Blimling and Associates Blog

As people who are inclined to obsess about demand-side issues, we marvel at how often market participants and analysts forget that price matters in the consumption equation. This was plenty ignored -- with major consequences -- in the global commodity price rally that took the world by storm in 2007 and 2008. 

With that in mind, the latest crude oil demand estimates from the International Energy Association (IEA) caught our eye:

Global oil demand is revised down by 190 kb/d on average for 2009 and 2010, equating to 84.8 mb/d (-1.2 mb/d year-on-year) and 86.4 mb/d (+1.6 mb/d) respectively. Revisions stem largely from changes to non-OECD historical baseline data, as slightly higher GDP prognoses from the IMF are counterbalanced by a higher price assumption.

For several months, we have casually (if inexpertly) asserted that $85 crude oil was perhaps in the "too hot" area. It seems as though IEA analysts see something similar -- a slowdown in demand at the upper-end of the recent price range.

Naturally enough, the market already suspected as much: the crude oil market is down by more than 10% since reaching the $85 mark last month. And, inter-month spreads have widened, suggesting the market is over-supplied on the front-end of the price curve (and willing to pay premiums for storage).

Price does matter.

Over the past week, we have spent a lot of time pondering China's seemingly insatiable appetite for dairy powders. WMP and SMP imports continued to run hot through March. Is it real? Can it continue? What does it mean?

Those questions are difficult to answer without also pondering larger questions about economic health globally and in China. Events over the past week have shaken confidence in a view that all is well (or, at least, all is okay). Robert Samuelson comments on the phenomenon on the Investor's Business Daily website:

The United States and many countries approved "stimulus" programs of tax cuts and additional spending. Panic was halted. A downward spiral of falling private spending and rising unemployment was reversed. The resulting economic slump was awful. But it was not another Great Depression. The worst has passed.

Or has it? Greece's plight challenges this optimistic interpretation. It implies that celebration is premature and that the economic crisis has moved into a new phase: one dominated by the huge debt burdens of governments in advanced societies. Comparisons with the Great Depression remain relevant — and unsettling. Now, as then, we may be prisoners of deep and poorly understood changes to the world economic system.

It should not escape notice that China's equity markets have been under pressure for several weeks. The government seems intent on tightening in an effort to fight inflation. It seems reasonable to wonder about export prospects into a weak Eurozone. More to the point, will fallout from tighter credit conditions or a cooling economy put the brakes on dairy product imports? We don't yet know enough to know for sure...and there are other germane lines of inquiry to explore. At the same time, we get the sense that it would be a mistake to simply assume that everything is okay and conditions tomorrow will resemble those prevailing today or in the first quarter.

Yesterday's rally in the domestic equity markets was, on it's face, heartening. European leaders seemed to reach for "shock and awe" measures over the weekend, restoring a measure of confidence for the short-run. As the day wore on, however, we couldn't help but notice that what began as a concurrent rally in the Euro largely fizzled. After bouncing all the way back to the 1.3000 level versus the US Dollar (up from about 1.2750 on Friday), the market faded back to close at 1.2731 -- making for slender 0.2% gain on the day. This could be a cause for concern in some circles considering that the rhetoric out of the EU over the weekend included a pledge that the Euro would be defended.

Count the analysts at Morgan Stanley as unimpressed. A post on "The Money Game" blog site quotes the Wall Street bank as commenting:

Overall, while fiscal policy might be on a more credible path the biggest threat to the euro is now coming from monetary policy. We believe we are not far away from a point in time when the ECB starts printing and effectively monetising euro area debt. We revert back to our “punish the printer” theme, where quantitative easing remains negative for a currency.

The above comes at a time when the US economy is in good shape and growth is surprising to the upside. While the Federal Reserve used the printing press a year ago we expect them to begin reversing this process through the summer, while it might be that the ECB is boosting its money supply.

It is likely that any rally in the EUR will be relatively shallow. The combination of fiscal credibility and a likely move to quantitative easing should put pressure on EUR to depreciate. Near term, there may be a relief rally, due to positioning and a removal of the extreme negative tail risk, but the lower trajectory remains in place.

Economic data from China overnight offers continued suggestion of improved economic health globally. According to published reports, exports from China in February jumped by nearly 46%, easily besting estimates for 35-40% growth. Imports were up too, climbing nearly 45% on a year-over-year basis. 

Export performance for January and February was up 34% -- which some say may be a better figure that takes into account activity (or lack of activity) around China's New Year celebrations/shutdowns.

A dispatch by the Associated Press on published by The New York Times offered a couple of comments:

''China's trade is extending its recovery,'' said Zhu Jianfang, an economist for Citic Securities in Beijing. ''Exporters are getting more orders these days.''

