Commodity traders have seen QE (the greatest monetary non-event) as a free ticket to speculate.  Due to sheer misinformation these traders are placing leveraged commodity bets with the idea that QE2 will soon flood the US economy with freshly printed dollars and cause rampant and destructive inflation.  Of course, that’s not even close to remotely true, but the speculative fervor has taken hold regardless.  Making matters worse is that this speculative ramp in commodities is occurring at a time when the economy remains fragile.  David Rosenberg elaborates:

“The first time oil went to $90/bbl in October 2007, the net speculative long position barely exceeded 130,000, and today it is over 200,000.  So if you think that this runup in crude prices reflects a booming global economy, with all deference to China’s backdrop, think again.  As in the case of most other commodities, the Fed has unleashed the floodgates of investor speculation on the commodity complex and while absolutely terrific windfall news for resource companies, this is going to represent the mother of all margin squeezes for businesses that actually have to deploy raw material in their production process.”

“Now, how can this possibly be constructive for the 90% of the U.S. earnings outlook that is not hooked to the basic commodity sector?  We don’t see where this is addressed anywhere in “Street” research, but maybe we’re just not looking hard enough.  But how will the surging energy costs fit in with expectations of record earnings and double-digit profit growth for 2011, or what this means for consumer discretionary spending as the surging price deflator depresses real incomes and expenditures.  Lest we remind you, when oil first tested the $90/bbl level back in October 2007, the U.S. economy slipped into recession, without anyone knowing it, including the Fed, including the long list of Wall Street economists, many of whom are still in their seats today.      But here is the difference.  Back in October 2007:

  • The trailing trend in U.S. real final sales was 2.5%, not 1.2%.
  • The unemployment rate was 4.7%, not 9.6%.
  • Core inflation (which removes the effects of food and energy) was running at 2.2%, not 0.8%.
  • Manufacturing capacity utilization rates were 79%, not 72%.
  • Consumer confidence was at 95 (the Conference Board’s measure), not 50.

In other words, the economy is much more vulnerable to an energy shock now than it was back then.  Indeed, did we hear right that John Chambers had the temerity to challenge consensus views and describe the macro background as being “a challenging environment”?”

Source: Gluskin Sheff


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • buckstar

    Would guess the traders are aware that QE will not change end demand, it’s just that each has the hubris to think they can get out before it crashes. Likely the usual suspects that see the most order flow like GS, MS will be able to sell their positions to the dumber money before pulling the plug on the bubble.

    TPC – I watched CNBC today which is unusual. I simply could not believe how many people were referring to this as money printing. The misinformation out there is unreal. Could you imagine if you had your money invested with some of these people and later found out that they have literally no idea how the monetary system works, but were placing speculative bets with your money? It’s incredible really….Even Ben Bernanke said explicitly that it’s not money printing….

  • ChickenLittle

    Yes, that is all true, but you are missing one important point. Unemployed people don’t need to drive to work.

  • B Ferro

    Check out steel prices – one commodity area in 2010 that hadn’t had any traction is now getting it – AKS, X, STLD all participating in the monster equity rally too now – same for coal…

    But we are a service economy and don’t use steel so it is all good…

  • Cowpoke

    look at what happed to Sugar today:

  • http://n/a vol-trader

    I think the exchange raised margins significantly

  • Librarian

    It really is amazing that so many people refer to QE as “money printing.” I think I know why people do this. It goes back to the “principle of least effort.” People are basically lazy. Instead of doing real research, they just repeat what they hear from other people. Here’s an odd example of this. The IRS issues tax refunds, yet over the years more and more people refer to a tax refund as a tax “return.” I have noticed this more and more. This may sound like it has nothing to do with anything, but it is similar. Once something takes hold, people just repeat what they hear. Calling a tax refund a “return” is just one example.

    Almost everyone I know who says “money printing” is just mindlessly repeating what they heard somewhere. Very few people take the time to do any real, intelligent research. My head was so messed up that I have had to spend hours reading TPC posts and replies on this to finally get my head straight. After spending a lot of time last night reading posts and replies, I think I am finally understanding that QE really, truly is a non-event. The bottom line is that it is easier to watch mindless television than do any intelligent, critical research. It’s the “principle of least effort.” People are inherently lazy.

