Tag Archives: commodities

Rookie Chinese Commodity Traders Run Trillions

The Chinese government repeatedly attempts to micro-manage the lives of its citizens. The effects of which continue to be unintended consequences both socially and economically. This week, we’ll discuss the citizens’ pool of money that the government continues to hold hostage and the mechanisms the Chinese government has employed thus far that have created a predictable ripple effect, visible to everyone but their own government. Somehow, they seem to be continually surprised by the unintended consequences of their own actions. We’ve watched Chinese investors’ money run from property to the stock market and now, to commodities. We’ll look at some of the massive scale of fairly predictable rookie trader outcomes that have been their unintended consequences.

Continue reading Rookie Chinese Commodity Traders Run Trillions

Tracking Commercial Interest in the Commodity Markets

The commodity markets have been unkind to long only funds and indexes in 2014. Most of the commodity markets have been sideways to lower with a couple of exceptions like cocoa and cattle. This week, we’re focusing on the broader commodity landscape due to an article published on Bloomberg by Debarati Roy in which she stated that open interest in gold had slumped to a five year low. We’ve expanded on this topic to include 27 general commodity markets and compared their current open interest to where they stood both one month and one year ago respectively. The purpose is to determine whether smart money is headed into or, out of the commodity markets in general as well as what affect this may have on the markets going forward.

Continue reading Tracking Commercial Interest in the Commodity Markets

Economic Recovery or, Shell Game?

The National Bureau of Economic Research, the ones in charge of official business cycle dating, said Monday that the recession officially ended in June of 2009. Their statement allowed that although economic conditions may not have been favorable since then and that the economy has not returned to normal operating capacity, the recession ended and a recovery began in June 2009. This is good press for the incumbent party heading into election season. However, this is also a brightly burning example of why we shouldn’t trust a sound bite.


The bursting of the domestic consumption based economic bubble has left the politicians scrambling to secure their next terms in office. The best way to guarantee re-election is to make everything seem all right to the general voting public. I’m not taking sides in this. The problem is more systemic than it is partisan. The issue starts at the top with former Federal Reserve Chairman Alan Greenspan and the torch has been passed to Ben Bernanke, another Federal Reserve Chairman bound and determined to keep the money flowing. My sincere fear is that the day of reckoning will come when the people who buy our Treasuries to service, and grow, our debt will say, “This is a bad deal. We need to be paid a higher interest rate to take on your credit risk.”


The United States as a country has become an unfortunate reflection of the consumer society that our politicians have sought for generations to instill in their constituents. We are now facing the same economic problems at the national level that used to be handled at the dining room table by the family. We are simply over extended. We have spent too much for too long. We must admit that the budget surplus of the Clinton era had more to do with fortuitous timing than sustainable growth and that our projections were wrong. The paradox is that the same legal/governmental system that is all too ready to jump in and save the individual from their own bad decisions fails to acknowledge their own fallibility. The institution of government is being failed by the hubris of the individuals running it.


Enough hyperbole. The shell game is being played out in the transfer of private debt to governmental debt. This has enabled business and personal consumption to carry on with as little personal or, corporate lifestyle adjustment as possible. The United States’ personal rate of savings has climbed from 0% in June of 2004 to 6% currently. Over the last 50 years, 6% is much closer to the average. As individuals began to save, governmental spending increased 82% and our deficit grew from 7.35 trillion in 2004 to an estimated 13.4 trillion this year. It is estimated that the gross federal debt will approach 90% of gross domestic product. That leaves 10% of GDP to make the interest payments on existing debt and cover all national expenditures. For example, if your take home pay were $50,000, $45,000 of it would cover your minimum monthly interest payments. The leftover $5,000 would have to cover a year’s worth of basic living expenses like food, clothes, gas, entertainment, etc. The Congressional Budget Office estimates that gross federal debt will exceed gross domestic product by 2012.


