Monday, May 23, 2011

With QE2 Winding Down - Which ‘Flation Will Rule the Day?

The reported end, or at least pause, of QE, is exactly what the deflation camp has been waiting for.  (Well...sort of.  Since some liquidity is going to be hanging around in the form of “QE2.5”.  Remember when Bernanke claimed that after QE1, the Fed would remove the excess liquidity from the system?)Regardless, after June, the Treasury will have a cool $100 billion plus to finance monthly, without the help of the Fed - at least for now.  And there will not be nearly $100 billion per month in newly printed money searching for a home in emerging markets, agricultural futures, and crude oil contracts.  Will this trigger a return to 2008’s deflation nation?

First, let’s review what we *think* we know.  Ben Bernanke became, as Felix Zulauf noted, the first central banker in history to actually say that he wants stock prices to go up.  And boost stock prices he did!

Along with food prices...and energy prices...and other stock markets...etc.  We haven’t seen much inflation here in the US because, as I learned last month while traveling in Asia, inflation has been America’s leading export over the last year!

The growing, industrializing countries in Asia - which on the whole boast more favorable, and inflationary, demographics than we have in the Western world (especially Europe and the US) - have been bearing the brunt of Bernanke’s QE.  Here in the US, we’ve been getting squeezed on higher food and energy prices - but service based prices, and wages, have been largely stagnant, as there’s no pricing power.

Looking ahead over the next 5-10 years, there are fundamental reasons why Asia should continue to grow, and why food and energy prices should continue to climb.  There are also fundamental reasons why Europe and the US will probably be slow growth economies at best, and why their aging populations will exert some natural deflationary headwinds on their economies (much like Japan post-1990).

The wild card, of course, is money printing.  Bernanke sure made me, and other debt deflationists, look foolish over the last 24 months.  The correct play was to purchase traditional inflation hedges - like commodities and gold - when the money printing started.

And over the next 5-10 years, I think it’s highly likely that we’ll see more rounds of QE.  Sentiment is now against the Fed continuing to print, but when things roll over again, they’ll probably be able to garner enough support to turn on the printing presses again.

QE2, to me, was crazy.  In retrospect, the kickoff of QE2 should have been a glaring red flag that everyone was on tilt.  The world was not ending.  But a 20% drop in stocks put the fear of God into the Fed that if they didn’t “do something”, financial rapture would be upon us.

History appears to be rhyming here.  Andrew Dickson White’s excellent Fiat Money Inflation in France (hat tip Dr. Evil for the rec) profiles the political roadmap behind France’s classic hyperinflation of the late 1790’s.  They printed once - and the economy looked a little better.  They stopped, and things turned down.

So, they printed a second time.  And things got a little better, but not as much as the first time.  Gee, who knew finance was like heroin!

But now, the French government was hooked - they printed til, as Jim Rogers would say, they ran out of trees.

I don’t know of a historical example of a government printing money once, and then stopping.  It’s an addiction that is very hard to break.  So, over the long term, continued money printing appears to be the most likely scenario.

But what about the short term?  We very well could get another bout of deflation.  And with commodities and stocks looking winded after a 2+ year one way run to the sky, this might not be the best time to pile into inflation hedges.

Net-net, we are fortunate in investing that we don’t have to make every trade.  I like Jim Rogers’ take on agriculture the best.  Over the next 10 years, it has bullish fundamentals.  Prices will continue to rise until new supply comes on line - and that takes time.

Continued money printing will, unfortunately for the world but fortunately for us ag investors, add some very volatile fuel to price increases in the grains.

In summary, inflation or deflation?  It depends - and really, it doesn’t matter either.  Medium to long term, prices of food and energy will continue to rise, until new supply comes on line.  Emerging and growth markets will have to contend with inflation, while Japan, Europe, and the US will probably see a dichotomy of inflation and deflation.  Until and unless we see “QE Infinite” as Marc Faber is fond of saying.

Regardless of how this all plays out, agriculture appears to be the most sound bet on the board to me.

Related reading: Our exclusive interview with Jim Rogers from Singapore - on commodities, China, and more

Monday, May 09, 2011

China's Concerns About the Corn Supply (and Potential Shortages)

Beijing remains concerned about corn supplies, especially in the medium to long-term, the South China Morning Post reports, as China is becoming a big-time importer of corn:
"China's net import of corn could exceed 20 million tonnes in three years," said Liu Xiaobo, a Shanghai-based food analyst from Everbright Securities. "Most of the corn imports come from the United States, which is expected to increase its domestic consumption of corn for ethanol production and the same applies for corn-export countries in South America like Brazil.

"So, China can't assume it will always be able to buy enough corn from the international market," he said.

According to data from research institute, the mainland will need to import one million tonnes of corn in 2010-11, down from 1.5 million tonnes the previous year. Corn consumption is expected to grow from 158.8 million tonnes to 163 million tonnes, while corn production should increase from 155.5 million tonnes to 165.8 million tonnes.
Full article here: Corn Supply Remains a Worry for Beijing

This doesn't leave much supply slack in the system.  When countries swap from net exporter to net importer status, that can be quite bullish for the specific commodity in question.  This has happened in the oil market over the past 15 years, with more and more countries becoming net importers of the goo.
Corn Futures Price Chart 
Corn, which is traditionally said to rally up to July 4th, has ironically been on a tear since roughly July 4, 2010!

Rising demand coupled with tight supply is the theme of this 12-year old commodity bull market - and with that, let's revisit the words of our commodity investing patriarch, Jim Rogers:
“The average farmer in the United States is 57 years old,” Rogers shared (providing me with yet another “How the heck did he know that offhand?” moment).

“Who’s going to farm the land 10 years from now?  These guys will be 67…if they’re still around.  And nobody is graduating with farming degrees today.”

“There are just not enough farmers in the world.  There are vast stretches of empty land in Japan, believe it or not – with nobody to farm them.”

He thinks this commodity bull market could continue to rock and roll for some time because “little or no supply has come on line yet.”
Source: Live From Singapore, an Exclusive Interview With Jim Rogers

Over much of the past century, the US has been the sole driver of commodity markets.  It now appears we've got company in the front seat.

Investing note: There are a few ETFs that partially track the price of corn, with DBA being the most notable.
DBA price chart 2011 
DBA broke out in 2011.

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