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Tuesday, August 15, 2006

Copper: Inflation or Corner?

I just ran across this April 24 post by Pierre Gave of GaveKal on the GaveKal forum. I don't have any way of verifying the facts, but I have a great deal of respect for Gave Kal.

"From many quarters, some within the financial community and others within the copper consuming industry we have come to the following conclusion - and this is not a first in base metals history.

A group of funds started to take pyhsical metal (cu) off the market in 2nd half 2004 and have continued to do so and more recently with the other metals. They then called on some of the large producers and told them they had put cu or whatever metal into play and would buy up the available stocks on the exchanges. They have in effect created a corner. Money is pouring into these funds at rates that are astonishing. IN effect the funds are pyramiding themselves taking on ever larger positions at ever elevated prices as their assets under manegment continue to soar. We estimate that the inner group of funds, numbering some 6-8, have a firepower for the base metals complex alone - asstes + leverage (times 5) of at least $500bn with the hangers on on top of that figure.

Never in the history of copper have prices risen to such a multiple of marginal costs (the 9th decile). Prices always revert to the mean. For copper, we will probably see solme 20MT of copper futures having to be sold - 10MT of fund longs and 10MT of delta selling yet to be done. How this comes about and what the risks to the financial system will be set out in a note that I hope goes out today which is being co-authored by a very experienced metals trader who has been on the right side of previous price debacles (Hamanaka in mid-1990s and tin crisis in mid 1980s - whow every mid-decade!)"

Note that copper topped (so far) a couple of weeks after this post.

This indicates the potential perils of commodity-based monetary policy in these days of massive hedge fund capital resources sloshing around the world. It also makes me wonder if something similar is occurring in Gold.


Blogger ed hanson said...

I find the article quite interesting but would respect it more if it named names. Why didn't it?

11:27 AM  
Blogger David Wood said...

GaveKal is in the advice business, and this post is just on the public part of their website. I presume their report to subscribers on the subject had more complete data.

11:52 AM  
Blogger Henry Meers said...

The history of these things is nasty. If you don't have a corner, you're in real trouble. They seldom work for a whole bunch of reasons, including the exchanges don't like them. These guys may think they're terriblely smart by taking delivery; I wouldn't count on it. Maybe they're getting advice from the Hunts.

In any case, a collapse would be spectacular, along the lines of the the South Seas Bubble. The good news would be that Benanke wouldn't have to tighten were these guys to make hundresds of billions disappear.

12:07 PM  
Blogger Henry Meers said...

The weakness of commodity-based monetary policy is an important phrase to us. Yes, tracking commodities is dangerous, but that's not what the gold standard did, which is why I support it. Countries and central banks maintained gold reserves to maintain the convertibility of their currencies into gold during a crisis.

The point I have been making is that, even though the major countries retain gold reserves, the link to each currency is missing, so they are not available to the markets as a way to maintain the promise of convertibility; and, thereby, smooth the trading.

12:15 PM  
Blogger David Wood said...

I agree, Henry.

I used to argue against Don Lloyd in his insistence that the gold polaris was not at all as workable as the old gold standard because convertibility made all the difference. Now, over the years, I have come round to his way of thinking. The more I observe the behavior of the gold market, the more skeptical I become of the gold polaris. The gold market is just too small now in relation to the amount of speculative capital out there, so it is vulnerable to the type of manipulation Gave is seeing in the copper market. Gold just isn't money any more. It is a commodity with some monetary characteristics, but that just isn't a good enough base for monetary policy.

5:09 PM  
Anonymous judith said...

For the record, I respectfully disagree with you doubters of the gold polaris.
If the President or Fed would announce a reasonable gold target for the $, all of our inflation/deflation problems would be solved (I firmly believe).
Until then.... the current level and volatility of the POG is telling us expect more inflation to continue to show up in all of those lagging indicators over time.
I never thought I would ever see $600+ gold ever again in my lifetime. I now shudder to think how high gold may go over the next 30 years - depending on what kind of monetary errors are made in the future.
I keep a 1 oz gold coin by my desk at home (that I bought at $300). When I hold it in my hand.... it keeps me 'calibrated' to the reality of current monetary policy.

7:49 AM  
Anonymous Anonymous said...

The gold polaris is alive and well. Gold remains the defacto world currency and not 'just a commodity' for a number of reasons: amid a world of rising commodity prices, AU has not backwardized for any sustained period; AU lease rates continue to be lower than comparable U.S. and Eurodollar rates - reflecting its low risk status; unlike other commodities, the stockpile of bullion remains enormous relative to supply and demand - it is not susceptible to production/consumption shocks. It is true that the amount of above-ground gold is quite small, however, it appears that the large size of the gold derivatives market has limited speculative and hedging influences. These are but a few observations I can think of for now.
Kirn Dhaliwal

8:29 AM  
Blogger Henry Meers said...

Judith, under the gold polaris, governments have no requirement to manage the gold/currency link. Your broker or car dealer has to keep his promise to delvier something at a fixed price, whether he is long or short; he can't just walk away and say "too bad", the market changed. We, as individuals, have been on the gold polaris since 1933 one way or another, because we look at gold to see how much the dollar has depreciated. How much good did it do us? Think about it, the feds have been telling us for years that they are fighting inflation, so they must be watching too.

Announcing a price is a variation on the above. The U.S. was supposed to pay gold on demand to foreign central banks at $35 an ounce after 1933 too. It did for a while. Absent the free convertibility of gold into dollars, the whole thing is something of a joke. The automaticity of the gold conversion system in Britain and the U.S. from 1878 to 1914 made it work very well and the two countries quite prosperous (or two prosperous countries even more so by attracting ever more capital through London and to a lesser extent New York).

Ironically, the U.S. could go on the gold standard tomorrow without too much trouble, if it wanted to. Pick a price, very tricky right now, and support it by managing the dollar and gold supplies to the market (there is more than enough capability in the New York brokerage community to make it easy for the Treasury). The conditions which took us off are long gone, and the American economy is strong and diverse enough to handle it. In a way, we are in the position Britain was immediately after the Napoleonic Wars, just substitute the Cold War for the struggle with imperial France.

As international trade heats up, we might have to go to gold simply for competitive reasons. The Bankers in London saw the advantage, because Great Britain had the financial reputation of honoring its debts and a strong rule of law that no other significant power had. Investors tripped over themselves to send money there in the uncertain Nineteenth Century.

9:55 AM  

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