FYI | Nov 15 2010
BTIG market strategist Mike O'Rourke reported on Tuesday last week to BTIG clients (we left out the opening paragraph that specifically referred to that day's trading on Wall Street):
The commodity inflation talk has finally hit a feverish extreme. It started with the global mindset of investors mistakenly believing QE is equivalent to a literal money print. The Federal Reserve’s reputation of ignoring commodity prices does help, and fuels the commodity fears. Since the summer, commodities have been running on a combination of fundamental stories and QE, with QE being the big driver. This has culminated with a string of headlines related to Q3 earnings from companies feeling margin pressure from significant increases in commodity prices.
As a result of that development, one might think that the Fed has miraculously created inflation overnight, but we all know that is not the case. Considering Q3 ended well before QE2 commenced that is an impressive feat. The move had to start somewhere, and since the
perception is that prices are rising as the Fed talks up QE, the price action confirms the worst inflation expectations markets have. Despite the short term price action, we remain adamant in our belief that the Fed has created the potential for future inflation, but the inflation is not here now and is not likely in the near term.
On numerous occasions, we have discussed how intellectually easy the QE trades are to embrace. To embrace Equities, one has to expect an economic recovery, or at least a better than expectations recovery. Buying commodities is an easy sell, emerging markets are booming and the perception is the Fed is "printing" money. It is hard to argue with that. Needless to say, the investment community has embraced commodities en masse. If one thinks about how small the commodity markets are relative to the equity markets, that is a great deal of money, most of it leveraged going into a small asset.
What people are mistakenly referring to as commodity inflation is really the sum of numerous speculative bets made by the investment community.
Below we have posted charts of the speculative long and short positions in most major commodities. (Note: We consolidated multiple listings like Wheat and adjusted E-Minis to match large contracts). It does not take more than a quick glance to realize that almost every commodity (Silver & Soybeans being the exceptions) and the speculative long positions (Red line) are at or near record levels.
When that much money is in position for a trade, especially after significant gains have been registered, little things like increasing margin requirements and a stronger Dollar can and will send fast money running for the exit. It is also worth taking a look at the final chart, which is S&P 500 speculative positions.
The views expressed are O'Rourke's, not FNArena's (see our disclaimer).
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