February's growth rate was boosted by comparison with last year's weak trade amid the global downturn and came despite the weeklong Lunar New Year holiday, when many companies shut down.

Zhu said the data increase chances the government might allow China's currency, the yuan, to rise in value. Beijing has held the yuan steady against the dollar for 18 months to help Chinese exporters but is under pressure from Washington and other trading partners that say it is undervalued and is swelling China's trade surplus.

In a reflection of stronger global trade, China's total Fe bruary imports and exports were up 45.2 percent from the same month last year. China overtook Germany in 2009 as the world's top exporter.

Chinese economic growth accelerated to 10.9 percent in the final quarter of 2009 on the strength of massive stimulus spending and bank loans. That drove demand for imported iron ore and other materials used in stimulus-financed construction projects.

''Stronger domestic demand led to the good performance of imports,'' said Liu Qiyuan, an economist for China Merchant Securities. ''We can see the domestic economic is on track for recovery.''

Equity markets in China have been on a bit of a comeback since fading earlier in the year. The benchmark Shanghai Index is up 4% since early February. But as the chart below shows, the market appears to be at an interesting "decision point" -- trapped in a narrowing gap between the 50-day and 200-day moving averages.

The Euro has been crushed over the last week or so as markets react to concerns about Greece's fiscal woes and presumed need for help from its European brethren. On February 3, the Euro traded to as high as 1.40 versus the US Dollar. This week the Euro has been flirting with 1.36 versus the US Dollar (down nearly 3%).

As European leaders search for ways to help, the Prime Minister of Greece -- George Papandreou -- has indicated that he will try to get the house in order, declaring that the government will embark on a fiscal austerity program. 

Such plans have not, to put it mildly, been embraced by Greece's powerful public sector unions. Indeed, they have gone on strike (from The New York Times):

A strike by civil servants shut schools and grounded flights across Greece on Wednesday, as unions challenged cutbacks aimed at ending a government debt crisis that has shaken the entire European Union.

Air traffic controllers, customs and tax officials, hospital doctors and schoolteachers walked off the job for 24 hours to protest sweeping government spending cuts that will freeze salaries and new hiring, cut bonuses and stipends and increase the average retirement age by two years to 63.

The strike left state hospitals working with emergency staff only and disrupted national rail travel, although urban mass transport was unaffected.

''It's a war against workers and we will answer with war, with constant struggles until this policy is overturned,'' said Christos Katsiotis, a representative of a communist-party affiliated labor union.< /em>

So much for austerity...and for quick, easy solutions to a serious challenge for the European Union. A challenge, that many note, could grow if Portugal, Spain and Italy have to line up for help, too.

Currency valuation is a two-way street. That is, price can be dictated by forces affecting either side of the currency pair. Strength of the US Dollar versus the Euro could be as much about Euro-zone weakness as it is about US economic strength. The former appears to be the case presently, as concerns about financial conditions in Greece, Ireland and elsewhere are weighing heavily on the Euro. Indeed, the Euro has fairly crashed in recent days, with the market dropping from over 1.45 versus the USD to near 1.40. That is huge currency movement in just five or six trading sessions. 

Strength in the USD has weighed on commodity pricing this week, as have actions taken by China to stem inflationary pressures. The comparatively small, comparatively insular US dairy markets can sometimes stand to the side, somewhat insulated from forces that affect, say, crude oil. Yet it is perhaps not entirely coincidental to see some downward pressure in the US dairy space this week and a significant downtick in prices for European butter.

Commodity mania was just about at its peak in 2008 when the OECD published a breathlessly anticipated report on global food supply and prices. There was a concurrent conference in Rome that attracted a fair amount of media attention. The challenges of feeding a growing world were front and center.

Naturally enough, the issue got pushed to the background amid the subsequent global economic collapse. Slowly but surely, however, the issue of food security, scarcity and pricing is creeping its way back to the foreground. Saturday's editions of The Wall Street Journal featured an article entitled "Commodity-Cost Jump Threatens Rebound":

From corn to crude, prices for a wide range of commodities are on the rise across the globe, a trend that underscores -- but could also hinder -- a gathering economic recovery. In recent months, global food prices have been growing at a rate that rivals some of the wildest months of 2008, when food riots erupted across the developing world. Higher prices could be a positive sign that companies are gearing up for a rebound in consumer spending, or the harbinger of a return to the upward spiral that plagued consumers before the recession took hold. The surge in commodities "is a reflection of extremely strong demand in the emerging world, and growing hopes of stronger demand in the developed world," said Jim O'Neill, head of global economic research at Goldman Sachs in London. It is "encouraging so long as it isn't too persistent." But Hugh Grant, chairman and chief executive of St. Louis crop-biotechnology company Monsanto Co., said the recession merely "masked" the 2008 food crisis. The price of a bushel of corn -- a ubiquitous ingredient in the U.S. diet -- rose 24% since Sept. 1. In Thailand, the price of a metric ton of rice, a staple across the region, stood at $618 in December, up 11% from September, but well below a peak of about $1,000 in April 2008. An index of global food prices compiled by the United Nations jumped 6.9% in November alone from the month before.