The government, just like us, has run deficits going back to the Civil War. The issues are size and accountability. Deficits were designed to allow for the purchase of goods and services based on future earnings. This is how we buy houses and cars. The concern is the overextension and lack of self or, governmental control. It is the inability, “Just say no,” that gets all of us into trouble. A politician who stands up and suggests we all tighten our belts will have $0 funding for his election campaign. Businesses won’t contribute, banks won’t contribute, special interest groups won’t contribute and if the politician’s constituents listen, they won’t contribute either. Therefore, the plan to get us out of this mess is by spending more money while devaluing the U.S. Dollar.


The plan goes something like this. The government sells more Treasuries on the open market to generate stimulus funds to be spent on domestic programs to placate the people, domestic businesses and special interest groups.  The more Treasuries the government sells, the more U.S. Dollars it places in circulation. The more Dollars in circulation, the less they’re worth. The less the Dollar is worth, the more expensive it becomes to purchase foreign goods and services. This encourages more people to, “buy American.” This also makes domestically produced goods and services cheaper to purchase for foreign countries, therefore, increasing U.S. exports. The hope is that this will allow U.S. businesses to gain traction and begin hiring again.


In normal times, this has kept the balance of things moving forwards. I would suggest that these are not normal times. First of all, we are starting this process from a much higher debt ratio than ever before. Assume that you’re very nearly maxed out when an unexpected major medical expense or car repair comes up. Secondly, the U.S. has been able to grow its debt periodically through the sale of Treasuries when needed because we have, more or less, managed our expenses, which made the U.S. a safe credit risk. This is like being able to make at least the minimum monthly payments to your creditors in the roughest of financial times. Third, the Dollars we are borrowing will not be worth as much as the Dollars we are repaying. Typically, this difference is made up in the interest that we have to pay back with the principal. Finally, this is the same path being sought out by the entire Euro zone, England, and Japan, which puts us in the middle of a global competitive devaluation.


The end result is that it won’t take long for the countries that are lending us money to decide that they can do better lending to someone else, perhaps another country or, their own populations. Keep in mind that we are talking about the creation of new debt or, extending more credit on top of the current debt we will be struggling to pay the interest on. Essentially, following the path of increasing deficits in an attempt to grow our way out of societal gluttony and the misguided actions of elected representatives will only continue the downward debt spiral until someone has the courage to stand up and yell, STOP! As we approach this election season, I’ll cast my ballot for the candidate that simply states, “We’re going to have to learn to do more, with less.”

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.


World Wide Wheat Shortage?

Russian drought news has been the dominant factor in the grain market this summer. Wheat prices began to rally in early June as commercial traders fully supported the lows around $4.50 while accumulating a net long position of over 80,000 contracts. At this time, the Russian drought news began to hit the wires. The month of July was fueled by the daily weather reports across Europe as this turned out to be the worst drought in 50 years. Wheat prices sky rocketed to $8.41 by August 6th and have since been in a trading range between $6.45 and $7.34 while waiting for further assessment of the weather’s impact on this year’s crop. Facts are now replacing hyperbole. It has been reported that Russian wheat will be off by 31% along with a carryover effect to a winter wheat crop that will also be off about the same amount late this year. Global wheat production is expected to be around 660 million metric tons for 2010. Russia was expected to produce around 60 million bushels and will end up closer to 40 million metric tons. Considering ending stock surplus is around 175 million metric tons as of the end of 2009, Russia’s 20 million ton shortfall should be easily covered.

Now that the actual numbers are starting to come out, there are three important points to be made in this example.

1)   The futures markets are completely democratic. Everyone has access to trade them and the prices represent global supply and demand. This means that farmers all over the world compete to create the best available bids and offers. This also means that local farmers have access to the best global bids and offers and therefore, are not tied to the local grain elevator operator’s basis offers $.60 – $1.50 below the futures price. This is exactly the type of market inefficiency that the exchanges were created to eliminate.

2)   There have been nine years in the last 25 when global wheat production did not exceed global wheat consumption. The surplus that was created by 16 year’s worth of excess production makes up the global ending stocks and provides the cushion necessary to make up for anomalies like Russia’s drought. In spite of sporadic annual wheat deficits, at no point over the last 25 years have global wheat ending stocks dropped below 50 days’ supply.

