(DBA) Archives

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.

Not as Shiny as it Once Was

The China View from 30,000 Feet

Diary, Newsletter

I have long sat beside the table of McKinsey & Co., the best management consulting company in Asia, hoping to catch some crumbs of wisdom (click here for their home page). So, I jumped at the chance to have breakfast with Shanghai based Worldwide Managing Director, Dominic Barton, when he passed through San Francisco visiting clients.

These are usually sedentary affairs, but Dominic spit out fascinating statistics so fast I had to write furiously to keep up. Sadly, my bacon and eggs grew cold and congealed. Asia has accounted for 50% of world GDP for most of human history. It dipped down to only 10% over the last two centuries, but is now on the way back up. That implies that China?s GDP will triple relative to our own from current levels.

A $500 billion infrastructure oriented stimulus package enabled the Middle Kingdom to recover faster from the Great Recession than the West, and if this didn?t work, they had another $500 billion package sitting on the shelf. But with GDP of only $6.5 trillion today, don?t count on China bailing out our $16.5 trillion economy.

China is trying to free itself from an overdependence on exports by creating a domestic demand driven economy. The result will be 900 million Asians joining the global middle class who are all going to want cell phones, PC?s, and to live in big cities. Asia has a huge edge over the West with a very pro-growth demographic pyramid. China needs to spend a further $2 trillion in infrastructure spending, and a new 75-story skyscraper is going up there every three hours!

Some 1,000 years ago, the Silk Road was the world?s major trade route, and today intra-Asian trade exceeds trade with the West. The commodity boom will accelerate as China withdraws supplies from the market for its own consumption, as it has already done with the rare earths.

Climate change is going to become a contentious political issue, with per capita carbon emission at 19 tons in the US, compared to only 4.6 tons in China, but with all of the new growth coming from the latter. Protectionism, pandemics, huge food and water shortages, and rising income inequality are other threats to growth.

To me, this all adds up to buying on the next substantial dip big core longs in China (FXI), commodities (DBC) and the 2X (DYY), food (DBA), and water (PHO). A quick Egg McMuffin next door filled my other needs.

It?s Pedal to the Metal Once Again

Newsletter

If the prospect of WWIII can?t knock this market down, what will it take? A giant asteroid that destroys the earth?

I would have used ?Balls to the Wall? in the headline for this piece. But as this is a family oriented newsletter I opted for the more politically correct screamer.

Even the most hardened and seasoned traders, like me and Mad Day Trader Jim Parker, were stunned by how fast the markets bounced back from Monday?s war scares in the Ukraine. Of course, everything I said in my Monday letter came true.

It would have been nice if the recovery stretched out over a longer period of time, giving me better entry points for my Trade Alerts. But that was not to be. Too many people are still frantically trying to get in this market. There are oceans of cash everywhere earning virtually nothing. It seems the new trading strategy is that if something hasn?t gone down for three days, you buy it.

Bizarre as it may seem, the weather is emerging as the big driver of markets this year. Even the Federal Reserve is now saying that the weather was a big drag on the economy. This means that every negative data point for the next few months has a great excuse to be ignored.

It also means the growth which was lost in Q1 will get added back in during Q2 as the economy plays catch up. This has the potential to create a growth surge, possibly from a 1% annualized rate to as much as a 5% in the spring.

It is inevitable that this would trigger a major spike up in all risk assets. This realization is rippling throughout the markets to create one of those ?Aha? moments, much like we saw last October, when it became obvious that the indexes would melt up for the rest of 2013. Fasten your seat belt!

If you have any doubts about this scenario, you better take a look at the commodities markets, both hard and soft (DBA). After a dreadful three years, the chart now has the trajectory of a bat out of hell. What might cause this? How about a global synchronized economic recovery that boost US growth by a full 100 basis points or higher in 2014?

