A duck on the pond

There’s an old visualization that’s used in different scenarios about a duck floating on a pond. The water looks calm. The duck looks calm. However, underneath the surface the ducks feet are paddling rapidly. The duck paddles and paddles, and yet to the casual observer, the duck isn’t moving fast and seems to be totally at peace. And so it is with our current financial markets.

On the surface, everything seems peaceful and nice. Calm even. Volume is so low, I forgot it was the middle of the week and thought that it was a Friday in summer and everyone except for me had headed out of town. The average are treading water. As I write this, the S&P 500 is showing exactly 0 points up. And yet…

Oil is taking out 2008 highs. Due to the US’s insane ethanol policy, which takes food and makes it expensive, inefficient energy, we have corn rallying almost 5%, and taking the rest of the ag space with it.

As readers know, I’m not in the hyperinflation camp. However, one doesn’t need to believe in hyperinflation to see that certain inputs are slated to rise, while at the same time, stores of wealth will deflate. We’ve spoken about this environment in the past and it has served us well on the whole. In this era of biflation, inputs such as energy and food may continue to see price pressures. An increase in geopolitical tension only serves to embolden politicians to call for “self-sufficiency”, which in turn will lead to higher energy prices and subsequently higher food prices. At the same time, lower consumer spending coming from high unemployment and large debt constraints will continue to pressure retailers and the traditional stores of wealth (real estate, bonds, equities) alike. So investors need to choose their spots.

We already have high exposure to energy and precious metals, and are maintaining it. We recently increased our exposure to the agricultural space through a new ETF, CROP. Its main advantage is that it has small cap exposure to global agribusinesses, lower exposure to chemicals than MOO, and emerging markets exposure. Its main drawbacks are that its new and less liquid, and has a 20% exposure to China, which I am not keen on. Since it is only going in as a small allocation in the portfolio, the exposure to China is worth it for us, but it should be noted by potential investors. This is in no way a recommendation, just a highlight of the implementation vehicle we used. Also, there are rumors of direct farmland ETF’s on the way, which I will keep an eye out for. That being said, they may come at the end of the opportunity and might be a contra-indicator.

Lastly, speaking of the duck’s feet…notice that gold and silver are approaching all-time highs, the yen is finally weakening, and financials haven’t been able to rally. At the same time, multiple articles are being sent to me with headlines screaming that equities are the new safe haven. Absolutely not. Equities are expensive and any valuation metric that uses the current peak margins as a basis will prove misleading in the upcoming quarters. We’ll talk more about this element of the duck’s feet later in the week.

Relevant ETFs: GLD, SLV, CROP, MOO, USO

MacroView

A quick tour around some key markets: signals from gold, the next leg for AG, and what is the euro thinking(!) – all part of today’s MacroView charts. We have mentioned it before, but it’s worth pointing out that the averages are hiding some massive rotations. It’s not so much whether your long or short these days, but rather WHAT you’re long or short.

macroview_9Mar11

Treasuries – Can we finally agree the bond bull is over?

Treasuries continue to fall. 10 year yield is sitting at 3.6% and it doesn’t look like they’re heading back to 2.6% in the near future. Maybe we’ll have a bounce, but the bond bull is over – it has been for a while.

In an environment with increasing yield, can equities continue to rally? The answer is easy: it depends.

If yields are rising due to inflationary pressures, than equities can rise as corporations gain pricing power, are able to pass on rising costs to the end consumer, and earnings rise in line. However, if yields rise due to a debt deflation cycle, where companies have limited pricing power, but debt gets revalued lower, then equities will be hurt. My fear for a while has been that we are entering the latter. Yesterday, I increased our short exposure to equities, and maintain a large cash position. I have been early for a long while on the end of the equity surge, but have not taken the other side actively until this week. I think we’ll start with an 8-10% correction, which investors will think is an opportunity to buy-the-dip, but any bounce will be short-lived.

In the meantime, fears of inflation coming from commodity speculators will prove ephemeral, as debt deflation leaves companies with less pricing power, and will just serve to squeeze margins. I still like the precious metals and energy, but I’m not putting funds to work in the ag space at these levels.

Relevant ETFs: TLT, TBT, SH, SDS, SPY, IWM, RWM, TIPS

Where have all the corn seeds gone?