3)   Following the commercial traders’ actions through the commitment of traders report provided actual trading opportunities while the media fueled hysteria with headlines like, “Worst Russian Drought in 50 Years,” and “Russia Imposes Ban on Exports,” “Global Warming Killing Crops,” etc. Commercial traders went from long 80,000 contracts when they collectively felt that wheat was undervalued below $4.75 to currently short 10,000 contracts. The 90,000 contracts sold represent commercial wheat traders’ analysis of their market and the consensus of all of the fundamental factors affecting it. Their actions can also be seen through technical analysis that shows the wheat market stopping dead at the 38% Fibonacci retracement level from the January ’08 highs over $15 to the lows at $4.40.

The next actionable clue to future movement in the wheat market will be seen in technical analysis that points to a retracement to $6.05. This represents a 50% retracement from the $8.50 highs to the $4.40 low. We will combine our technical expectations with commercial trader’s actions through this consolidation between $6.45 and $7.34 to form a cohesive trading plan involving both fundamental and technical analysis that cuts through the media’s noise and allows us place trades based on proactive action rather than reactive reaction.

See the first “Interesting Formation ” to view the accompanying chart. Registration is free.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.

What a Cycle!

Sixteen years ago, I considered myself a rookie trader on
the floor of the Chicago Mercantile Exchange. Bright eyed and eager to learn, I
followed every market I could. I actively traded the S&P 500 but, I always
went in early for the currency and interest rate openings, as well. I actively
and, knowingly took advantage of any of the major market players willing to
have a cup of coffee with me. The economic times were significantly different
than those of today. Trading volume was ushering in a major stock market bull-
run, even as memories of the ’87 crash still lingered. The trading floors were
flush with people who made more in one day than most make in a year or some, in
a lifetime. The technology wave was just beginning to trickle in and financial
modeling was at the forefront of quantitative investment strategies.

I still come in early and I still actively trade the stock
indices. I still actively and knowingly pick the brains of the market players I
am fortunate enough to gain an audience with. Sixteen years later, I find
myself at the beginning of the cycle…..again.

I know many of you are thinking that I must be nuts.
However, if you give me a chance to explain, I think I can tease this out in
terms simple enough for myself to understand. I’ve read so much over the last
month that I feel like I’ve learned an entirely new language. Separating the
wheat from the chaff and allowing myself an opportunity to collect my thoughts,
thank goodness for rainy weekends, I’ve come to the conclusion that we’re near
equilibrium and will extend beyond the mean before finally reverting and
building a base very similarly to the process of the early 1990’s.

Economically, the circumstances couldn’t be more different.
In the 90’s, many of the excesses of the eighties had already been purged. The
savings and loan crisis had been effectively dealt with (net cost- 85 billion) and
the stock market crash provided everyone with a whole new perspective on what
risk really was. Interest rates had been coming down for more than a year,
falling from 7.25% to under 3% in less than a year. The U.S. Dollar was still
king having been defended effectively from the Pound by George Soros. This
helped check global inflation and kept commodity prices low while commodity
demand remained, primarily, domestic. Finally, on a quantitative note, the
S&P 500 was at 415 and had a price/earnings ratio of 19.6.

Trading volumes are soaring as technology has removed so
many of the barriers between the pits, the customers and finally, the world.
Money has never moved at a more rapid pace (good or bad).  This same technology brought with it a
generation of misguided applications. Historically, it will be my generation
that brought computer modeling to the financial and commodity markets. We are
the poster generation for “GIGO” garbage in – garbage out. Computer modeling
and optimization provided us with “statistically valid” risk models that would
allow us to take on more leverage and increase the bottom line. Apparently, the
one market excess able to survive the savings and loan crisis as well as the
’87 crash was greed.

