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Global Effects of Pricey Oil, Grain Only Grow Bigger

By Hans Parisis
Wednesday, 09 Feb 2011 12:53 PM Current | Bio | Archive

This week has given us many headlines that have highlighted how the surge in commodity prices during the past seven months has become a main catalyst in driving economic policies, politics, financial markets and business around the world.

Among the headlines that caught my attention is an article in the U.K. newspaper The Guardian: “WikiLeaks Cables: Saudi Arabia Cannot Pump Enough Oil to Keep a Lid on Prices.” The article referred to publications by WikiLeaks of U.S. diplomatic cables from 2007 to 2009 saying that Saudi Arabia's reserves may be overstated by nearly 40 percent.

The report also states: “According to al-Husseini (Aramco geologist and former exploration chief) ... it is possible that Saudi reserves are not as bountiful as sometimes described, and the timeline for their production not as unrestrained as Aramco and energy optimists would like to portray.”

Another article was the U.N. Food and Agriculture Organization’s (FAO) special alert titled: “A Severe Winter Drought in the North China Plain May Put Wheat Production at Risk.” It states that “substantially below-normal rainfall since October 2010 in the North China Plain, the country’s main winter wheat producing area, puts at risk the winter wheat crop to be harvested later in the month of June.”

The report says that about 4.9 million acres of winter wheat have been affected and no significant rain is expected in the next week. According to the Chinese newspaper Xinhua, Shandong is facing its worst drought in 200 years if the region doesn’t receive rain by the end of the month.

China is the largest wheat consumer, representing about 17 percent of global usage. The only thing we can do at this moment is to pray that the rain or snow comes quickly.

Meanwhile, the People’s Bank of China (PBOC) has raised its benchmark one-year lending rate again by 25 basis points to 6.06 percent.

We could easily say that these stories are just the tip of the iceberg and it is difficult not to see rising food prices as being one of the primary catalysts for the ongoing events in Egypt, Tunisia and beyond.

I don’t think it’s an overstatement to say that the shift in focus of many eurozone central bankers, and other U.K. officials, has been driven by rising commodity prices.

With Federal Reserve Chairman Ben Bernanke making it clear that he expects the U.S. unemployment rate to remain stubbornly high and inflation to remain stubbornly below the Fed’s target zone (which hasn’t still been officially defined yet but should be in the 2 percent area), it seems reasonable to suppose that the primary uptrend in core commodities should continue.

Such a sustained outbreak in commodity prices brings with it severe dangers. From the perspective of financial markets, the primary concern should be the fact that the last two times we have witnessed commodity prices rising at similar rates in 1973 and 2008, these moves have been quickly followed by the two most vicious bear markets in equities we have seen over the past 50 years.

Investors should take note of the fact that equity markets in the developed economies have, so far, shown little in the way of a negative response to the price movements seen in commodity prices, but the same cannot be said for equities in the emerging markets. For example, the Shanghai Composite is down 13 percent from its November peak while there is clear evidence that shows a marked drying up of inflows into the markets of the emerging economies.

Taking all this into account, we are back to that extremely difficult question of: What should an investor, not a speculator, own as a safe haven asset under these circumstances? With a question mark over the outlook for equities, of course commodity-related companies excepted, and bond markets under pressure while developed economies’ central bankers still largely commit to highly accommodative monetary policy, even the most hawkish of eurozone and U.K. bankers are hardly calling for a radical tightening of policy.

I still favor gold in the shorter term while I also continue to favor those currencies traditionally associated with gold, most obviously the Australian dollar. However, I don’t expect this situation to last. Of course, this implies that I’m right in my “read” of the current situation.

In particular, investors should remember that during the financial crisis of 2008 that gold lost one-third of its value in the space of five months while between July 1973 and December 1973, gold’s price fell by 28 percent. In other words, while gold and its associated currencies should perform as the current bubble continues to inflate, the bursting of that bubble could see a radical reversal in their fortunes.

The moment the bubble bursts, and, in my opinion at least, it’s not a question of “if” but “when,” we can expect a full-blown retreat from “risk.”

And then the most likely — and for most investors, most ironic — outcome would be a massive move back into the U.S. dollar, as we have seen during the second halves of 1973, as well as of in 2008.

While I certainly remain bearish on the U.S. dollar that still remains in its nine-year downtrend, my bearishness on the dollar would certainly change if I saw any signs of sentiment starting to turn to rather more negative in the mainstream markets.

So, it’s no surprise that I continue to watch closely developments in emerging equity markets. I also continue to look for any signs of the prevailing negative sentiment in these markets starting to spread.

Yes, the “blinking red light” or the “alarm bell” will pop up in the emerging markets that include, of course, the BRICs. Again, if I’m right, it’s not a question of “if” but “when.”

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HansParisis
This week has given us many headlines that have highlighted how the surge in commodity prices during the past seven months has become a main catalyst in driving economic policies, politics, financial markets and business around the world. Among the headlines that caught...
hans,parisis,commodity,wheat,grain,euro,dollar,inflation,prices,global,economic,political
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