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Turning the Corner

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July 17, 2013 – Comments (5)

Board: Macro Economics

Author: FastMike

”…Surplus production and record-low interest rates combined to encourage financing deals in everything from aluminum to zinc. They typically involve the purchase of metal for nearby delivery and a forward sale to take advantage of a market in contango, where prices rise into the future. The transactions lock up metal in warehouses and make it unavailable to buyers…”

Dear head scratching Fools:

At one time, not too long ago, (perhaps a week or so) this strategy was known as “cornering the market”.

http://www.bloomberg.com/news/2013-07-10/commodity-traders-f...

The article seems to imply that this strategy, applied to metals has reached its maximum. The next step is to ‘carry over’ to agricultural commodities: ”…”They’ve seen this work in metals so all they’ve done is taken it across to agriculture,” said Colin Hamilton, the head of commodities research at Macquarie Group Ltd. in London. “You have so much material in a given location that it becomes essentially impossible to load that out to the extent that the market needs…”

It seems that cocoa is piling up in concentrated locations: “…Warehouses in Antwerp, Belgium, held 61 percent of cocoa certified for delivery by the NYSE Liffe exchange on June 24, compared with 36 percent a year earlier, bourse data show…”

So could this be happening with other agricultural commodities as well?

Perhaps this goes part way to explaining why we’re seeing prices rise on the retail level for all sorts of things. It isn’t because of robust, booming, wildly exuberant consumer demand but it is, in part, because of supply constraints. Let me point out here that the same thing is happening in the US housing market. Supply constraints are causing bubble like increases in single family homes and an increase in the production of rental units. I can tell you from a lifetime of experience, even with a reasonable well-paying job, rent takes a big bite out of savings. Low rates are good for housing in the short term, but destroying a sustainable housing market long term.

And as if to add insult to injury, the recent housing boom has caused a spike in mortgage rates! Ah! So supply trumps Fed policy??

I’m amazed that central bankers from Tokyo to Beijing to Brussels to Washington just don’t get it! Asset and commodities markets have efficiently adapted to take advantage of low interest rates and that adaptation is doing very little, if anything to help the real economy. Central Bank policies have incentivized markets to profit by making use of low rates to employ strategies that are completely disjoint from real economies the world over.

In fact one just might be inclined to think that as long as low rates are used by the private sector to continually leverage up to meet (or beat) their return benchmarks, then there’s less incentive to invest capital towards growth.

If that premise is correct, then the incentive becomes to not grow, since growth will lead to higher rates and higher rates will force leverage strategy unwinding and thus diminish returns. Rate repression is, in fact, creating a society of equity poor renters and under employed part timers! Rate repression is discouraging saving and investing and makes it difficult or impossible to retire! It’s making equity and fixed income markets way too risky for even ‘long term’ investing, unless you don’t mind getting stuck with a 30 year bond at 3.5% or thereabouts.

What I simply can’t comprehend, based on what I’ve heard and read recently is that central bank policy is blind to the big picture: economies are stagnant, with supply driven rising prices and asset markets hanging on their every word. They seem to believe that weak, mediocre trends are an indication of overwhelming success and record breaking asset markets are no cause for concern!

It’s possible that a different approach will increase the velocity of money through the real economy. This seems to me to be a less risky approach than claiming that money velocity is irrelevant while markets are breaking new highs every day!

”…Former Federal Reserve Gov. Laurence Meyer told CNBC Tuesday that velocity of money—the rate at which capital is transacted in an economy—shouldn't concern markets, and he dismissed the metric as a guide in setting central bank policy…”---CNBC

http://www.cnbc.com/id/100873633

Do Fed governors, former or otherwise think this way? If the indication is bad, the indication doesn't matter?

Are they for real?

The problem is not that rates are low. The problem is that rates are too low. Rates must be allowed to rise enough to force those oceans of capital out of ever levered markets, thus making consumer lending more competitive and profitable, but not so high as to make money too expensive for those consumers.

Just forcing rates as low as possible is a “brute force method” needed for the worst possible situation. We’re well past that point. Central banks need to allow markets to find their own level and the sooner the better.

The Fed and their Asian and European counterparts need to choose between two realities. One is stagnation created by artificially supported prices and markets, ad infinitum or until it works. The second is to risk letting rates rise to a sustainable level and suffer through a market correction.

If policy relentlessly continues along these lines, it won’t just be cornered markets, but a cornered middle class!

