End of the Commodity Super Cycle

When the Trade Alerts quit working. I stop sending them out. That?s my trading strategy right now. It?s as simple as that.

So when I received a dozen emails this morning asking if it is time to double up on Linn Energy (LINE), I shot back ?Not yet!? There is no point until oil puts in a convincing bottom, and that may be 2015 business.

Traders have been watching in complete awe the rapid decent the price of Linn Energy, which is emerging as the most despised asset of 2014, after commodity producer Russia (RSX).

But it is becoming increasingly apparent that the collapse of prices for the many commodities is part of a much larger, longer-term macro trend.

(LINN) is doing the best impersonation of a company going chapter 11 I have ever seen, without actually going through with it. Only last Thursday, it paid out a dividend, which at today?s low, works out to a mind numbing 30% yield.

I tried calling the company, but they aren?t picking up, as they are inundated with inquires from investors. Search the Internet, and you find absolutely nothing. What you do find are the following reasons not to buy Linn Energy today:

1) Falling oil revenue is causing Venezuela to go bankrupt.
2) Large layoffs have started in the US oil industry.
3) The Houston real estate industry has gone zero bid.
4) Midwestern banks are either calling in oil patch loans, or not renewing them.
5) Hedge Funds have gone catatonic, their hands tied until new investor funds come in during the New Year.
6) Every oil storage facility in the world is now filled to the brim, including many of the largest tankers.

Let me tell you how insanely cheap (LINN) has gotten. In 2009, when the financial system was imploding and the global economy was thought to be entering a prolonged Great Depression, oil dropped to $30, and (LINN) to $7.50. Today, the US economy is booming, interest rates are scraping the bottom, employment is at an eight year high, and (LINE) hit $9.70, down $70 in six months.

Go figure.

My colleague, Mad Day Trader, Jim Parker, says this could all end on Thursday, when the front month oil futures contract expires. It could.

It isn?t just the oil that is hurting. So are the rest of the precious and semi precious metals (SLV), (PPLT), (PALL), base metals (CU), (BHP), oil (USO), and food (CORN), (WEAT), (SOYB), (DBA).

Many senior hedge fund managers are now implementing strategies assuming that the commodity super cycle, which ran like a horse with the bit between its teeth for ten years, is over, done, and kaput.

Former George Soros partner, hedge fund legend Paul Tudor Jones, has been leading the intellectual charge since last year for this concept. Many major funds have joined him.

Launching at the end of 2001, when gold, silver, copper, iron ore, and other base metals, hit bottom after a 21 year bear market, it is looking like the sector reached a multi decade peak in 2011.

Commodities have long been a leading source of profits for investors of every persuasion. During the 1970?s, when president Richard Nixon took the US off of the gold standard and inflation soared into double digits, commodities were everybody?s best friend. Then, Federal Reserve governor, Paul Volker, killed them off en masse by raising the federal funds rate up to a nosebleed 18.5%.

Commodities died a long slow and painful death. I joined Morgan Stanley about that time with the mandate to build an international equities business from scratch. In those days, the most commonly traded foreign securities were gold stocks. For years, I watched long-suffering clients buy every dip until they no longer ceased to exist.

The managing director responsible for covering the copper industry was steadily moved to ever smaller offices, first near the elevators, then the men?s room, and finally out of the building completely. He retired early when the industry consolidated into just two companies, and there was no one left to cover. It was heartbreaking to watch. Warning: we could be in for a repeat.

After two decades of downsizing, rationalization, and bankruptcies, the supply of most commodities shrank to a shadow of its former self by 2000. Then, China suddenly showed up as a voracious consumer of everything. It was off to the races, and hedge fund managers were sent scurrying to look up long forgotten ticker symbols and futures contracts.

By then commodities promoters, especially the gold bugs, had become a pretty scruffy lot. They would show up at conferences with dirt under their fingernails, wearing threadbare shirts and suits that looked like they came from the Salvation Army. As prices steadily rose, the Brioni suits started making appearances, followed by Turnbull & Asser shirts and Gucci loafers.

There was a crucial aspect of the bull case for commodities that made it particularly compelling. While you can simply create more stocks and bonds by running a printing press, or these days, creating digital entries on excel spreadsheets, that is definitely not the case with commodities. To discover deposits, raise the capital, get permits and licenses, pay the bribes, build the infrastructure, and dig the mines and pits for most commodities, takes 5-15 years.

So while demand may soar, supply comes on at a snail pace. Because these markets were so illiquid, a 1% rise in demand would easily crease price hikes of 50%, 100%, and more. That is exactly what happened. Gold soared from $250 to $1,922. This is what a hedge fund manager will tell us is the perfect asymmetric trade. Silver rocketed from $2 to $50. Copper leapt from 80 cents a pound to $4.50. Everyone instantly became commodities experts. An underweight position in the sector left most managers in the dust.

Some 14 years later and now what are we seeing? Many of the gigantic projects that started showing up on drawing boards in 2001 are coming on stream. In the meantime, slowing economic growth in China means their appetite has become less than endless.

Supply and demand fell out of balance. The infinitesimal change in demand that delivered red-hot price gains in the 2000?s is now producing equally impressive price declines. And therein lies the problem. Click here for my piece on the mothballing of brand new Australian iron ore projects, ?BHP Cuts Bode Ill for the Global Economy?.

But this time it may be different. In my discussions with the senior Chinese leadership over the years, there has been one recurring theme. They would love to have America?s service economy.

I always tell them that they have a real beef with their ancient ancestors. When they migrated out of Africa 50,000 years ago, they stopped moving the people exactly where the natural resources aren?t. If they had only continued a little farther across the Bering Straights to North America, they would be drowning in resources, as we are in the US.

By upgrading their economy from a manufacturing, to a services based economy, the Chinese will substantially change the makeup of their GDP growth. Added value will come in the form of intellectual capital, which creates patents, trademarks, copyrights, and brands. The raw material is brainpower, which China already has plenty of.

There will no longer be any need to import massive amounts of commodities from abroad. If I am right, this would explain why prices for many commodities have fallen further that a Middle Kingdom economy growing at a 7.5% annual rate would suggest. This is the heart of the argument that the commodities super cycle is over.

If so, the implications for global assets prices are huge. It is great news for equities, especially for big commod
ity importing countries like the US, Japan, and Europe. This may be why we are seeing such straight line, one way moves up in global equity markets this year.

It is very bad news for commodity exporting countries, like Australia, South America, and the Middle East. This is why a large short position in the Australian dollar is a core position in Tudor-Jones? portfolio. Take a look at the chart for Aussie against the US dollar (FXA) since 2013, and it looks like it has come down with a severe case of Montezuma?s revenge.

The Aussie could hit 80 cents, and eventually 75 cents to the greenback before the crying ends. Australians better pay for their foreign vacations fast before prices go through the roof. It also explains why the route has carried on across such a broad, seemingly unconnected range of commodities.

In the end, my friend at Morgan Stanley had the last laugh.

When the commodity super cycle began, there was almost no one around still working who knew the industry as he did. He was hired by a big hedge fund and earned a $25 million performance bonus in the first year out. And he ended up with the biggest damn office in the whole company, a corner one with a spectacular view of midtown Manhattan.

He is now retired for good, working on his short game at Pebble Beach.

Good for you, John.

 

LINE 12-15-14

TNX 12-15-14

COPPER 3-21-14

FXA 12-15-14

GOLD 3-21-14

WTIC 12-12-14

 

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