It is worth noting that, while dairy prices managed to flirt with multi-decade lows, other markets fell to levels that would have been considered on the high side five or ten years ago. Look at corn. Yes, corn prices came unglued. But in the face of (a) worldwide economic collapse and (b) the largest crop ever growing in the field, nearby futures never got lower than $2.90-$3.00/bu. Those used to be high prices. The CRB Foodstuffs Index offers an interesting view of what looks to be a structural shift that could last for a long, long time.

Interest rates in China are up, which observers see as perhaps the first move toward addressing mounting inflation pressures and asset bubbles. Rates had been steady for several months. From The New York Times: 

Raising interest rates may help discourage speculative investments by Chinese companies and individuals in real estate projects and other areas of economic activity. China’s dilemma is that higher rates may also prompt overseas investors seeking higher returns to redouble their efforts to push money into China, despite the country’s stringent capital controls.The People’s Bank of China announced Thursday that the yield from its weekly sale of three-month central bank bills had inched up to 1.3684 percent. The yield had been stuck at 1.328 percent since Aug. 13. An increase of less than 0.05 of a percentage point might sound small, but economists said it was a harbinger of more interest rate increases to come.They cited expectations that consumer and producer prices would rise in the months ahead, particularly compared with low price levels a year ago, when demand temporarily slumped in China as well as the rest of the world. “It is a turning point,” said Ben Simpfendorfer, an economist in the Hong Kong offices of Royal Bank of Scotland. “There is a convergence of events that will lead to higher rates.” The increase in the interest rate turned mainland China’s stock markets into Asia’s worst performers Thursday. The CSI 300 index of shares on the Shanghai and Shenzhen stock markets slumped 1.98 percent.

Given that few commodity stories with any depth can avoid mention of China it is reasonable to wonder whether efforts to fight inflation there will have a negative impact on a variety of markets. China's appetite for soybeans, for example, has been voracious. Closer to the dairy industry, whole milk powder imports have been exceptionally strong. In light of today's news should it surprise that WMP prices were down 7% in the latest Global Dairy Trade auction?

The Goldman Sachs Commodity Index was off to a strong start in the first week of the new year, largely as a function of strength in energy markets. It will be interesting to see if prices come under pressure in the wake of the China news.

Federal Reserve Chairman Ben Bernanke delivered a speech this morning at the Economic Club of New York. His remarks included some commentary on the value of the US Dollar. He said that, "we are attentive to the implications of changes in the value of the Dollar...[we will continue] to monitor those developments closely."

An Associated Press dispatch noted that:

Bernanke engaged in a delicate dance. He made clear that Fed policymakers will keep rates at super-low levels. Yet through his words, Mr. Bernanke is also trying to bolster confidence in the dollar without actually raising rates, a move that could short-circuit the fragile recovery. Economists say a free-fall in the value of the dollar is remote but cannot be entirely dismissed. Although low interest rates can put additional downward pressure on the dollar, they are needed to encourage American consumers and businesses to spend more and fuel the economic turnaround.

"Delicate dance" seems to accurately capture the Fed's dilemma, which we have noted is a battle between deflationary forces in the real economy and inflationary forces. Bernanke and other central bankers globally have taken the age-old tack to flight deflation -- pumping massive amounts of liquidity into the financial system. That liquidity, however, can create asset inflation -- dangerous levels. 

Bernanke said today that he expects inflation to be "subdued for some time..." But is that a comment about the real economy (such as capacity utilization) or about commodities (such as the price of oil)?

The Dollar today? It's down some.

Widely followed market commentator Dennis Gartman appeared on CNBC's Squawk Box this morning. He had an interesting take on the gold market (according to cnbc.com):

While not being comfortable with the current gold trade, Dennis Gartman, founder of The Gartman Letter, told CNBC Monday that the price of the precious metal will "continue to go up until it stops."

"It is a gold bubble," Gartman told CNBC. He called the trade on gold "mind boggling," but also said he is currently long — or betting gold will go higher.

Gold hit a fresh record high above $1,130 an ounce early Monday as the dollar fell against other Western currencies. Gold's Friday low of $1,102 an ounce is the floor, according to Gartman. If it falls below that mark, he suggests investors should "head to the sidelines."

Though "gold is in a bubble...but by it..." seems contradictory, the fact that the gold market might be in a bubble (and other commodities, too) does not mean it has to pop anytime soon. Indeed, the bubble could continue to inflate for months. Gartman identifies his stop and is content to trade with the momentum until the trade no longer works.