    Incidentally, I heard someone the other day say that after “hyperinflation” hits that a cup of coffee will cost $25. I started to laugh out loud. Who the hell is going to pay $25 for a cup of coffee? Demand will drop so severely, that the price will have to drop as well. This whole “hyperinflation” thing is completely nuts.

    TPC –

    “Incidentally, I heard someone the other day say that after “hyperinflation” hits that a cup of coffee will cost $25. I started to laugh out loud. Who the hell is going to pay $25 for a cup of coffee? Demand will drop so severely, that the price will have to drop as well. This whole “hyperinflation” thing is completely nuts.”

    Welcome to my world. Listening to these so called “experts” is like banging your head against a wall and then following it up by smashing your face against your desk. Half of what these people say regarding QE is just sheer nonsense.

    Thanks Librarian. One of my favorite comments ever….

  • hobo trader

    well, looks like time to bet the farm short

  • TPC

    One thing has been enlightening though. It has proven who has an ounce of knowledge in them and who doesn’t.

  • Nico

    China down 4% intraday, EU’s periphery in limbo, commodities going haywire, Brazil’s leading indicators slowing, seems like we are headed for volatile days very soon.

  • http://none GLH

    I would like to thank Ben Bernanke for this opportunity to short commodities. Also, Librarian, I was in the same boat as you until I found this site. And, I think it is Glenn Beck who is spouting off about the price of coffee and hyperinflation. We had all better heed Mr. Beck’s priceless words.

  • Mediocritas

    Good article. I’ve been trying to talk sense into the folks at ZeroHedge but they just don’t get it.

  • ermen

    Me too. It took me many months and many many readings of TPC and others to totally understand MMT.

  • Diffused

    Trying to talk sense into the folks at ZeroHedge is like trying to get a Pre-K class ready for naptime after having passed around 12 oz. cans of Red Bull.

  • Mitch

    Never underestimate the Fed and especially BB.
    (A while ago I read from TPC “Bernanke doesn’t understand the monetary system”. I couldn’t disagree more.)
    Ben is a master of psychology and knows how to exploit the dumb masses.
    Who says the Fed’s monetary policy has “unintended” consequences? Bubbles e.g. are a perfect way to transfer and reallocate wealth. These guys are brilliant. They (ab)use perfectly the complexity of the monetary system to their (and ultimately the US’) advantage and nobody gets it.

    In my opinion QE2 has 2 main goals (which are politically explosive, so BB of course doesn’t mention them) beside of lowering lending costs:
    1) continued backdoor bailout of big banks (let big banks earn their way out of the balance sheet mess by letting PD’s frontrun the Fed in their Bond purchases for risk free profits and keeping the yield curve steep in targetting the mid range in order to not hurt margins)
    2) political goal: Show the world who’s the boss (also often referenced to as starting a “currency war”, but that’s not the whole story. Imo the “currency war” began 20 years ago when emerging economies started to peg their currencies to the Dollar, so it is to end the “currency war”)

    To understand this you must see how the USD carry trade is psychologically ignited by QE2 with no downside risk:
    Knowing that most investors/traders don’t understand that QE2 itself has no inflationary effects / is a non event the Fed plays the psychological card of letting the Mainstream media of the whole world repeat that what’s happening is “money printing”
    -> buying frenzy of commodities, equities and foreign currencies / assets (USD carry trade: putting USD to work in emerging economies by borrowing at no cost / selling USD and buying e.g. SGD -> USD goes down, SGD goes up) even in mere anticipation of QE2
    -> herd behaviour of the dumb masses / self-fulfilling prophecy of rising prices, depreciating Dollar even after launching QE2 (and even when BB demasks it)
    -> enormous short term pressure on emerging (export) nations through high commodity prices / weak Dollar (resulting in inflation)
    So BB basically says (knowing it isn’t even a bluff): Look, I’m the master of the world’s reserve currency and if I want to I can crush your economy in a short period of time. So who’s the boss?
    Capital controls, babbling, downgrading the US’s credit rating etc. is pure sabre rattling.
    Unless they want nationwide riots, emerging economies, especially China, have no choice but to subdue to US (Fed) hegemony in the long run and let their currencies appreciate, tighten monetary policy and so on.
    The US doesn’t need a “Plaza Accord 2.0″, it has BB and the Fed.