Your locked-in Fool,
FM 

5 Comments – Post Your Own

#1) On July 17, 2013 at 11:55 AM, Goofyhoofy (< 20) wrote:

This is baloney, and typical of the "government must do nothing" aura that infects so many these days. That's what happened in 1929, as people stood around helplessly watching the economy collapse. Curiously, since then, the Fed and/or Congress (via infrastructure or other spending) has ameliorated most fiscal panics and recessions to minor annoyances. With Congress in thrall to the "do nothing" crowd, that leaves only the Fed with a few tools to combat the worst of it.

Bank panics happen. They happened dozens of times in the 19th century, and again in the early 20th. Once we figured out that there was a way to prevent them and/or deal with them timely, only idiots and fools stand around saying "No, you shouldn't do anything." 

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#2) On July 17, 2013 at 2:31 PM, FastMike (< 20) wrote:

2013 - 1929 = 84 years since the great depression, the Model T, the first washing machines and telephones, the solo crossing of the Atlantic Ocean and a NY Yankees team so good people were clamoring to 'break dem up!'. Trades on the NYSE were walked from the order desk to the trading post.

Lastly, if one were to purchase a sovereign bond from say France or England it would have taken weeks to complete the transaction.

Today, cross border transactions are completed in milliseconds.

Times have changed!

I'm not saying government should do nothing.

What I am saying that when rates are suppressed to near zero, and risk is taken out of Treasury Bonds (and other sovereigns)  then markets adapt. It becomes more profitable to use this too cheap capital to leverage, as the example in the post noted, to stockpile creating artificial price increases.

It's creating distortions in fixed income assets, too. People really have to pay up for lower quality fixed income assets.

Crises measures are no longer needed. Markets need to do some of the work now, in particular, determining lending rates that are not harmfully low, nor harmfully high.

In particular, central banks must allow risk to return to markets.

 FM  

 

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#3) On July 17, 2013 at 7:18 PM, awallejr (79.54) wrote:

"the recent housing boom has caused a spike in mortgage rates!"

That is not correct.  The spike in mortgage rates was a direct result of the rise in T Bill rates.  It was the selling of bonds that was the cause. 

Everyone keeps arguing how this is a slow, tepid economy.  Setting aside the cause for the initial crash, if you listened to Bernanke today he said basically if Congress got their act together we would be pacing 3 1/2 pct GDP instead of the, hopefully, 2 pct.

How can the Fed raise their funds rate with at best 2pct GDP and 1 pct inflation?  You want to throw the Country into another depression?

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#4) On July 18, 2013 at 9:08 AM, FastMike (< 20) wrote:

Mortgage rates were increasing in anticipation of a rate increase and a shortage of supply of homes which drove prices up, igniting bidding wars in some cases:

http://www.cnbc.com/id/100890224

On 6 June, a couple of weeks before the Fed hinted at a policy change the 30 year bond was at 3.28% vs. a recent high of about 3.68% and the 10 year note was at 2.07% vs. the recent high of 2.71%. (Published 6 June):

http://money.cnn.com/2013/06/06/real_estate/mortgage-rates/index.html

So yes, an increase in Treasury rates caused mortgage rates to rise, but only in part. It was also due to, in part, supply constraints in real estate causing a sharp increase in prices!

As far as government spending cuts, well that was bound to happen anyway. Government spending will not come back to the same extent whether or not Congress can come to a resolution.

But to get back to the point, there is no precedent to prove that suppressing rates as much as possible for as long as possible will generate a self sustaining recovery.

Too much central bank support and too much rate suppression is proving itself to be as much of a drag as not enough Fed support and not enough rate suppression.

The economy is recovered enough to let markets determine optimal rates in all sectors of the economy.

FM

 

 

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#5) On July 18, 2013 at 5:59 PM, awallejr (79.54) wrote:

FM I am in the business, supply may impact price, mortgage rates may impact price, but supply and price does not matter to mortgage rates.  6 months ago we had the lowest mortgage rates I have ever seen all during rising price and declining supply.  Bond rates matter.

If we had a more accommodating fiscal policy then Bernanke can let up.  But we don't.  We have a totally dysfunctional Congress. I don't agree that the economy recovered enough, the data is still mixed.  If the Fed starts to tighten while Congress pursues austerity, which is what the sequester is all about over the years, I see recession.

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