History has proven time and time again that there is no
economic free lunch. The tech boom of the ‘90’s made millionaires out of John
Doe’s the same way that the crash made overnight millionaires out of pit
traders. Intelligence and ability should never be confused with being in the
right place at the right time. The separation of those with ability from those
with geographical good fortune can only be told over the course of time. The
trading pits took away the free lunch of pit traders (The Epitome of Free
Trade) just as the dot com bust erased other, unearned fortunes. Currently, it
is the financial industry being forced to endure their comeuppance. Their
computer modeled diversification of bundled risk and carefully designed
tranches sold to global institutions allowed them to over leverage low interest
rates and put people into homes and businesses that should never have been put
into existence. The models that were designed were put into action based on
their ability to compress risk while adding to the bottom line. Does anyone
remember Long Term Capital Management or Enron?

Finally, it is the long term global nature of hubris and
contrition that drives the long term cycles of the stock market. Contrition is
clearly the leading factor since October. Fortunately, just like the oil
market, we have tools to tell us when the fat part of the move may be over.
Fundamental analysis of the Commitment of Traders Report to find under and overvalued markets
fairly successfully while our humility has allowed us let the markets tell us
just what over and undervalued means in real terms. I’ve been writing for more
than six months that the stock market will revert to its mean… and then some.
Markets always overshoot. If this is a normal bear market, we can assume the
following set of parameters.

ratios decline by approximately 60%. The peak for this run was around 43.

decline is approximately 30% form peak.

length is around 14 months.

If we look at these figures, it appears as though it’s going
to be a gloomy holiday season. I believe we entered an, “official” bear market
at a 20% decline from market peaks. Depending on the index, this started in
July. The P/E ratio, even with today’s declines, remains near fair value, at 17
and change. Just as markets tend to overshoot on the upside, so too do they
overshoot on the downside. We will grind our way through and there will be
rallies and failures, just as there always are. The question investors should
be asking themselves is, “How do I best manage my way through this period
without affecting my long term goals or, giving into short term emotions?”

I believe that this is where the commodity futures trading industry, through
stock index futures like the S&P 500, Dow, Nasdaq 100 and Russell 2000
should be employed. They are offered in a wide range of sizes and can be
tailored to cover most any equity portfolio. The margins and account sizes are
exceptionally favorable, as well. Currently, an individual can still protect
$30,000 worth of tech holdings with a $5,000 account.

Individuals who don’t utilize the futures markets to limit
their losses on the way down or, to maximize their return on the way up are
simply hiding their heads in the sand and pretending that they don’t know better.
Any investor who feels they are responsible for the lifestyle of their
retirement should act in their own best interest and take advantage of these
opportunities. I thank goodness that I can see the beginning of the next
sixteen years far more clearly than I was able to see the beginning of the
first sixteen.


Georgia and Iraq – New President’s Nightmare

The following is from a weekly newsletter I read. I think they do a wonderful job of taking the “spin” off of the media’s issue of the moment. They also provide possible strategic reasons for actions taken around the world. This article has nothing to do with trading. However, it does provide some context for my job as a commodity broker and the issues our next President is going to face.    



By George Friedman

The United States has been fighting a war in the Islamic world since 2001.
Its main theaters of operation are in Afghanistan and Iraq, but its
politico-military focus spreads throughout the Islamic world, from Mindanao to
Morocco. The situation on Aug. 7, 2008, was as follows:

  1. The
    war in Iraq
    was moving toward an acceptable but not optimal solution.
    The government in Baghdad was not pro-American, but neither was it an
    Iranian puppet, and that was the best that could be hoped for. The United
    States anticipated pulling out troops, but not in a disorderly fashion.
  2. The
    war in Afghanistan
    was deteriorating for the United States and NATO
    forces. The Taliban was increasingly effective, and large areas of the
    country were falling to its control. Force in Afghanistan was
    insufficient, and any troops withdrawn from Iraq would have to be deployed
    to Afghanistan to stabilize the situation. Political
    conditions in neighboring Pakistan
    were deteriorating, and that
    deterioration inevitably affected Afghanistan.
  3. The United
    States had been locked in a confrontation with Iran over its nuclear
    , demanding that Tehran halt enrichment of uranium or face U.S.
    action. The United States had assembled a group of six countries (the
    permanent members of the U.N. Security Council plus Germany) that agreed
    with the U.S. goal, was engaged in negotiations with Iran, and had agreed
    at some point to impose sanctions on Iran if Tehran failed to comply. The
    United States was also leaking stories about impending
    air attacks on Iran by Israel or the United States
    if Tehran didn’t
    abandon its enrichment program. The United States had the implicit
    agreement of the group of six not to sell arms to Tehran, creating a real
    sense of isolation in Iran.

