite for raw materials for its industrialization has made it the No.1 consumer of copper, steel, and iron ore in the world, consuming more of theses metals than the United States and Japan combined.

   China now ranks No.2 in consumption of oil and energy products, and China's population of 1.3 billion has become the world's No.1 consumer of soybeans.

   Evidence of an impressive bull-run is stacking up, with crude oil surging 60% to $96 per barrel in 2007, and tripling since late 2003. Platinum hit an all-time record high above $1,550 per ounce in the first week of Jan. '08, and if the world's 500 million cars were fitted with fuel cells, the world's platinum supply would be exhausted in 15 years.

   Copper was a laggard last year, with a mere 10% gain, but it's still five times higher in value since 2003, hitting a record $8,800 per ton in 2006, while lead and tin are now at historic highs.

   Agricultural commodities joined the party in 2007, with wheat futures in Chicago climbing 77%, as global demand outpaced supply. Soybeans were up 79%; corn rose 16%; and rice futures were up 35%.

   A weaker US Dollar makes American grain prices less expensive to buyers abroad, and US wheat exporters have already sold more than 90% of the 1.18 billion bushels the US Department of Agriculture expects will be exported during the whole marketing year, which ends in June 2008.

   Rough rice futures in Chicago soared to all-time highs, led by strong export demand and weather-related Asian crop shortages in India, the world's second-largest rice exporter, and in Vietnam, the third-largest shipper. Global rice supplies fell 6.5% in the fourth quarter alone to 72.1 million tons, and according to latest estimates, supplies are headed down to 50 million tons, the lowest level since 1983-84.

   Food prices are 18% higher in China from a year ago, and the Communist kingpins in Beijing fear that runaway inflation could ignite social unrest.

   The price of pork, which forms the core of most Chinese diets, was up by a staggering 56%. "We're facing a grave situation," said Ma Kai, the country's top planner. China has a fifth of the world's population, with 1.3 billion people using 7% of the world's farmland.

   Zheng Guogan, head of the State Meteorological Administration forecasts global warming will cut China's annual grain harvest by up to 10%. That would mean about 50 million tons less grain in the current tight supply situation and a potential for further food inflation in world markets.

   "Given the tightened food supply in the international market, a decline in domestic grain production could lead to more price hikes," said Song Tingmin, VP of the China National Association of Grain.

   The US Department of Agriculture has also cut its estimate of world wheat stocks for 2007-08 to 112.4 million tons, a 30-year low. If sustained, sharply higher wheat prices will eventually work their way into the grocery aisle for bread, cereal, cookies and other products. Overseas buyers are in a panic, anticipating the US will run out of wheat, and that prices will have to increase to ration the remaining supply.

   And since wheat, corn and soybeans are used to feed livestock, as those costs go up, so does the retail cost of beef to consumers. US food prices rose at a 4.1% annual rate in the three months ended in November largely due to higher milk, egg and meat prices.

   British supermarket prices are up 14% over last year, adding £750 to the average family's annual grocery shop. And the cost of shipping dry goods across the ocean, measured by the Baltic Dry Index, doubled last year.

   Riding on the wings of the Commodity Super Cycle and the resulting rampant global inflation has been the glittering Gold Market, up 32% in 2007, its biggest annual gain in the eight-year run so far.

   Gold Prices were energized by reckless central bankers and the explosive growth of the world's money supply:

  • In Australia the M3 money supply rose 20.7% from a year ago;
  • Brazil's M3 rose 17%;
  • Canada's M3 increased 12.9%;
  • China's M2 grew by 18.5%;
  • the Eurozone's M3 increased by 12.3%;
  • Hong Kong's M3 grew by 31.5%;
  • India's M3 added 21.5%; and
  • the USA's M3 rose by almost 16% at a 47-year record pace.

Chinese & Indian Imports Fuel the Commodity Super Cycle

   Maybe the longevity of the "Commodity Super Cycle" boils down to one simple equation – population growth.

   According to the latest population count by the United Nations, the world had 6.5 billion inhabitants in 2005, 380 million more than in 2000, making an annual gain of 76 million people.

