Today's Commodities Market

by Horacio Marquez

Today's Commodities Market: The Commodity-Driven "Treasury" Hunt Is On

by Mark Skousen, Chairman, Investment U

Friday, October 6, 2006: Issue #589

Editor's Note: It's been eventful couple of days on Wall Street, especially in the commodities market Oil's pulled back to $58.55 - down more than 24% since early August, the Dow's set another all-time high and we've had several welcomed economic reports. So far, so good. What can we expect in the weeks and months ahead? And in the overseas markets? According to Horacio Marquez, The Oxford Club's global equities specialist and the former head of Emerging Markets Research at Merrill Lynch, worldwide expansion is alive and well today...

Recent news indicates that Amaranth Advisors, the hedge fund company that lost some 60% of its equity last month, will be liquidated.

The management company's devastating loss was due to the forced liquidation that followed tremendous losses in natural gas futures. And the "forced liquidation" has been key to the exaggerated pullback in oil, natural gas and commodities.

The sequence goes like this:

1. Forced liquidation of natural gas positions at tremendous losses, in turn, forces the liquidation of unrelated positions, starting with the ones that are profitable, in order to make margin calls.

2. Those forced liquidations in otherwise good investments, in turn, cascade throughout the market. Market players who see the downturn might even go short, helping to exaggerate the move and compound losses for the liquidating fund.

In this case, the aftermath is critical...

U.S. Treasury Yields and Other Commodities Take A Hit

We now know that the very capable and superbly capitalized JPMorgan Chase and Citadel bought Amaranth's energy position, but now it appears that the remaining operation of Amaranth will be liquidated as investors pull the plug because of lack of confidence.

And as investors made room in their portfolios for distressed assets at bargain basement prices (oil and gas), they sold other commodities and commodity companies. Some, fearing the worst, might have rushed into U.S. Treasuries, helping push U.S. rates to very low levels.

In addition, the Deputy Assistant Treasury Secretary James Clouse issued a warning to the market with respect to apparent attempts to manipulate the five-year and 10-year U.S. Treasury obligations and said that regulators at the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) were pursuing cases.

The Commodities Market Is Back

What this tells us is that the collapse of energy prices and U.S. Treasury yields, which helped propel the recent U.S. equity rally, is done and in reverse. This supports my view that the commodity trade is back and that the large-caps and high-tech are due for their October annual profit-taking, after an exemplary summer and all-time record highs for the Dow.

Oil and energy companies made the turn, based on the fact that JPMorgan Chase and Citadel are solid hands for Amaranth's positions.

Helping oil move higher is verbal intervention by OPEC players, saying that some members will be cutting production voluntarily. This should stabilize oil in the $60-$70 range for a while, as winter comes.

And we have good news on global growth:

  • China says it expects to accelerate growth to 10.5%! A positive figure for commodity demand.
  • India just showed growth of 8.9% in the second quarter.
  • Japan showed strong industrial production numbers based on export growth. And the Bank of Japan is NOT expected to raise rates soon, contrary to market expectations, in order to keep the second-largest economic expansion in Japanese history alive. Inflation is a mere 0.3% and is not a risk. This move by BOJ to keep rates at near zero will add more liquidity to global markets, especially commodities.
  • The Central Bank of Brazil, which cut growth estimates for 2006 from 4% to 3.5%, also cut inflation estimates, opening room to lower rates even more.
  • In the U.S., the Fed rate is on hold and market participants increasingly talk of having the Fed ease it in 2007, as we have been saying all along. With the housing market tanking, but the rest of the economy doing well (as seen by the Richmond Fed, personal income figures and the Chicago purchasing managers index), the economy is landing softly as we have been saying allyear. And inflation is under control.

The Fed's preferred gauge, the core PCE deflator, ticked only 0.2% for August, but it is still at 2.5% year-on-year, which is above the 2.0% top end of the Fed's comfort range. This indicates that the Fed will have to wait a while before easing, but will probably start easing once it sees the yearly figures start moving down.

Good trading,

Horacio Marquez

Today's Investment U Cribsheet

  • Amaranth Advisors isn't the only fund management company that's taken a loss While its loss was big - nearly 60% of its equity - the majority of mutual funds don't match the performance of their benchmark indexes. In Investment U #584: Mutual Fund Investment Strategy: If You Can't Beat Them, Join Them... Dr. Skousen takes a look at a more profitable way to "use" mutual funds.

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