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In short, the United States remained heavily committed to a region
stretching from Iraq to Pakistan, with main force committed to Iraq and
Afghanistan, and the possibility of commitments to Pakistan (and
above all to Iran
) on the table. U.S. ground forces were stretched to the
limit, and U.S. airpower, naval and land-based forces had to stand by for the
possibility of an air campaign in Iran — regardless of whether the U.S. planned
an attack, since the credibility of a bluff depended on the availability of

The situation in this region actually was improving, but the United States
had to remain committed there. It was therefore no accident that the Russians
invaded Georgia on Aug. 8
following a Georgian attack on South Ossetia.
Forgetting the details of who did what to whom, the United States had created a
massive window of opportunity for the Russians: For the foreseeable future, the
United States had no significant forces to spare to deploy elsewhere in the
world, nor the ability to sustain them in extended combat. Moreover, the United
States was relying on Russian cooperation both against Iran and potentially in
Afghanistan, where Moscow’s influence with some factions remains substantial.
The United States needed the Russians and couldn’t block the Russians.
Therefore, the Russians inevitably chose this moment to strike.

On Sunday, Russian Prime Minister Dmitri Medvedev in effect ran
up the Jolly Roger
. Whatever the United States thought it was dealing with
in Russia, Medvedev made the Russian position very clear. He stated Russian
foreign policy in five succinct points, which we can think of as the Medvedev
Doctrine (and which we see fit to quote here):

  • First, Russia recognizes the primacy of the fundamental
    principles of international law, which define the relations between
    civilized peoples. We will build our relations with other countries within
    the framework of these principles and this concept of international law.
  • Second, the world should be multipolar. A single-pole
    world is unacceptable. Domination is something we cannot allow. We cannot
    accept a world order in which one country makes all the decisions, even as
    serious and influential a country as the United States of America. Such a
    world is unstable and threatened by conflict.
  • Third, Russia does not want confrontation with any
    other country. Russia has no intention of isolating itself. We will
    develop friendly relations with Europe, the United States, and other
    countries, as much as is possible.
  • Fourth, protecting the lives and dignity of our
    citizens, wherever they may be, is an unquestionable priority for our
    country. Our foreign policy decisions will be based on this need. We will
    also protect the interests of our business community abroad. It should be
    clear to all that we will respond to any aggressive acts committed against
  • Finally, fifth, as is the case of other countries,
    there are regions in which Russia has privileged interests. These regions
    are home to countries with which we share special historical relations and
    are bound together as friends and good neighbors. We will pay particular
    attention to our work in these regions and build friendly ties with these
    countries, our close neighbors.

Medvedev concluded, “These are the principles I will follow in carrying out
our foreign policy. As for the future, it depends not only on us but also on our
friends and partners in the international community. They have a choice.”

The second point in this doctrine states that Russia does not accept the
primacy of the United States in the international system. According to the
third point, while Russia wants good relations with the United States and
Europe, this depends on their behavior toward Russia and not just on Russia’s
behavior. The fourth point states that Russia will protect the interests of
Russians wherever they are — even if they live in the Baltic states or in
Georgia, for example. This provides a doctrinal basis for intervention in such
countries if Russia finds it necessary.