  • jim

    Like all bubbles the sweet spot is at the end when everything goes parabolic. The question is timing. Why would they want to cut this commodity bubble off at the knees when there is still so much money to be made. The taxi drivers and box boys are not in yet.

  • Chris

    Massive hit to commodities today…these are obvious margin calls on the weak hands…today is a good day to buy my friends.

    The carry trade is unstoppable until the FED ceases the stupidity of using monetary policy to bailout the banks. The Chinese threat to raise interest rates is real, but that makes the miss pricing of the peg even more unsustainable. The FED isn’t going to blink…Bernanke will leave rates at 0% until are banks are solvent or the Chinese give up the peg. I’m hoping that maybe we have cut a deal with the Chinese on trade, but this looks more like margin increases catching weak hands and snowballing.

    The big crash happens when the FED ends the carry trade. QE ending is the signal for interest rate hikes in the US.

  • Mitch

    ad 1) and of course as the most important bailout step beginning with QE2 (in the long run ending with QEN) generate enough excess reserve on the bank’s balance sheets to offset losses in the tens of trillions of Dollars in toxic MBS.

  • Joe

    Hahaha, great comparison.

  • Rob Luk

    Great stuff TPC! Reading all of these QE2 articles and the comments/responses has been quite informational. Thanks for all of your hard work!

  • Rob

    If wages and prices go up by 10X or so and the average worker is making $500K/year, then $25 for a cup of coffee might not be such a bad deal. Note that I am not predicting this. I am just explaining how it could happen.

    Regarding QE2, the Fed will be buying bonds sold by the US Treasury. The Treasury gives the money from the bonds to the other agencies of the government which use it to pay salaries, social security checks, medicare payments, and so forth. Where do you think is going to get this money? It will create it ex nihilo (“out of nothing”) which is another way of saying that it will print the money.

    Now if the Fed could just create money ex nihilo with no negative consequences, that would be a great discovery! The US government could eliminate all taxes and borrow all the money that it needs for its operations from the Fed which would just create it ex nihilo. To do this, it would only be necessary for the Fed to expand its QE2 from $600B to around $3550B. Sounds great! A one year tax holiday would certainly stimulate the economy!

    Unfortunately, it has been found again and again throughout history that printing money causes inflation. Total US currency in circulation is around $900B and the Fed is proposing to create another $600B. This wouldn’t be enough to double prices but it would be enough to cause more inflation than we have seen in a long time.

    Of course, in theory the Fed could always pull the $600B back out of the system by selling bonds as inflation begins to pick up. Unfortunately, pulling money out of the system is much less fun than pumping it in and I wonder if the Fed will really have the stomach to do that when the need arises.

    I simply cannot understand how TPC can so consistently discount the danger of infation. Was TPC alive during the 70’s? If so, was he awake? I lived through the 70’s and am here to attest that serious inflation can happen in the US. It is not just something that happens south of the equator.

  • where is 9th Nov 2010 COT report ?

    I was wondering if anybody knows where I could find last Tuesday’s COT report??
    Besides the official site, which “don’t has” it.

    Great timing for a technical glitch, don’t you think?

  • ajit kumar

    I have a question for all who understand QE (asset swap)…….so fed’s bond buying is not money printing in conventional sense…well tomorrow fed says it will buy all the houses at elevated prices….so what wud we call that? according to TPC this is mere asset swap n should have no impact what so ever

  • Diffused

    You’re kidding, right?

    For a moment, let’s say your analogy is an asset swap. Let’s look at how this would play out if it were a true asset swap in an open market…

    In the case of a bond (an actual asset swap), the former bondholder gives up the rights associated with owning the bond: the face value and income stream of the bond. In exchange, the former bondholder receives the bond’s present market value in dollars.

    Similarly, if the FED buys the house, the former owner gives up the rights associated with owning the house: living in it and benefiting from property appreciation.

    He/she moves out and uses any available leftover equity to:

    1. Buy another house (with a new mortgage).
    2. Rent.
    3. Buy gold and live in the forest with the squirrels.

    If your analogy dictates that the owner lives rent free in the FED-bought house, you have an arrangement, not an asset swap analogy. If the FED pays double the market value of the house, it’s not an “open-market operation”. By definition, that’s also not an asset swap.

    TPC – It’s an unrealistic example regardless. They would never buy homes.

  • Diffused

    Best comment:

    “Let me know when they get to Bre-X.”