The main argument supporting inflation is based on the current prices in the commodity markets. The argument postulates that the massive injections of capital through low interest rates and the government’s active purchase of long term treasuries is debasing the U.S dollar and making our products cheaper on the international market. The logic is sound in assuming that price paid has a direct relation to the exchange rate. However, since 2007, the U.S. Dollar Index is down less than 5%. This doesn’t seem so bad on the surface until one considers that because the U.S. Dollar Index is trade weighted with more than 40% of its allocation going to the Euro currency futures, it doesn’t accurately reflect the Dollar’s value against the developing Asian nations and thus, the world.
United States’ businesses have made their profit margin through purchasing goods and services overseas at a favorable exchange rate and reselling them domestically for years. As a country, we have enjoyed our success for many years. During this process, we helped to develop an economic infrastructure overseas that we failed to remain competitive with domestically. The economies in these countries have continued to develop and strengthen and so have their currencies. We’ve seen the Dollar decline by more than 20% against the Indian Rupee and nearly 30% against the Japanese Yen since ’07. The Chinese Yuan/Renminbi is artificially capped by their government and has only been allowed to rise 7% against the Dollar over this same period.
The fact that the countries we’ve done business with for years are now stealing some of our economic thunder should come as no surprise. We’ve witnessed this story throughout history as cultures adapt new foreign technologies to their own use and use their production advantages of cheap labor, fewer legal restrictions and years’ worth of foreign direct investment to implement the same business plan in their own country, thus exploiting their own competitive edge in labor and capital, just like we did here, 100 years ago.
Productive land is the only production input with any upward price pressure. The inflation argument based on commodity prices is domestically tied to the agricultural land component of the economic equation. We have not seen inflation in labor as our own unemployment rate hovers under 10%. We have not seen inflation in the capital markets as the Federal Reserve Board recently committed to near zero interest rates for the foreseeable future. Finally, non- agricultural land has seen a crash in the housing market, which is being followed by the commercial market. Arable farmland and mineral deposits are the only sources of upward price pressure. The growing middle class of India, China and other Asian nations is creating a consumption premium in the finite goods that must be grown or mined through their new found purchasing power.
Fortunately, we are able to benefit from the growing agricultural demand to help offset the years of domestic overspending. The United States still holds a strong lead in grain production. U.S. grain exports are on a tear this year and are expected to continue. China has been an importer of corn for the first time in 14 years and their soybean imports are up more than 5% from last year. We should be able to exploit this advantage as the developing middle class in India, China and the rest of Asia continue to move up the personal consumption ladder, which includes eating more of what they want and less of what they can afford. We will also see a surge in textiles and technology purchases as their disposable income climbs.
The net result of this is a changing shift in the floor prices for commodities as the world adapts to new levels of consumption and global production catches up. The old normal of $4 beans and $400 gold is long gone. The panic low of the economic meltdown in December of ’08 was $4.40 in soybeans and $700 in gold. Markets like corn and sugar never broke their upward trends. Currently, corn is supported by China’s continued imports while India remains the largest gold consumer.
The most compelling case, in my opinion, is in soybeans. Soybeans are fully supported by both China and India through solid demand in feed and cooking products. Technically, the soybean market has been trapped in a $2 sideways range for more than a year, trading between $8.75 and $10.50. Furthermore, as of January of this year, commercial traders, via the Commitment of Traders Report had actually accumulated, and held a net long position in this market until the recent test of the $10.50 highs. This implies that both soybean producers and end production consumers believe this area to be, “fair value.” Finally, we are on the cusp of the seasonally strongest time of year for the active soybean commodity futures contract. Therefore, any disruption in supply could generate a violent breakout higher, easily approaching $12.50 per bushel or, $10,000 per futures contract.
The United States will continue to benefit from our major advantage in farmable land and push it’s agricultural technology efficiencies to the utmost. Unfortunately, as a country, we would be lucky to cover 2% of the national debt through agricultural profits. A better personal finance option is to put the only source of domestic inflation to work by studying the markets themselves and learning how to take advantage of the supply and demand dynamics of a global agricultural imbalance.
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.