The fifth point is the critical one: “As is the case of other countries,
there are regions in which Russia has privileged interests.” In other words,
the Russians have special interests in the former Soviet Union and in friendly
relations with these states. Intrusions by others into these regions that
undermine pro-Russian regimes will be regarded as a threat to Russia’s “special

Thus, the Georgian
conflict was not an isolated event
— rather, Medvedev is saying that Russia
is engaged in a general redefinition of the regional and global system.
Locally, it would not be correct to say that Russia is trying to resurrect the
Soviet Union or the Russian empire. It would be correct to say that Russia
is creating a new structure of relations
in the geography of its predecessors,
with a new institutional structure with Moscow at its center. Globally, the
Russians want to use this new regional power — and substantial Russian nuclear
assets — to be part of a global system in which the United States loses its

These are ambitious goals, to say the least. But the Russians believe that
the United States is off balance in the Islamic world and that there is an
opportunity here, if they move quickly, to create a new reality before the
United States is ready to respond. Europe
has neither the military weight nor the will to actively resist Russia.
Moreover, the Europeans are heavily dependent on Russian natural gas supplies
over the coming years, and Russia can survive without selling it to them far
better than the Europeans can survive without buying it. The Europeans are not
a substantial factor in the equation, nor are they likely to become

This leaves the United States in an extremely difficult strategic position.
The United States opposed the Soviet Union after 1945 not only for ideological
reasons but also for geopolitical ones. If the Soviet Union had broken out of
its encirclement and dominated all of Europe, the total economic power at its
disposal, coupled with its population, would have allowed the Soviets to
construct a navy that could challenge U.S. maritime hegemony and put the
continental United States in jeopardy. It was U.S. policy during World Wars I
and II and the Cold War to act militarily to prevent any power from dominating
the Eurasian landmass. For the United States, this was the most important task
throughout the 20th century.

The U.S.-jihadist war was waged in a strategic framework that assumed that
the question of hegemony over Eurasia was closed. Germany’s defeat in World War
II and the Soviet Union’s defeat in the Cold War meant that there was no
claimant to Eurasia, and the United States was free to focus on what appeared
to be the current priority — the defeat of radical Islamism. It appeared that
the main threat to this strategy was the patience of the American public, not
an attempt to resurrect a major Eurasian power.

The United States now faces a massive strategic dilemma, and it has limited
military options against the Russians. It could choose a naval
, in which it would block the four Russian maritime outlets, the Sea
of Japan and the Black,
Baltic and Barents seas. The United States has ample military force with which
to do this and could potentially do so without allied cooperation, which it
would lack. It is extremely unlikely that the NATO council would unanimously
support a blockade of Russia, which would be an act of war.

But while a blockade like this would certainly hurt the Russians, Russia is
ultimately a land power. It is also capable of shipping and importing through
third parties, meaning it could potentially acquire and ship key goods through
European or Turkish ports (or Iranian ports, for that matter). The blockade
option is thus more attractive on first glance than on deeper analysis.

More important, any overt U.S. action against Russia would result in
counteractions. During the Cold War, the Soviets attacked American global
interest not by sending Soviet troops, but by supporting regimes and factions
with weapons and economic aid. Vietnam was the classic example: The Russians tied
down 500,000 U.S. troops without placing major Russian forces at risk.
Throughout the world, the Soviets implemented programs of subversion and aid to
friendly regimes, forcing the United States either to accept pro-Soviet
regimes, as with Cuba, or fight them at disproportionate cost.

In the present situation, the Russian response would strike at the heart of
American strategy in the Islamic world. In the long run, the Russians have
little interest in strengthening the Islamic world — but for the moment, they
have substantial interest in maintaining American imbalance and sapping U.S.
forces. The Russians have a long history of supporting Middle Eastern regimes
with weapons shipments, and it is no accident that the first world leader they
met with after invading Georgia was Syrian
President Bashar al Assad
. This was a clear signal that if the U.S.
responded aggressively to Russia’s actions in Georgia, Moscow would ship a
range of weapons to Syria — and far worse, to Iran. Indeed, Russia could
conceivably send weapons to factions in Iraq that do not support the current
regime, as well as to groups like Hezbollah. Moscow also could encourage the
Iranians to withdraw their support for the Iraqi government and plunge Iraq
back into conflict. Finally, Russia could ship weapons to the Taliban and work
to further destabilize Pakistan.

