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.

Who is Regulating the Federal Reserve?

Treasury Swap Auctions have begun where the U.S. treasury department has agreed to buy (or trade) highly liquid T-Bills for Mortgage Backed Securities from "Primary Dealers". What has been hailed as the economic move of the millenium that saved the country from the 2nd Great Depression is legally questionable? Bernanke's extension of U.S. backed credit in exchange for "non-agency" AAA and Aaa rated Mortgage Backed Securities has greatly extended the government's role in America's free market. It is shocking that the news headline of the day was that JPMorgan and the Federal Reserved bailed out Bear Stearns, when a massive political action was truly in progress. In times of crisis we seem to be blinded by our patriotism, and often open doors that should not be opened. The Fed has seriously violated its seemingly Laissez-faire economic policy and set in stone its monetarist fundamental as the economic auctioneer (i.e. lender of last resort).

Housing Declines of 50%

Some have estimated the severity of the housing decline to include drops as much as 50% from peak to trough in certain markets. People don't just expect it. The markets are betting on it. Below are values of where the Case Shiller futures markets are trading.

S&P/Case-Shiller Index - January 2008 v Highs
	High	High	Jan 2008	High v	Nov 2012	High v
	Month	Index	Index	Jan 2008	Futures*	Nov 2012
Atl	Jul 07	136.47	127.08	-6.88%
Bos	Sep 05	182.48	162.59	-10.90%	-11.80%	-22.70%
Char	Aug 07	135.88	131.70	-3.08%
Chi	Sep 06	168.60	156.47	-7.19%	-7.10%	-14.29%
Clev	Jul 06	123.49	108.49	-12.15%
Dal	Jun 07	126.47	118.56	-6.25%
Den	Aug 06	140.27	128.98	-8.05%	-13.90%	-21.95%
Det	Dec 05	127.05	100.17	-21.16%
LA	Sep 06	273.94	224.41	-18.08%	-27.70%	-47.78%
LV	Aug 06	234.78	186.05	-20.76%	-16.80%	-37.56%
Mia	Dec 06	280.87	225.40	-19.75%	-30.80%	-50.55%
Min	Sep 06	171.12	151.16	-11.66%
NY	Jun 06	215.83	200.49	-7.11%	-19.00%	-26.11%
Pho	Jun 06	227.42	180.06	-20.82%
Port	Jul 07	186.51	178.81	-4.13%
SD	Nov 05	250.34	197.45	-21.13%	-21.80%	-42.93%
Sea	Jul 07	192.30	181.62	-5.55%
SF	May 06	218.37	183.81	-15.83%	-15.70%	-31.53%
Tamp	Jul 06	238.09	194.64	-18.25%
WDC	May 06	251.07	212.83	-15.23%	-22.00%	-35.23%
10-C	Jun 06	226.29	196.06	-13.36%	-21.50%	-34.86%
20-C	Jul 06	206.52	180.65	-12.53%
* based on CME Settlements March 18, 2008
Source: S&P, Bloomberg, TFS

Inflation?

http://www.abalert.com/FT/?files=GetPDF2&Password=ZJJAY6DL

I think that this link is telling of a few things. First the fact that asset backed security issuance was 83% lower the first quarter of 2008 compared to 2007, means the effects of the credit contraction are huge, but haven't been felt by the average consumer. A change of issuance from $702 Billion in Q1 of 2007 to $120 Billion in Q1 of 2008 means we are trending to a yearly credit issuance that is 1/5 of the approximate $2 Trillion issued last year. Those are big numbers. It also leaves you wondering who is lending all of the money (i.e. buying the securitized debt)? One source is leveraged money management funds, another Sovereign Wealth Funds (including the Middle East, China, India, etc. / after all one cannot both lend and borrow to oneself). Those countries have reserves instead of deficits. The dollar crunch is making paying back all this debt even harder (as we all know). So what happens next? The lagged consumption (the largest percentage of US GDP) contraction tsunami has got to hit (I think the stock market has priced in the pain, but John Doe hasn't felt it...yet). Surprisingly, recent consumption numbers only remained even. It is coming, don't worry. I think this will be the dampening effect from run away inflation (and the cause of the recent retraction of commodity prices), and I think the fed knows it. I think we are in for a massive asset price contraction (most of which we've already had). I think we are also in for a significant reshaping of the American Economy because of the dollar crash. I think America will become perceived as the cheap getaway and an influx of European and Asian travelers / opportunists will arrive. The potential recovery will be what is interesting. When I get to pessimistic, I remind myself of how many cars are packed on the 405 going to work every morning. There are a lot of educated ambitious people going to work everyday. The question is, what kind of demand will their be for their services? Likely to shift to foreign, currency strong preferences.