Economic Update September, 2008
By Jim Oelschlager
Two months ago, commodities were reaching all-time highs and showed no sign of abating their climb. Talking heads, the experts and pundits all agreed that commodity prices had to go straight up continually and the dollar was in the tank and likely to go sharply lower in the immediate future. Some people known for their financial acumen, such as rock stars, demanded they be paid in Euros rather than dollars. Everyone should have known that marked the bottom of the dollar, which has risen sharply in the last two months. At the same time, commodities have dropped very sharply, also. Oil was $147 a barrel, today it is $104 a barrel. Right…there were no speculators in there. This is a change in fundamentals. One commentator used to say that rising oil prices is a one-way cinch bet. It could only go up. I don’t think so. Remember people said this time it is different. Well it isn’t different. It never is. Extrapolating recent trends but not recognizing an inflection point can be very dangerous to one’s financial health. As discussed before, people didn’t recognize the housing bubble until it was over; and, now they are just recognizing the commodity bubble now that it is over. In two months, oil dropped about thirty-five percent. Silver has dropped almost fifty percent. Gold has dropped a little over twenty percent. Wheat (remember when we were running out of food?) has gone from $13.00 to $7.50 a bushel. Corn has gone from about $8.00 to $5.50 a bushel. Copper has dropped about 25%. And, most other commodities have shown comparable declines. The rules of supply and demand apparently have not been repealed. The hedge funds that have been aggressively playing the commodities on the long side have had great difficulty recently. In fact, five or six hundred of them have gone out of business in calendar ’08; and, more are likely to go under in the near future. What this does, unfortunately, is cause temporary dislocation and volatility in the market. The decline in commodity prices is good news for a whole lot of reasons. First, the consumer has a few extra dollars in his pocket from what he used to spend at the gas pump which he can use for other purchases. As this reduction in commodity prices works its way through the chain, food and other prices should continue to drop. These declines will eventually show up in the CPI, which should show dramatically better numbers than we have been seeing. And, as indicated earlier, we may actually see some negative numbers for short periods of time with respect to inflation data. This should lead to improved consumer sentiment, which has been running at rock-bottom lows.
There has been a lot of talk recently that the Fed is in a bit of a quandary because they may have to raise rates to choke off inflation, which would be a difficult and dangerous thing to do in a weak economy such as we have been experiencing. Well, looks like the market, once again, has self-corrected, and the pressure is off the Fed to raise interest rates. In fact, my guess is that the next move in interest rates will be down as opposed to what the “experts” have been saying recently, i.e., that the next change by the Fed in interest rates will be up. Unemployment numbers came out last week and were disappointing. The unemployment rate is at 6.1%, the highest in five years. The good news is that the impact on inflation of the decline in commodity prices should give the Fed the latitude it needs to lower interest rates to try to stimulate the economy.
I am surprised and disappointed that the stock market has not responded more favorably as commodity prices have declined. I can understand the indices and commodity stocks not doing well; however an index like the NASDAQ 100, which has very little exposure to commodity-type stocks, has also been very weak in the last two months. In the last three weeks, it has dropped 10%. Once people figure out what is happening and how good the news is, and once the hedge funds get out of the way with their liquidations, we might see a surprisingly strong market. If interest rates go down, multiples should expand to offset weakening earnings. Earnings have been surprisingly strong throughout this whole economic slowdown, one of the primary reasons being that productivity gains continue to be significantly higher than, again, the “experts” anticipate. Of course, this is all a result of improved technology, and to some extent, globalization.
The soft dollar spurred huge increases in exports from the United States to the rest of the world. As the dollar continues to strengthen, that benefit to our economy will wane; however, there will be other positive offsets to the rising dollar.
Freddie Mac and Fannie Mae have been in serious financial trouble as a result of their holding fifty percent of the mortgages that exist in this country. And, they hold seventy percent of the mortgages issued in the last two years, which is the pool of mortgages with the greatest problems. Hopefully, the takeover of these entities by the Treasury will provide some stability to not only the housing market, but to the general financial markets, which continue to be under stress and wildly volatile. Stocks like Merrill Lynch were up eight percent in one day and down six percent the next day.
Again, back to commodities – people tend to do a static analysis and think things don’t change, except for the fact that people are joining the workforce in places around the world, places like China and India. Most tend to do static analyses. They fail to recognize that although additional demand exists for commodities and materials, new finds are continuing to occur. A major copper, gold and lead discovery was made in Australia just within the last couple weeks. Not to mention the oil in North Dakota. And, now the likelihood that more drilling will occur offshore in the lower Forty-Eight and even the possibility of drilling in Anwar has increased. Here is an observation I have never heard but find interesting: of all these people that are joining the workforce and demanding additional commodities, is there any chance that a small number of those people may also be joining industries that are producing and discovering commodities? It is hard to make an argument that they are not, particularly given recent profits in those areas. Recent profits generally tend to attract new people.
I mentioned in an earlier Update that these kinds of changes could change the dynamics in the election in November. National politics have been turned on their ear with the introduction of a moose-hunting hockey mom.
You will recall that it wasn’t too long ago that the media, and in particular, the political elite, discounted the daughter of a grocery-owner and a B-movie actor named Thatcher and Reagan, respectively. To be sure, many politicians have come out of the mainstream political arena and carried Ivy-league-type pedigrees. But, not all. Palin may be just the person to turn things on their ear, just as Thatcher and Reagan did before her. Two years ago, I thought this was going to be the dullest election campaign I would ever witness. I guess I couldn’t have been more wrong! It is probably the most exciting Presidential election --at least in my memory; and, the excitement is not over yet! At minimum, it is getting people more involved in politics, which is good. Thirty-eight million people watched the Democratic convention and about the same number watched the Republican convention. Of course, there is no way of measuring the number of people that, even though they didn’t watch the conventions, were still a part of water-cooler discussions at the office and other places in the days following. Having a couple of mavericks challenge conventional dogma is not only healthy, but exciting!
The dollar ain’t dead. The political process ain’t dead. And, America ain’t dead! And, oh yes, corporate America’s not dead, either. So, my advice is to keep the remote handy. Keep Internet access handy. Follow unfolding economic events and the unfolding political developments. You won’t be bored.
I recommend a website: www.realclearpolitics.com. It is a non-partisan website, which presents twenty to twenty-five different articles from different publications, both in the United States and from around the world, regarding politics in the U.S. Attached to these articles are comments from readers which may number in the hundreds for one article alone. If you haven’t discovered reading these comments after articles, you are missing some great entertainment! People comment under anonymity, unabashed and let it all hang out. While I am surprised, at times, at the intensity of the comments, bordering on being vicious, it is a positive, I believe, to see a large number of people getting involved and willing to share their opinions. In addition, they slice and dice poll numbers from virtually every polling organization, in more ways than anybody really cares to know. Do you really need to know how many people in Ohio, who voted Republican, eat ice cream more than three times a week? An exaggeration, of course, but the computer’s ability to slice and dice the data is limitless and entertaining.
Countries like Russia, Iran and Venezuela have been emboldened by unexpectedly high revenues from unanticipated high oil prices, and as prices and revenues decline, they may be not as bold.
Best regards,
Jim
This manager commentary represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice. Neither Oak Funds nor the manager are affiliated with the recommended website and the views expressed on the website should not be considered the views of the Funds or the manager.