   By 2050, the world is expected to house 9.1 billion persons, assuming declining fertility rates, particularly in the West. So a world of finite raw materials, along with an increasing population base, translates into higher commodity prices. China and India house one-third of the world's population with 2.3 billion inhabitants.

   In an ironic twist, China has become a victim of its own phenomenal success.

   China's economy expanded at a blistering 11.5% last year, but was plagued with a 7% inflation rate, largely linked to the country's voracious appetite for global commodities. China's imports climbed 20.5% to $865.5 billion in the first 11-months of 2007, from the year earlier period, and Chinese demand effectively put a floor under the DJCI, whenever panicky commodity traders in London, New York, Tokyo or Shanghai got the urge to turn paper profits into cash.

   To combat consumer inflation, the People's Bank of China (PBoC) has tightened its monetary policy, ordering banks to set aside 14.5% of their deposits as reserves, an all-time high.

   The PBoC also raised bank lending rates five times to 7.47% in 2007, and announced a special bond sale of 750 billion Yuan to drain cash from the financial system. The latest tightening moves took some steam out of the Shanghai stock index, which still ended 97% higher last year, the world's gold medal winner.

   Then on Dec 27th, China's central bank signaled it would allow the Yuan to appreciate faster in 2008, a move designed to lower the cost of Dollar-denominated commodities imported from overseas.

   Yao Jingyuan, chief economist of the state statistics agency, explained, "The weakening Dollar and rising global commodity prices would create inflationary pressures for China next year, but a quicker appreciation of the Yuan would probably help offset some of those price increases."

   But a stronger Yuan vs. the US Dollar will also boost China's purchasing power abroad, and could exert more upward pressure on commodity prices worldwide. And China must compete with India, the world's second fastest growing economy, with one billion consumers for global commodities.

   India's imports rose to $20.8 billion in October, up from $4.6 billion in February 2004, also supporting the commodity markets.

   Interestingly enough, India could face a supply shortfall of about four million tons of rice in 2008, threatening to turn the world's largest exporter of rice into a net importer. With tight supplies of wheat this year, Indian demand for rice could grow to 96 million tons or higher, and above the rice crop of 92 million tons last year.

   India is also Asia's third-largest oil consumer, and imported 9.25 million tons of crude oil in November, or 2.8 million barrels per day, up 6.5% from a year ago.

Bernanke Fed Ignites Commodity Super Cycle in 2007

   For 24-months until June 2006, the Federal Reserve embarked on a long, but predictable road of lifting short-term US interest rates, aiming to reach an unknown "neutral rate" that would neither stimulate nor weaken the US economy.

   The Fed was also tracking the Commodity Super Cycle and appeared to have finally gotten ahead of the inflation curve with its final rate hike to 5.25% in June 2006.

   "The Fed will be vigilant to ensure that the recent pattern of elevated monthly core inflation readings is not sustained," declared Fed chief Ben "B-52" Bernanke at the International Monetary Conference on June 6, 2006.

   "The Fed must continue to resist any tendency for increases in energy and commodity prices to become permanently embedded in core inflation," he said, telegraphing the last rate hike to 5.25%.

   The two-year cycle of Fed rate hikes was the longest in a quarter of a century, and finally put a dent in the Commodity Super Cycle.

   Crude oil tumbled $30 per barrel, and Gold Prices fell $160 per oz in the second half of 2006. The Fed had finally corralled the commodities bull market, and put the Fed funds rate on ice for 15-months.

   The Fed then relied on other G-20 central banks to tighten their monetary policies to keep the Commodity Super Cycle in check while it sat on the sidelines.

   However, other G-20 central banks were reluctant to tighten their money spigots, and only lifted their lending rates in tiny baby-steps, failing to rein-in double digit credit and money supply growth. Central bankers were clandestinely inflating their economies to prosperity, by pumping up stock markets with monetary steroids, and in turn, hoping to bolster consumer confidence and spending.

   The bursting the $1.8 trillion sub-prime credit bubble in the summer of 2007 then rattled the Bernanke Fed into a series of rate cuts totaling 1% to 4.25% by December. The Fed's aggressive rate-cutting campaign knocked the US Dollar index to 20-year lows and ignited the fastest money supply growth in 47-years, with US M3 hitting an annualized 16% growth rate in November, while the narrower MZM money supply soared 12.8% higher from a year earlier.

