Today’s commodity markets are not representative of physical supply and demand, but of financial supply and demand. That is to say they have become “financialized,” full of QE1 and QE2 money (QE being Quantitative easing). As we head into a full credit meltdown in Europe, the likelihood that markets around the world will capitulate is high. As the interbank credit markets freeze and we move into a deflationary spin, the commodities which were used by banks and financial traders (oil and gold to hedge against inflation) are moving into a deflationary spin. Property is already in a downward spin. Oil and gold, however, will be the prime movers in my Colossal Commodity Collapse Prediction.
In 2008, the global financial system went into cardiac arrest, with the collapse of Lehman Brothers. Luckily for Wall Street, Dr. Bernanke was on hand with his magic wand and was able to create enough new funny money in the form of more credit to pump into the arresting system. This money did not flow to the struggling home owners with huge mortgages and collapsing home values, or to small businesses that needed it to pay for wages and stimulate job growth. The money, which became known as QE1 and QE2, went to banks and insurance companies’ balance sheets. The credit markets had frozen and the banks began to hoard the cash, not least because they knew the perilous state of each other’s balance sheets.
One of the side effects of printing money, as the Federal Reserve did in order to revive the global financial markets, is that it devalues the value of each dollar printed; inflation. The idea is to create liquidity for lending to business, to create job growth and economic growth. However, due to the fact that the dollars being printed was zero interest, it created short-term demand by the banks and traders to inject these dollars into oil and gold, to provide growth/return and as a hedge against inflation. The effect has been an inflated oil and gold price. Other commodities have also seen huge increases, but oil and gold have been the main markets of choice mostly due to their size and therefore liquidity. Few other commodity markets could accommodate the tidal wave of freshly printed dollars.
There is no shortage of analyses out in the public domain as to what is happening with markets, which way they are going, whether there is economic growth and where there is value. If you read enough analyses, it will leave you suitably confused as to which way markets are going. Technical analyses, based on charts and support lines, are especially confusing. The simple fact is however, deflation means assets prices will devalue, while the debt against them will not, which will mean assets will be sold to raise cash to pay debts, until we reach insolvency. We arrived at this point in 2008, but due to the Feds magic wand, the patient, being the global financial system, was resuscitated by printing money. This time the cardiac arrest is likely to happen in Europe, and soon, and by all accounts, European leaders do not possess a magic wand. The banks in Europe are in trouble and that means the banks in the United States are also in trouble.
Since the banks have been the recipients of most, if not all the QE money, it is fair to assume that they have also been the main buyers of gold and oil. They are buying not because they demand it physically, but because they demand it financially. It has been a hedge against inflation, or a hedge against the devaluing of the U.S. dollar. However, the flow of freshly printed money has stopped and the credit markets are seizing up, which will lead to a terminal arrest of the current dollar-based system, but not the dollar itself. Banks still need liquidity however, and will sell their paper gold and oil positions.
Oil is already in backwardation, a situation when the future price is lower than the current/spot price. This generally only occurs at times when current demand is high, which it is not at present. Not even cutting Libya’s oil supply from the market has been able to support the price, and with weak economic outlook globally, oil prices are set to slide, and they could well go back to around $30 U.S..
As for gold being a safe haven investment, no one has any savings, they only have debt. Since only one in every 100 trades is actually in physical gold, it is fair to assume that QE money has also been driving the gold price, and I expect gold to close year on year, in negative territory, well below $1,400 U.S.
With the QE dollar pump switched off, a European banking crisis about to unravel, commodity prices are set to collapse.
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Current markets are anything but global or integrated. What if we had a paradigm shift in the way we think and transact when doing business with each other? Balanced global trade can only occur if we have transparent, accessible and efficient markets. We are on the cusp of achieving this, although most people cannot see it. Sam’s Exchange aims to give its readers a clearer view and a platform for discussion. Markets, trade and economics are in fact nothing more than the result of our thoughts and actions expressed in numbers, not the reverse.
Sam Barden is founding Partner of SBI Markets DMCC, a Dubai-registered commodities trading and advisory company. Barden has worked in the global financial markets for more than 17 years in Europe, Russia and the Middle East. He has advised and executed strategic transactions for both the government and private sector, in particular in energy and commodity markets, advising various energy producing nations on their strategic market developments and interaction. He holds a degree in economics and finance from Victoria University, Melbourne, Australia.
