What will prick the Commodities Bubble?

Despite weak economic indicators, rapidly deflating housing prices, and flat to negative consumer consumption commodity prices soar. Why? When looking at the price trending of commodities one can't help but notice that in the fall of 2007 rapid price appreciation starting taking place. Is it coincidence that as commodities roared fears of defaulting bond insurers, collapsing "bears", and credit market evaporation spread like wild fire? The correlation should be noted, but also take note that the commodities market has not corrected as equities market have seemed to heal (with the exception of tanking gold). Has fear of a housing market collapse driven investors to hold their wealth in terms of gold, oil, wheat, sugar, and aluminum? It couldn't be. Housing prices drive construction ....a major consumer of the economic nuts and bolts (i.e. commodities). It must be the fear that the dollars in our pockets have decayed in value faster than nearly all natural phenomena. U.S. Dollars, however, are not decaying at any rate, magnitude, or depth near that of appreciating commodities. Another interesting development (suspiciously timed with the boom in this market) is the creation of commodity linked Exchange Traded Funds. An interesting experiment was conducted in an undergraduate economic course I took in college. The professor created a "mock" economy with goods, services, and specific wealth allocated to each student. We then sprung into action, with instructions to act as economic agents. We placed bids for various valued items and services. We learned how price discrepancies were arbitraged by "rational economic agents". Then, the professor dramatically increased our means, by introducing credit. Prices, like our purchasing abilities soared. The rage in recent commodity prices are similar. A fundamental market shift has occurred by the introduction of new trading instruments to the novice speculator. Just as debt securitization turned risk taking activities on their head, Exchange Traded Funds have created a niche for commodities to be part of any "balanced" pension plan portfolio.

Brazil's Sugar Loaf Oil Field and American Oil Dependence

Petroleo Brasileiro SA, Brazil's behemoth oil driller and producer has seen its stock rage from $25 / share in September 2007 to $84.59 on Friday April 26, 2008. Similarly Brazil's Exchange Traded Fund iShares MSCI Brazil Index Fund has more than doubled in the same time period. There is huge market demand for Brazil's equity. Why? Brazil may provide a much more significant percentage of America's oil needs in the future. Those are very big needs. The Carioca/Sugar Loaf field is a potential deepwater oil field in the Atlantic Ocean off the coast of São Paulo, Brazil. The field is part of an important emerging petroleum basin known as the Santos Subsalt Basin. Two other large oil fields have been discovered in this basin in 2007 and 2008, the Tupi and Jupiter fields. By now the state and size of the Carioca/Sugar Loaf field has not been clarified, but estimates are between 25 and 40 billion barrels.

According to Bloomberg:

http://www.bloomberg.com

*Among discoveries in the past 30 years, only the 15-billion-barrel Kashagan field in Kazakhstan is larger than the Tupi's field estimated 8 billion barrels.
*Haroldo Lima, director of the country's oil agency, last week said another subsea field, Carioca, may have 33 billion barrels of oil. That would be the third biggest field in history, behind only the Ghawar field in Saudi Arabia and Burgan in Kuwait.
*The U.S. imports about 10 million barrels of oil a day, or 66 percent of its needs, according to the Energy Department in Washington. Saudi Arabia was the second-largest supplier in January, behind Canada.
*Persian Gulf nations accounted for 23 percent of U.S. imports, compared with Brazil's 1.7 percent share. Brazilian crude output rose 1.9 percent last year to 2.14 million barrels, according to the International Energy Agency.

With Oil trading at $116 US Dollars per Barrel...this means that Brazil may have recently added 2.9 to 4.6 Trillion Dollars to their national wealth. It is kind of like finding 15 to 25% of the U.S.'s total value of outstanding equities ($20 Trillion) off the coast of Sao Paulo.

According to Peter Zeihan, vice president of analysis at Strategic Forecasting in Austin, Texas.``The finds they've got so far are just the tip of the iceberg,'' Zeihan said. ``Brazil is going to change the balance of the global oil markets, and Petrobras will become a geopolitical supermajor.''

Bracing for Phase 2 Decline

Get ready.....