   Because most international commodities are traded in US Dollars, the Fed must defend the value of the US Dollar in the foreign exchange market, with higher interest rates if necessary, to keep the Commodity Super Cycle in check.

   But with the Fed moving in the opposite direction, and slashing the Fed funds rate to 4.25% in response to the sub-prime collapse and resulting credit crunch, the US central bank let the inflation genie out of its bottle, awakening the Commodity Super Cycle from a near 18-month siesta.

   Thus, the finger of blame for global inflation points to the Bernanke Fed and the US Treasury, for engineering the devaluation of the US Dollar in the second half of 2007.

   Traders should only trust the hard dollars and cents that flow through the commodity markets for real-time indications of future inflation, and not government statistics, which are manipulated by apparatchiks and adopted as gospel by the mainstream media. The Fed's rate cuts and Dollar devaluation pumped crude oil prices $25 per barrel higher, even after a $12 per barrel "Iranian war premium" was wiped out.

   G-7 central bankers are injecting liquidity into the money markets at a time when inflation is rearing its ugly head across the globe, led by sharply higher food and energy prices.

   European and US central bankers are intellectually dishonest about food and energy prices, routinely subtracting the "essentials of life" from their inflation equations. They reckon that commodity price spikes are self-correcting, due to the laws of gravity, and shouldn't be countered with higher interest rates.

   In the US, producer prices were 7.7% higher in November from a year ago, the highest in 34-years. Consumer prices rose at an annual rate of 4.2% through the first 11-months of 2007, the most in 17 years, thanks to soaring food and energy prices. Yet remarkably, federal funds futures traders in Chicago are betting on a quarter-point Fed rate cut to 4.00% on January 30th, aimed to bail out Wall Street bankers from massive losses in sub-prime mortgages, despite elevated inflation.

   There's a big difference between the way US households and the Fed view inflation. To the average household, food and energy prices are the most closely watched costs. To the Fed, they are subject to cyclical swings and ignored.

   "If inflation expectations are well anchored, changes in energy and food prices should have relatively little influence on core inflation," Fed chief Ben "B-52" Bernanke told the National Bureau of Economic Research on July 10th, 2007.

   So far, investment banks and brokers have recognized $97 billion of losses related to the collapse of the $1.8 trillion sub-prime mortgage market. That could just be the tip of the iceberg of bank write downs for 2008. But additional Fed rate cuts could weaken the US Dollar still further, unleashing the fastest rate of inflation and money supply growth that the world has seen in decades. And that would lead to the "Stagflation" trap.

European Central Bank Helps Stoke Global Inflation

   Under the leadership of Jean "Tricky" Trichet, the European Central Bank has veered far away from its monetarist roots and its original 4.5% growth target for Euro M3.

   Since Trichet got his hands on the printing presses in November 2003, the Euro M3 money supply has exploded from a 5% growth rate to an annualized 12.3% in October, its fastest in history, lifting the Eurozone's inflation rate to a six-year high of 3.1%, and far above the ECB's target of 2%.

   Trichet has immunized the Eurozone stock markets from record high oil prices with carefully calibrated dosages of monetary morphine. The ECB engineered an 11% Euro rally against the US Dollar in 2007 by running the printing presses at a slightly slower pace than the Bernanke Fed.

   Still, North Sea Brent crude oil rose to a record €65 per barrel, and European wheat futures closed at €248, posting a 68% gain on the Paris-based Euronext exchange.

   ECB chief Trichet and his sidekick, Bundesbank chief Axel Weber, have forgotten the sound advice of the late ECB chief Wim Duisenberg.

   "Trying to use monetary policy to fine-tune economic activity or asset markets, or to gear it above a sustainable level will, in the long run, simply lead to rising inflation – not to faster economic growth," Duisenberg warned on Sept 5, 2003, just before he retired from the ECB.

   With Eurozone inflation getting out of control, Trichet and Weber are conducting "open-mouth" operations through the media, talking tough and making bold threats, but taking no action to tighten monetary policy.

   European gold traders have seen through the ECB's propaganda and empty rhetoric, and are bidding €570 for an ounce of gold, up 75% from just three years ago.