So I am going to take advantage of the pre Friday nonfarm payroll doldrums to start loading the boat with positions and scaling up risk. That?s why I picked up General Electric (GE) and Delta Airlines (DAL) today, classic cyclical names. Also on the short list are EBAY (EBAY), Gilead Sciences (GILD) for another visit to the trough, Goldman Sachs Group (GS), and QUALCOMM (QCOM).

Today?s new trades graciously turned immediately profitable, taking my performance up to yet another all time high of 134.41% since inception, and a 2014 year to date gain of 11.91%. That improves my average annualized return to a stratospheric 41.4%. Incredibly, after last year?s torrid 68% profit, my performance is getting even better. It appears that, like a fine Napa Valley wine, I improve with age.

Yes, I know you have been told by the talking heads on TV that stocks are expensive, and that a crash is imminent. Personally, I think equities are cheap and that we are on our way to a Dow Average of 100,000-200,000 by 2030 (no typo here). I will keep that view as long as the stocks that I am buying pay higher dividends than the ten-year Treasury yield (TLT), now at 2.69%.

To support my view take a look at the chart below produced by my friends at Business Insider. It shows that the share of technology names, the lead sector for the entire market, trading at more than five times sales is below 40%, a fraction of the 2000 peak.

I think we have to match, or exceed, this peak before the party is over and the lights get turned out.

A Perfect Storm Hits the Grain Trade

Diary, Newsletter

Grain traders have suffered a terrible 2013, a perfect storm of great news for farmers and terrible news for prices. But while farmers can make up for low prices with higher production, no such convenience exists for grain traders.

In January, right out of the gate, the USDA predicted that the US would produce the largest corn crop in history, or some 96 million bushels. That would be the largest since 1936. It now appears that this could be a low-ball figure.

Some private estimated see the total reaching 100 million bushels before the crying is over. Some 63% of the corn crop is now rated good/excellent, well above the five-year average of 58%, and trending northward.

Geopolitics has also conspired to drive prices southward. Egypt, with its burgeoning 83 million population, with a single river (the Nile) and a bleak desert to support it, is far and away the world?s largest wheat importer. A recent coup d??tat on the heels on an economic collapse promises to remove it from the marketplace soon. Buyers without cash are not buyers at all, no matter how dire the need. Only food aid from the US government or the United Nations can step in at this stage to head off mass starvation.

As if the news were not bad enough, the Russian cartel that controls two thirds of the world?s $22 billion a year potash supply, a crucial fertilizer used globally, collapsed last week over a price dispute. Known to chemists like me as Potassium carbonate, potassium sulfate, or potassium chloride, this compound is a key factor in strengthening roots during the growing cycle. One analyst said that the breakup of the cartel is akin to ?Saudi Arabia dropping out of OPEC.?

The move promises to take potash prices down from the 2008 peak of $1,000/tonne to $300 by yearend. Potash stocks crashed worldwide, with lead firm Potash (OT) diving 30%. Agrium (AGU) was down by 15%.

This will enable farmers to buy more fertilizer at cheaper prices next year, driving down the prices on far month futures contracts today. Too bad the Canadian government didn?t allow the sale of Potash (POT) to China go through on national security grounds. The shareholders must be kicking themselves.

The move promises to demolish the entire grade trade for this year. Not only has the Potash industry been hurt, so have agricultural equipment manufacturers, like Deere (DE) and Caterpillar (CAT) and the Powershares Multisector Agricultural Commodity Fund ETF (DBA).

Long gone are the heady days of last year, when scorching temperatures induced by global warming caused grain prices to nearly double. Some nine out of the ten last years have been the hottest in recorded history. Global warming denier-in-chief, Texas governor Rick Perry, saw his state suffer 100 consecutive days of over 100 degree temperature.

For me, these developments put the grain trade off limits for the foreseeable future. The only kind thing to be said here is that this will eventually lead to a final bottom that we can eventually trade off of. That would set up a killer position for the nimble if hot weather returns in 2014.

Potash Crystals

I Don?t See Any Grain Buyers Here

An Environmental Activist?s Take on the Markets

Diary, Newsletter

I spent an evening with Lester Brown, president of the Earth Policy Institute and a winner of the coveted MacArthur Prize, for some long-term thinking about the environment and its investment implications.

