Monday, January 31, 2011

The Commodities Bubble, Speculation, and Demand Destruction

Today's 'Worth Reading'

This post is for all of you commodity bulls out there. If you read the source article, a case is made for commodity speculation bringing down the financial services industry a few years from now. (As if they've nothing else to worry about...)


source: FT Alphaville

Scenario #1:
Based on the currently inflated commodity prices, commodity producers in countries such as Brazil and Russia have clear business cases for investing in projects to dig more commodities out of the ground. As competition to launch such projects increases, the costs of completing them also starts to rise, with the owners of mining equipment and laborers capitalizing on the increased demand by charging higher rates. Because a portion of the demand for the projects is not coming from the real economy, an excess supply of mining capacity and commodities will be created.

...So as soon as investors start to doubt what constitutes ‘real’ demand for commodities and what’s pure speculation, they’ll head for the exits en masse, which will lead to a collapse in commodity prices, abandoned development projects and bank losses.

Besides the obvious food security stories in today's global news, inflated commodities are making a great target for those in need of cash, too. We are seeing sheep and turkey thefts in Europe, cattle rustling here in the U.S., and significant copper thefts around the world.

As for future scenarios, I particularly liked this next one from yesterday's DesMoines Register since input costs are always looming dangerously for those other than the mega-industrial farm producer of efficient scale. This coming year, the cost to plant one acre of corn is estimated to be $500 here in the U.S.

Scenario #2:
Corn prices rise to $8-$11 as bad weather (maybe in the United States this year?) worsens shortages. Cattle and hog herds shrink more as producers can't pay for feed, causing meat prices to skyrocket. Farmers profits are squeezed by higher costs for diesel fuel and fertilizer. Demand is destroyed. Corn and soybean processing plants, meatpacking plants and ethanol plants are forced to curtail or close. ----Sue Martin of Ag Investments

The number of cattle in the U.S. has been trimmed to a 53 year low. When producers lose money they quit producing. At some point volatile weather, volatile commodity prices, and volatile energy prices will result in difficult choices about whether to plant a crop, or not. Food production costs are closely tied to energy costs. Energy production is tied to the political stability of the oil producing nations which is tied to their food security.

These are reasons why, a few weeks ago, I included this next item from Kenya in my news, as I knew it could happen anywhere:

In Kenya, high agricultural inputs and fuel costs are driving the farmers in the grain producing region to diversify into dairy, fish farming and other ventures.
"“The current fuel prices are too high and we have no option but to reduce acreage under crop production to minimise losses,” said Mr Jackson Too, a farmer from Nandi County."

Commodity bubble warnings are not new and no one can time the popping of a bubble. Of course, the two above commodity popping scenarios don't even mention what would or could result in the way of the world's food-poor victims, food-inflation affected nations, and all of the resulting world political instability. Those things are too ugly to mention.
---Kalpa