At the moment, the United States faces the strategic problem that the
Russians have options while the United States does not. Not only does the U.S.
commitment of ground forces in the Islamic world leave the United States
without strategic reserve, but the political arrangements under which these
troops operate make them highly vulnerable to Russian manipulation — with few
satisfactory U.S. counters.

The U.S. government is trying to think through how it can maintain its
commitment in the Islamic world and resist the Russian reassertion of hegemony
in the former Soviet Union. If the United States could very rapidly win its
wars in the region, this would be possible. But the Russians are in a position
to prolong these wars, and even without such agitation, the American ability to
close off the conflicts is severely limited. The United States could massively
increase the size of its army and make deployments into the Baltics, Ukraine
and Central Asia to thwart Russian plans, but it would take years to build up
these forces and the active cooperation of Europe to deploy them. Logistically,
European support would be essential — but the Europeans in general, and the
Germans in particular, have no appetite for this war. Expanding the U.S. Army
is necessary, but it does not affect the current strategic reality.

This logistical issue might be manageable, but the real heart of this
problem is not merely the deployment of U.S. forces in the Islamic world — it
is the Russians’ ability to use weapons sales and covert means to deteriorate
conditions dramatically. With active Russian hostility added to the current
reality, the strategic situation in the Islamic world could rapidly spin out of

The United States is therefore trapped by its commitment to the Islamic
world. It does not have sufficient forces to block Russian hegemony in the
former Soviet Union, and if it tries to block the Russians with naval or air
forces, it faces a dangerous riposte from the Russians in the Islamic world. If
it does nothing, it creates a strategic threat that potentially towers over the
threat in the Islamic world.

The United States now has to make a fundamental strategic decision. If it
remains committed to its current strategy, it cannot respond to the Russians.
If it does not respond to the Russians for five or 10 years, the world will
look very much like it did from 1945 to 1992. There will be another Cold War at
the very least, with a peer power much poorer than the United States but prepared
to devote huge amounts of money to national defense.

There are four broad U.S. options:

  1. Attempt to make a settlement
    with Iran
    that would guarantee the neutral stability of Iraq and
    permit the rapid withdrawal of U.S. forces there. Iran is the key here.
    The Iranians might also mistrust a re-emergent Russia, and while Tehran
    might be tempted to work with the Russians against the Americans, Iran
    might consider an arrangement with the United States — particularly if the
    United States refocuses its attentions elsewhere. On the upside, this
    would free the U.S. from Iraq. On the downside, the Iranians might not
    want —or honor — such a deal.
  2. Enter into negotiations with the Russians, granting
    them the sphere of influence they want in the former Soviet Union in
    return for guarantees not to project Russian power into Europe proper. The
    Russians will be busy consolidating their position for years, giving the U.S.
    time to re-energize NATO
    . On the upside, this would free the United
    States to continue its war in the Islamic world. On the downside, it would
    create a framework for the re-emergence of a powerful Russian empire that
    would be as difficult to contain as the Soviet Union.
  3. Refuse to engage the Russians and leave
    the problem to the Europeans
    . On the upside, this would allow the
    United States to continue war in the Islamic world and force the Europeans
    to act. On the downside, the Europeans are too divided, dependent on
    Russia and dispirited to resist the Russians. This strategy could speed up
    Russia’s re-emergence.
  4. Rapidly disengage from Iraq, leaving a residual force
    there and in Afghanistan. The upside is that this creates
    a reserve force
    to reinforce the Baltics and Ukraine that might
    restrain Russia in the former Soviet Union. The downside is that it would
    create chaos in the Islamic world, threatening regimes that have sided
    with the United States and potentially reviving effective intercontinental
    terrorism. The trade-off is between a hegemonic threat from Eurasia and
    instability and a terror threat from the Islamic world.