Global warming is causing the melting of ice sheets in Greenland and Antarctica, glaciers in the Himalayas, and the Sierra snowpack. Water tables are falling and fossil aquifers are depleting. In the coming decades this will cause severe shortages of fresh water that could lead to crop failures in India and China, where one billion people depend on mountain runoff to irrigate crops, and even California, which delivers 80% of America?s vegetables.

The fresh water inputs in one person?s food and materials consumption works out to some 2,000 liters a day. That is no typo. As a result, all food prices will rise. To head off the greatest threat to the global food supply in human history, we need to cut carbon emissions by 80% before 2020, not 2050, as is being discussed in Copenhagen.

This can only be accomplished by redefining food and the environment as national security issue and launching a wartime mobilization. These difficult goals are achievable. Enough sunlight hits the earth in a day to power the global economy for a year. Texas alone has more than 20 gigawatts of wind power operating, under construction, or planned, enough to take 5% of our 250 coal fired power plants offline. Electricity demand could be cut by 90% purely through greater efficiencies, like switching from incandescent bulbs to LED?s.

Europe could get its entire 300 gigawatt power supply from solar plants in North Africa at current market prices. Cars powered by wind generated electricity would bring fuel costs down to an equivalent 75 cents a gallon, as electric motors are three times more efficient than internal combustion engines.

While Brown?s predictions are a little extreme for many, they mesh perfectly with my long term bullish cases for food and water plays. Take another look at the food sector ETF?s, (DBA) and (MOO), and the water space ETF?s (PHO) and (FIW).

The China View from 30,000 Feet

Diary, Newsletter

I have long sat beside the table of McKinsey & Co., the best management consulting company in Asia, hoping to catch some crumbs of wisdom. So, I jumped at the chance to have breakfast with Shanghai based Worldwide Managing Director, Dominic Barton, when he passed through San Francisco visiting clients.

These are usually sedentary affairs, but Dominic spit out fascinating statistics so fast I had to write furiously to keep up. Sadly, my bacon and eggs grew cold and congealed. Asia has accounted for 50% of world GDP for most of human history. It dipped down to only 10% over the last two centuries, but is now on the way back up. That implies that China?s GDP will triple relative to our own from current levels.

A $500 billion infrastructure oriented stimulus package enabled the Middle Kingdom to recover faster from the Great Recession than the West, and if this didn?t work, they had another $500 billion package sitting on the shelf. But with GDP of only $5.5 trillion today, don?t count on China bailing out our $15.5 trillion economy.

China is trying to free itself from an overdependence on exports by creating a domestic demand driven economy. The result will be 900 million Asians joining the global middle class who are all going to want cell phones, PC?s, and to live in big cities. Asia has a huge edge over the West with a very pro-growth demographic pyramid. China needs to spend a further $2 trillion in infrastructure spending, and a new 75-story skyscraper is going up there every three hours!

Some 1,000 years ago, the Silk Road was the world?s major trade route, and today intra-Asian trade exceeds trade with the West. The commodity boom will accelerate as China withdraws supplies from the market for its own consumption, as it has already done with the rare earths.

Climate change is going to become a contentious political issue, with per capita carbon emission at 19 tons in the US, compared to only 4.6 tons in China, but with all of the new growth coming from the later. Protectionism, pandemics, huge food and water shortages, and rising income inequality are other threats to growth.

To me, this all adds up to buying on the next substantial dip big core longs in China (FXI), commodities (DBC) and the 2X (DYY), food (DBA), and water (PHO). A quick Egg McMuffin next door filled my other needs.

The Bottom is in for the Ags

Newsletter

Take a look at the drought monitor below, and you?ll see that it looks exactly like the one we saw a year ago. Yes, that?s the one right before we saw prices double for corn (CORN) and most other agricultural products.