*Dollar reaches all time low versus Euro. Is China converting reserves into alternate currencies? Dollar tipping point in question. Currency devaluation of world's largest borrower.
*Crude Oil reaches all time high.
*Nearly every financial institution posted losses in Q1...Market rallies because pessimism already priced in. Reference CitiGroup / Merrill. Bank of America / Washington Mutual bring surprises.
*Housing price decline accelerates. Biased National Association of Realtor's number indicates increasing decline. Case Shiller number due August 29. CME Case Shiller futures pricing major declines into August of 2009.
*Securitized debt underwriting trending towards 20% of 2006 and 2007 issuance. Mortgage Litigation skyrockets.
*Fed may be out of financial fixes (i.e. Overnight Fed Funds Rate / Term Auction Facility)...inflation concerns rising. England Central Banks mimic fed's toxic debt purchasing maneuver.
*VIX (CBOE Volatility Index) begins new rally after fears allayed by Fed fixes and successful hybric (equity / debt) funding by Wall Street investment banks.
*Credit Default Swaps and Interbank Counter Party risk concerns still near all time high. Ted Spread still posting impressive highs.
*ABX (Securitized Home Equity Indices) reaches all time lows in non-prime and sub-prime tranches....additional 50% declines from January 2008. Reference ABX-HE-BBB 07-2 Roll. $32.5 Oct. 07, $22.5 Jan. O8, $10 Apr. 08.
*IMF warns of systemic risk and $1 trillion credit losses, $250bn posted so far.

What about when Financials start writing assets up?

`Totally Uncorrelated'

The latest version for AAA rated subprime mortgage bonds slumped by 43 percent since it began trading in August, according to Markit, as rising U.S. home loan delinquencies triggered a surge in the cost of credit-default swaps. That implies a 53 percent loss on the underlying mortgages, according to Schultz, almost four times the 13.75 percent rate predicted by Wachovia.

The cost to protect $10 million of AAA commercial mortgage securities jumped 10-fold during one six-month period to $100,000 a year, based on the first CMBX index from Markit. That implies about 13 percent losses on the underlying loans, more than four times the 2.8 percent forecast in the event of a recession by JPMorgan Chase & Co. analyst Alan Todd in New York.

``ABX, CMBX, any kind of X you like, are totally uncorrelated to any kind of underlying market,'' Swiss Re's Aigrain said at the Dubai conference.

bloomberg.com

Are GE's Earnings Indicative of Bigger Declines?

America's largest corporation has failed to live up to wall street expectations. American consumers (who accounts for 70% of America's GDP) are being held accountable for the short fall. At least that is what the market's tanking this Friday indicates. Is GE at fault, high energy prices, or the overly debt burdened American buyer? Regardless, Wall Street expects the other big boys to follow suit. Next week will be an interesting one.

Is it time to start investing in Financials?

There seems to be cautious optimism that the worst of the Credit freeze is over. The federal government (after all) has provided a means for financial companies to off load risky, depressed, and illiquid loan instruments. The simple swap pays market rate for complex wall street created debt securities in the currency of U.S. T-bills. My question is, what percentage of average bank assets are Level 3 (i.e. difficult to price, illiquid derivative instruments)? Bloomberg estimates are in the range of 7-8% of underwriting business. According to recent reports Goldman Sachs (the one investment bank with little Level 3 exposure during the credit crisis) has increased their exposure to these assets by 83% in Q1. I think we can only anticipate this to mean that Goldman went bargain shopping after loan instruments were driven through the floor. But will prices ever return to fundamental values??? The credit quality of these instruments have driven certain investors away indefinetly. I think speculation and market craze has overly depressed financial stocks. Don't get me wrong...they've lost billions, but they've weathered it. Collatoralized loans are not the only product sold on Wall Street....they just happen to be a product kept somewhere near banker's books.

Are Asset Backed Securities Oversold?

The ABX indices

http://www.markit.com/information/products/category/indices/abx.html

is probably oversold at this point. While I don't have the models to verify the risk analysis, the investment banking community is claiming that current prices anticipate a 75% defaul rate in the BBB rated securities. I'm guessing that these securities are oversold, any buyers.