We are pointing to very stark strategic choices. Continuing the war in the
Islamic world has a much higher cost now than it did when it began, and Russia
potentially poses a far greater threat to the United States than the Islamic
world does. What might have been a rational policy in 2001 or 2003 has now
turned into a very dangerous enterprise, because a hostile major power now has
the option of making the U.S. position in the Middle East enormously more

If a U.S.
settlement with Iran
is impossible, and a diplomatic solution with the
Russians that would keep them from taking a hegemonic position in the former
Soviet Union cannot be reached, then the United States must consider rapidly
abandoning its wars in Iraq and Afghanistan and redeploying its forces to block
Russian expansion. The threat posed by the Soviet Union during the Cold War was
far graver than the threat posed now by the fragmented Islamic world. In the
end, the nations there will cancel each other out, and militant organizations
will be something the United States simply has to deal with. This is not an
ideal solution by any means, but the clock appears to have run out on the
American war in the Islamic world.

We do not expect the United States to take this option. It is difficult to
abandon a conflict that has gone on this long when it is not yet crystal clear
that the Russians will actually be a threat later. (It is far easier for an
analyst to make such suggestions than it is for a president to act on them.)
Instead, the United States will attempt to bridge the Russian situation with
gestures and half measures.

Nevertheless, American national strategy is in crisis. The United States has
insufficient power to cope with two threats and must choose between the two.
Continuing the current strategy means choosing to deal with the Islamic threat
rather than the Russian one, and that is reasonable only if the Islamic threat
represents a greater danger to American interests than the Russian threat does.
It is difficult to see how the chaos of the Islamic world will cohere to form a
global threat. But it is not difficult to imagine a Russia guided by the
Medvedev Doctrine rapidly becoming a global threat and a direct danger to
American interests.

We expect no immediate change in American strategic deployments — and we
expect this to be regretted later. However, given U.S. Vice President Dick
Cheney’s trip to the Caucasus region, now would be the time to see some
movement in U.S. foreign policy. If Cheney isn’t going to be talking to the
Russians, he needs to be talking to the Iranians. Otherwise, he will be writing
checks in the region that the U.S. is in no position to cash.

Commodity Index Funds & Investment Banks

This is from John Mauldin at http://www.frontlinethoughts.comI think he does a wonderful job of explaining how the Commodity Index Funds stay off of the CFTC’s radar in their weekly Commitment of Traders reports.

Swapping out Commodities

The Commodity Futures Trading Commission announced yesterday that they are
looking very hard at possibly closing a regulatory loophole that allowed some
extremely large commodity index funds to get around position limits. For those
not familiar with the concept of limits, it basically works like this. No trader
or fund is allowed to own more than a specific amount of a commodity traded on
the futures exchange. This limit varies from commodity to commodity and exchange
to exchange. The point is to keep one group from manipulating the price of a
commodity, as the Hunts did with silver in the early 80s.

The loophole is one where large investment banks can sell a “swap” for a
specific commodity like corn and then hedge their position in the futures
markets. There is no limit on the amount of the commodity that can be hedged.
So, a fund can accumulate sizeable positions far in excess of what they could do
directly by working with an investment bank. In essence, the swap is a
derivative issued by a bank which acts just like a futures trade, but it is with
the bank as guarantor and not an exchange. Swaps are not regulated as such. And
up until now, the banks were seen as legitimate hedgers so there were no limits
on what they could buy in the futures markets.

This works for very large commodity index funds which try to mirror a
particular commodity index and need to be able to buy very large positions in
excess of the normal limits (and there are scores of them), and for the banks
that make the commissions and profits on the swaps. Remember, the fund gets a
management fee, so growing the size of the fund grows their fees.

These indexes typically have about 26 commodities, with the largest
allocation to oil, but almost anything that is traded has some small portion of
the allocation. As I noted last week, there are some who believe this is working
to drive up the price of commodities beyond the simply supply and demand
principles. Whether or not you believe this to be the case, the CFTC is looking
at the loophole.

The key word in the announcement yesterday was the word “classification.” Their classification can be tracked in the Commitment of Traders Report classified as hedgers and as such have no limits. But
they are not rea lly hedging the actual physical commodity as a farmer or
General Mills might do, but the hedge is their financial position.