Monday, 10 January 2011

Fill 'er up with a commodity index please

The argument goes: the world's central banks are determined to debase paper money, by keeping the printing presses working overtime and are both unable and unwilling to reverse the monetary expansion in a timely manner. As a consequence, when Armageddon happens and paper money ends up as kindling, we will be safe as long we had the prescience to invest in gold bars and commodity indices. I may agree with the first sentence and indeed anticipated the current state of affairs over two years ago ("Sunrise"), but the second, which has become a popular view, is deeply misguided.

If Armageddon happens and paper money becomes worthless, then what would you want to hold? Certainly not any financial asset including gold. Gold yields no income, has limited practical uses and it's main consumption is gaudily decorative. It would neither feed you, clothe you, nor shelter you. It remains largely a shiny trinket. Yet humans in the 21st century retain an irrational and emotional attachmment to its glittering physicality and continue to promote privately it's role as a store of value for now defunct historical reasons. Lets be clear, neither would you want to hold a commodity index, which merely tracks the price of commodities but gives you no right to exchange them for the actual physical product. There is no GSCI button next to unleaded premium at the petrol pump. You will not be able to fill your car up with the oil component in your commodity index.

OK I can see some of the commodity bugs backing off but coming back with their next widely trumpeted argument which continues to silence and force even the most grown-up, intelligent western men and women into whimpering submission without even a hint of opposition. And that is "China". Or "China's insatiable appetite". "China needs more commodities than are available in the long term" (replace "China" with "humans", and that argument applied 200 years ago). Oil futures have once again risen to close to $100, due to the dual fear of a debasement of US$ (this is even whilst US$ has been rallying in recent times) and encouraging economic growth numbers coming out. Never mind that OPEC cheating on quotas has reached 7 year historic highs, and crude oil inventories are still close to historic highs, which suggests that despite Chinese demand oil continues to be over-supplied.

The real reason that commodities and gold are going up is due to herding of sheep-like investors by overpaid commodity "specialists" patrolling the corridors of every investment bank today (actually a large proportion of these "specialists" were hired from equity, FX and fixed income departments and know as much about commodities as your mum). Overheads at the banks to pay these commodity specialists have gotten so high that if the commodity rally fails to continue, half of the commodity teams will be out of work. They have to work the phones and sell opaque high-margin instruments linked to commodities

The real question is whether the portfolio managers, on the receiving end of those phone calls, in turn agree to blow for the Investment bank into sustaining the bubble? Not some of the wiser ones, who are already beginning publicly to question the wisdom of the latest commodity rally.

No comments:

Post a Comment