   Writing in Germany's Bild am Sonntag newspaper on Dec 31st, Bundesbank chief Axel Weber said that high energy and food prices would keep inflation elevated through the first half of 2008, but warned European workers not to ask for higher wages to compensate for the higher cost of living.

   "The current, unusually high inflation rates in Germany and the Eurozone must not be the yardstick for the next wage round. A spike in prices as a result of excess wage rises can endanger medium-term price stability. We would act decisively against this," he warned.

   Put another way, "our primary goal is to preserve price stability. We are alert and everybody must know that we will do whatever is needed to deliver price stability in the medium term and be credible in that delivery. The single needle in our compass is price stability," warned ECB chief Trichet on Dec 14th. But alas, the ECB's compass has been broken for three years, with Euro money and credit expanding at double digit rates.

   How are we to interpret the ECB's latest riddles, designed to keep commodity and gold speculators off balance. Would the ECB actually hike its repo rate to 4.25% to rein-in its money supply, when other G-7 central bankers in Canada, England, and the US are lowering their lending rates? That's doubtful. Yet the ECB would look like a hawk, by simply resisting the temptation to follow the rate-cutting Bernanke Fed and the Bank of England, by leaving its repo rate unchanged at 4.00%.

   Still, "the persistence of the current inflation shock entails the serious risk that inflation expectations could become unhinged and our credibility as central bankers could be significantly damaged," Bank of Spain chief Miguel Angel Fernandez Ordonez warned. Spain's consumer price index soared to +4.1% in November.

   "We are monitoring the situation very closely, and are permanently alert. Central bankers, even the best ones, cannot prevent an increase of oil prices or other international commodities," said Belgian central banker Guy Quaden on Dec 13th.

   That's music to the ears of global commodity traders, and why the world economy could be headed for hyper-inflation. "Central bankers always try to avoid their last big mistake. So every time there's the threat of a contraction in the economy, they'll over stimulate the economy, by printing too much money. The result will be a rising roller coaster of inflation, with each high and low being higher than the preceding one," said Milton Friedman, the late Nobel monetarist.

   "Inflation is always and everywhere a monetary phenomenon. As the government increases the rate at which it prints money, the result is too much money chasing too few goods and services. Higher wages don't cause inflation, and the whopping oil price increases between 1973 and 1980 didn't cause the stagflation – a stagnant economy with rising inflation. Rather, the oil price hikes were the form inflation took, as Friedman and Anna Schwartz argued.

Gold is a Safe Haven During Global Banking Crisis

   Nowadays, bankers are so afraid to lend money to each other, that they prefer to park their excess cash in "safe haven" Treasury bills and notes, even at negative rates of return, after adjusting for inflation. Big banks are reluctant to lend money in the LIBOR market (London interbank overnight rates), because of suspicions that borrowers might be holding big undisclosed losses in toxic sub-prime mortgages.

   Global banks are also hoarding cash to plug future losses that must be written off their balance sheets in the year ahead. The fear factor in the banking system is measured by the TED spread, which is the difference for yields on US Dollar Libor rates and for US Treasury bills.

   Since August, there have been two eruptions in the TED spread that lifted US Dollar Libor rates to +210 basis points above 3-month Treasury bills rates, the highest since the 1987 stock market crash.

   The Gold Market has done a reasonable job of tracking widening credit spreads between Libor rates and Treasury bills, and acting as a safe haven in a time of risk-aversion in the stock markets.

   Yet the same sophisticated bankers that bought $1.8 trillion of toxic sub-prime mortgages over the past few years are now locking in 10-year bond yields below the inflation rate, even though hyper-inflation might lie on the horizon.

   When measured in "hard money" terms, the US Treasury's 10-year note has lost 20% of its value compared to an ounce of gold since August 2007. Wouldn't it make better sense to park excess cash in gold, rather than US Treasury IOU's, during periods of double-digit money supply growth, and soaring commodities?

To get more detail and advice – and to stay on top of volatile markets – click through and subscribe to the Global Money Trends newsletter today for insightful analysis and predictions for the top stock markets around the world, plus commodities such as crude oil, copper, gold, silver, and related gold mining and oil company indexes as well as foreign currencies, interest rates, global bond markets and central bank monetary policies...

GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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