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30 April 2013

Price falls point the way to close examination of production costs

The nice cosy arrangement where governments print bucketloads of new money to reduce the size of their debts, and that money then gets reprocessed into buying power for industrial commodities and precious metals as a protection against the inflation threatened by precisely that QE policy (yes, it really is the simple opposite of a virtuous circle), took a massive hit this month.

The recent price drops are way more significant than anything we have seen for a long while.

So what’s caused that relationship to break down?

Well, a number of things. The immediate trigger, I suspect, was the realisation that in order to meet its bailout conditions, there is a strong possibility that the Cypriot government will be driven to liquidate some of its gold holdings; follow that thought, and, since the Eurocrats themselves have told us that Cyprus is the model for future bailouts, you begin to look nervously at the size of the gold position of, say, Slovenia, Spain, Portugal, Italy, and, whisper it, France. If any of that lot hit the market, it wouldn’t be pretty.

Next, the growth figures coming out of China have been a little disappointing. Now, many of us are not too surprised at that, but if you’ve kept being fed the same old line that Chinese demand can absorb all the metal the world produces, when you do wake up to reality, it’s going to be with a bang.

Base metal stock levels should have been a sufficient warning that demand has not been keeping up with supply for some time now, but not everybody seems to take account of that. The average copper price so far this year is a tad under $8,000; to achieve the $12,000 put forward for the year’s average by certain bank analysts – who knows why they would do that – for the remainder of the year we need to see prices consistently better than $13,300, if my calculation is correct. Seems unlikely, I would suggest.

So if the trigger was the threat of central government liquidation of gold and the underlying reality of the truth of the supply/demand picture, what else has been playing on the markets?

Clearly, investors are very nervous and have been for some time. It’s across the board, commodities, equities, currencies, all show signs of high uncertainty. The most common comment I hear is, “I don’t know what to invest in”. It stands to reason, then, that movements will be violent, as investors are easily spooked into following the herd. Ten-odd years of commodity supercycle won’t be undone in a couple of days of panic liquidation, but this drop, not only because of its magnitude, does feel as though it is telling us we are reaching a turning point.

I suspect, in base metals at any rate, we are going to spend some time taking a look at prices down around production cost; obviously aluminium is already there, but copper looks as though it is heading that way as well. In the long run, that’s probably a good thing, if it means we get a more balanced market between supply and (genuine) demand. Of course, I may be wrong, and the money-printing/warehousing games may come together again to shore up prices a little longer.

Two other interesting points. First, the Financial Times has just published a major piece on the money made by the world’s principal commodity traders. It almost feels as though it is a valedictory to the decade of the supercycle. And the best rumour is that the gold selling is orchestrated by the Fed, worried that the continual selling of the dollar to buy commodities could lead to them losing control of inflation. I guess one day a conspiracy theory will be true.

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