FBA Issue 32: May / June 2010
Tightening fundamentals & even tighter money: Have we seen this before?
After a minor rally in mid month, grains and oil seeds ended winter and entered spring on a sour note, with prices falling steeply. In a nutshell, bad news outweighed the good news and stronger long-term fundamentals were overshadowed by behind the scenes liquidity issues.
Indeed, we need to ask if we are witnessing an eerily familiar price divergence between grains, other commodities and equities last seen nearly two years ago. Over the last month, equities, oils and metals posted gains while grains, oil seeds and sugar have fallen significantly.
All this occurred as the EU (for the 4th or 5th time?) declared the Greek government debt crisis 'solved'. Within days, a Greek bond refinancing sale failed so miserably that Athens announced it would attempt the next bond sale in US dollars instead of Euros.
Similarly, the spring and summer of 2008 saw numerous official statements declaring that the subprime crisis was 'solved', rallies in non-agricultural commodities and stagnant, downward trending CBOT grains. Looking back, mid 2008's falling CBOT grains where an early bell weather of vanishing liquidity that heralded a crash in all equities and commodities.
Scarce market liquidity amid an ocean of money?
Someone reading this article may respond with, "how can there be a liquidity shortage for market trading when governments have printed up so much money"? At first, this looks like a valid criticism. To answer this question, you may wish to look at the accompanying chart.
The chart shows that in 2007-08, the initial subprime bailout's money went into private sector loans. Within months, that newly minted bailout money quickly found its way into grain markets. Guess what happened? Within a year, it propelled CBOT corn, soy and wheat to record highs.
Now, look again at the accompanying chart and notice how the nature of the money supply expansion changed after mid 2008: Ever since the Lehman/AIG crisis, a massive proportion of money being printed is going into government bonds - in fact, despite the huge money supply expansion of the last two years, the actual supply of money available to the private sector â€“and grain traders - has been falling for two years -and continues to do so!.
With so little of the money printed over the last two years going into the hands of private traders, this may explain CBOT grains' disappointing performance. In fact, with so little of that newly minted money going into the hands of private sector traders, it is fair to say that grains, despite their disappointing performance, held up well under monetary conditions that are far tighter than they may initially appear.
Consequently, an EU sovereign debt crisis, impending US Alt-A/commercial real estate default or a combination of the above could seriously destroy the only major source of grain market liquidity left: leveraged government bonds. Are CBOT grains feeling the liquidity pinch a few months before the rest of the commodity market does? The odds appear to be better than even.
In sum, one cannot ignore the coincidence of price divergence between CBOT grains and other commodities amid the ominous rumblings of an EU sovereign debt crisis in the making. In the recent past, this combination was a leading indicator of financial tensions preparing to hijack commodity markets. If that is indeed the case, led by a falling bond market, you can expect grains, other commodities and equities to plunge in tandem within three to five months.
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