The global warming trade may be about to return with a vengeance. If the weather so far this year is any indication, the trading pits in Chicago could break out in riots at any time. This winter, hurricane Sandy ravaged the east coast, tornadoes decimated Kansas, and California suffered its driest winter in 20 years. Water rationing on the west coast is now almost a certainty. Extreme weather is breaking out everywhere.

Regular readers are well aware of my predictions of major global food shortages in the years ahead (click here for ?Is Food the New Distressed Asset??).

The basic problem is that the world is making people faster than the food to feed them. Rising emerging market standards of living are increasing their food consumption at the expense of poorer countries.? If everyone in China eats one extra egg a day, the entire continent of Africa has to starve.

The global population is expected to rise from 7 billion to 9 billion over the next 40 years, and half of that increase will occur in countries that can?t feed themselves today, largely in the Middle East.

Global fresh water supplies are shrinking fast. Throw global warming into the mix, and a crisis will unfold sooner than later. These are all arguments to use a major dips in the food ETF?s, (CORN), (SOYB), (DBA), and (WEAT), to pick up long positions. And we have just witnessed a nine month long sell off in the sector. In addition, my technical trading pro, Jim Parker, The Mad Day Trader, loves the charts. It?s time to go shopping in the cereal section of your local stock exchange.

Time to Go Long Corn

The Corn Crash Continues

Newsletter

Pit traders of the ags are bruised, battered, and broken, in the wake of Thursday?s US Department of Agriculture crop report showing that there is a whole lot more food out there than anyone imagined possible.

Corn was the real shocker. It has long been a nostrum in the ag markets that high prices cure high prices, and that is exactly what is happening now. In the wake of last summer?s spectacular drought induced shortages, which saw corn prices nearly double, farmers rushed to expanding plantings in 2013. The government expects that some 97.3 million acres will be sown this year, the most since the Dust Bowl days of 1936.

The government agency boosted estimates of stockpiles nearly 10%, from 5 to 5.4 billion bushels. Demand from ethanol makers has collapsed as they have priced themselves out of the market, leading to the closure of nearly 10% of the country?s fermenting facilities. Purchases by ranchers as feedstuff for cattle have been weak. These are enormous upward revisions. Prices took a 10%, limit move down on Friday, and are taking another dive today.

Even though the numbers were not as dramatic for the other grains, their prices suffered as well. Some of the new corn is being grown at the expense of soybeans, which saw a small decline in plantings. But prices took a dump anyway. Wheat (WEAT) has amazingly dropped below the summer, 2012 lows. The ag ETF (DBA), which includes the machinery and fertilizer companies, has performed the worst of all, and is threatening a new three year low. Virtually the entire 2012 ag bubble has been given back.

The long term bull case for food could not be more compelling (click here for ?Is Food the New Distressed Asset??). The world is producing people faster than the food to feed them. The global population is expected to rise from 7 to 9 billion by 2050. Half of that increase will happen in countries that are unable to feed themselves, like the Middle East.

Food consumption in the US isn?t dropping anytime soon. According to Yahoo data, ?Plus sized swimsuits? searches were up 530% in March.

There is also a huge emerging market play here. Rising standards of living mean better diets. Better food requires more calories and water to grow. To raise one pound of beef, you need 2,200 gallons of fresh water. It is true that if everyone in China eats one extra egg a day, the entire continent of Africa has to starve.

I have been ignoring the ags since last summer, when, if you didn?t get in during the first week, you missed the entire drought play. Since then I dipped in on the short side in corn, playing the slow unwinding of the price bubble.

With this collapse, the long side is now, at last, back on the table. Let the current selloff shake itself out. Then, take a look at some long plays in case the global warming trade returns this summer. Nine of the ten past years have been the hottest in history. Why should this year be any different? If Texas governor, Rick Perry, says something isn?t happening with the environment, you can pretty much count that it is.

If you have any doubts, take a look at the latest drought monitor map below, which shows long-term arid conditions persisting in most of the Midwest.

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Not as Shiny as it Once Was