USDA cuts corn crop estimates and corn goes limit up. The entire CRB complex is rallying. DBA up 5%, MOO up almost 3%, corn ETF up almost 7% (futures can trade limit up, but the ETF can keep on going?), JJA up almost 7%. All the world needs now is another little supply shock in energy and Bernanke & Co. might have what they always dreamed of: complete loss of faith in fiat currencies.

Meantime, USD continues down.

Back to ag

Last week I highlighted some inflation stories that were beginning to surface and readers sent me more – everything from gold and silver hitting new highs to anecdotal evidence of Malawi land prices. You are preaching to the choir – there are global imbalances on the one hand, and power-shifting demographic changes on the other that are supporting the underlying strength in certain commodities (not all). One of the areas that we’ve mentioned in the past as a source of stability in volatile periods, a hedge against inflation, and a hedge against worst-case scenarios for those prone to hyberbole is direct investment in agricultural land. I’ve been discussing it for a few years, mentioning the potential and also the difficulty (both in implementation and in management).

We are not alone, as money continues to flow to arable land: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7997910/The-backlash-begins-against-the-world-landgrab.html. This article points out another trend that I’ve been discussing, which is the backlash against globalization as protectionist measures increase globally. In a best case scenario, I expect that countries will move to build up strategic supplies of food-stuffs, and perhaps place loose limits on foreign ownership – troubling, but manageable. In the worst case scenario, I think we could have actual land seizures, elimination of certain property rights – in the name of national security, ideology, or what have you, and nationalizations similar to previous decades in various parts. Egypt, which is enjoying a certain renaissance these days, comes immediately to mind, as do various South American countries.

Given some of the challenges of implementation, I continue to focus on diversified baskets of commodities, commodity-related companies, and second-degree beneficiaries for active investment opportunities. In terms of direct investment in agricultural land, there has been a mad rush to Africa, which I am currently avoiding (at the risk of missing significant returns), and sticking to areas that have ample water supply (north/midwest US and Canada). I don’t expect significant returns there – yields should hover in the 3-6% range unless inflation picks up, but in this environment, that’s not a bad place to wait.

For a succinct article with a few different options mentioned, click here.

The Case for Ag and H2O

We’ve often discussed the deflation in wants/inflation in needs trade. Marc Faber interviewed on Bloomberg the other day discussed how, when governments print endless money, inflation will show up somewhere -he mentioned Hong Kong real estate as an example, but that was before Wall Street bonuses were announced. For the full interview click here. In this research report, Passport Capital walks through the argument for ag and (by our interpretation from their argument) water (i.e. needs). For the full report: The Case For Agriculture From Hedge Fund Passport Capital.

Monsanto expects fiscal 2009 profit at $4.40-$4.50 a share

Monsanto seems to give guidance every week these days but I remain long the space.

NEW YORK (MarketWatch) — Monsanto Co. (MON) said Wednesday it is reconfirming its profit target of $4.40 to $4.50 a share for fiscal 2009, an increase over the $3.64 a share it reported in fiscal 2008. The agricultural-technology company also said it expects gross profit from its seeds & genomics segment to grow by more than 60% by fiscal 2012, providing “the fundamental driver to the company’s future growth.”

Cheap Crops Won’t Last, Credit Suisse Says: Chart of the Day

I am a fan of this space. We went thru demand destruction with high prices and now were in the supply destruction with low prices.

Feb. 5 (Bloomberg) — Corn, soybean and wheat prices are trading at discounts to their inflation-adjusted averages, and all three are likely to rally because output won’t keep pace with demand for crops to make food, animal feed and alternative fuels, said Eliane Tanner at Credit Suisse Group.

The CHART OF THE DAY shows corn futures on the Chicago Board of Trade, adjusted for inflation, are 32 percent below their monthly average price since 1972. Corn fell to an 18-month low on the CBOT in December. Soybeans futures are 27 percent cheaper than their monthly inflation-adjusted average, and wheat is at a 25 percent discount.

http://www.bloomberg.com/apps/news?pid=20601109&sid=aQdyxItDD8Mk&refer=home

Bonds and the Ag Complex…

Yields are approaching zero and many have been saying it’s the short of a lifetime. I’m not sure. If we’re going into a deflationary environment, yields can at least stay here for a long time. However, wouldn’t that, coupled with the increase in government spending we are witnessing put a floor (at least) in gold? But gold is a retail product. It is not a necessary commodity, but rather just a currency play. In an environment where “need” trumps any currency, I believe it might actually provide a floor for the ag complex. Not sure how to play it, but just some food for thought.