After the Commodities Rout

Addison Wiggin – May 6, 2011

  • Flash Crash redux? Alan Knuckman on how yesterday's commodities sell-off is "good and healthy"
  • Three numbers to watch for signs the sell-off will reverse… or pick up pace
  • Markets recover on new employment numbers… The 5 finds less reason for cheer
  • Silver on sale… the chart that points to a long-term run-up that will outpace gold
  • "We've all learned to hate the banks"… more frontline tales of mortgages playing hard to get… Beijing, Shanghai, Vientiane, Phnom Penh and other exotic travels…

Today is the one-year anniversary of the "Flash Crash" — in which the Dow fell 1,000 points by 2:45 p.m. and recovered 650 of those points by the close at 4:00.

Yesterday, on the eve of that auspicious occasion, amid a flurry of news stories about the nationwide average gasoline price about to crack $4.00 a gallon, oil put in its worst trading day since 2008:

More like, say, an instant correction. The black goo led the way down for the entire commodity market.

The abuse was already under way in earnest while we were crafting yesterday's snarky lead to The 5. Then, weekly unemployment claims missed the Street's expectations by a mile and sent the CRB index to the woodshed.

Selling begat selling, especially as margin calls came in. By the time the last Starbucks cup was swept from the trading floor, oil had fallen $12, from $109 to $97…

  • Gold fell below $1,500, down to $1,470
  • Silver tumbled from a level just below $40 to a low of $33.50 overnight
  • Even the grains took a 2-3% hit despite ongoing wet weather in the Midwest.

The dollar index, for its part, was happy to zoom in the other direction, up past 74.

"This is good and healthy for the markets," read a brief email Alan Knuckman sent us on his iPad in between a round of four TV interviews yesterday. Take your medicine and love it, in other words.

With oil and silver, "you're looking at two commodities that deal emotionally and have had huge moves," he told Canada's BNN. Silver doubled in 2010, and doubled again in 2011. Common sense says we're at much riskier levels when that happens.

"You've got to put it in perspective — the CRB commodity index just made new multiyear highs on Monday."

Still, "I am very encouraged by the way this happened today," Alan concluded, "in an orderly fashion. With the evolution of electronic markets, people got out based on their stop losses — these markets trade nearly 24 hours a day — so they could execute their plan.

"Unless you got in in just the last couple weeks, you still made money."

Later, Alan passed along the notes he made to himself to prepare for those interviews.

"The combination of the dollar jump, OPEC noise about raising production and the margin increase for silver traders caused selling that triggered a washout of protective built-up stop losses below.

"Improving economic data trends, stellar earnings and price recovery in stocks and commodities" — there was just too much good news in recent months.

"After the bin Laden news failed to lift the market, the positive scenarios may have already been priced in and discounted for now."

So what now?

"Watch to see any follow-through on the selling… or if buyers emerge at overdue discounted prices for assets. Watch S&P 1,300, gold $1,400 and oil $97. These were all breakout areas weeks ago that should act as support on a weekly basis."

After a pause of several weeks, we're reopening Alan's Resource Trader Alert to new members. So far in 2011, current readers have collected gains of 95% on soybean meal… 217% on wheat… and 295% on heating oil. For the next two weeks, you can access this guidance at a sharply reduced rate. Check it out here.

And so it goes. Nearly everything that got whacked yesterday is rallying today.

Today, traders are celebrating that the U.S. economy added the most jobs in nearly a year. Or so they're led to believe. Let's examine the payroll data first:

  • The economy supposedly added 244,000 jobs in April. The private sector added 268,000 jobs; government cut 24,000
  • However, 175,000 of those new jobs can be attributed to the BLS' "birth/death model" — in which the economists guess at the numbers based on the launch of new businesses and the demise of old ones.

In other words, nearly three-quarters of these new jobs are a statistical invention. And most of the rest are the 62,000 people McDonald's hired in a one-day job fair publicity stunt.

The separate household survey is nothing to write home about, however:

  • U-3 unemployment, the number the media latch onto, rose to from 8.8% to 9.0%
  • U-6, the more honest figure that includes people who've given up looking for work and part-timers who want to work full-time, rose from 15.7% to 15.9%.

As always in these situations, we turn to the two figures the statisticians can't game:

The red line is the percentage of the working-age population in the labor force. The black line is the employment rate of the overall population. Both lines are stuck at the same level they were when Hollywood inflicted the first Police Academy movie on an unsuspecting populace and Paul Volcker was getting kudos for "slaying inflation."

But as long as the narrative is that job growth is on track — whew, what a turnaround in just 24 hours — we will get results like this…

  • The major stock indexes have recovered most of yesterday's losses. The S&P is back above the key level of 1,344
  • Gold is within $5 of $1,500 again, and silver pushed past $36
  • Copper, which fell below $4 a pound yesterday, is back above it today
  • Crude oil is only 30 cents away from $100 again.

After this correction, the gold-silver ratio — very simply, the dollar price of gold divided by the dollar price of silver — is back to 41 this morning. One week ago today, when the metals were at record highs, the ratio was 32.

This number is important in terms of the long-term trend. A few years ago, Tennessee bullion dealer Franklin Sanders assembled this chart going back to the Coinage Act of 1792. We've updated it to the present day:

In the century since the creation of the Federal Reserve, the ratio's been all over the place. The key is that it's bottomed at or around 16 three times in the last century — 1919, 1968 and 1980.

Sanders is among many who believe long term, it's headed back toward 16. Canadian fund genius Eric Sprott is another. Sixteen was the ratio for centuries before massive silver discoveries in the Americas in the 1800s.

With gold at $1,500 today, a 16:1 gold-silver ratio implies $94 silver. That's a compelling case for silver… and with the ratio reverting for the moment above 40, silver's on sale.

How's this for intellectual property law reduced to the absurd?

The actress who played Elly May Clampett on The Beverly Hillbillies is suing Mattel for putting out an Elly May Barbie:

A likeness… or parody?

Mattel says it went through all the proper channels to license the character. But actress Donna Douglas, now 77, says Mattel never consulted her.

Mattel, she says, violated her "right to control her public image, likeness, endorsements and publicity as Elly May Clampett, a character closely identified with her," according to an account by CNN. She's seeking $300,000 in damages.

Given how Elly May Barbie turned out, we suspect she'd have a stronger libel case.

"Regarding home loans," writes a reader who seeks to weigh in on the why-you-can't-get-a-mortgage thread, "even if you have a job, which I did; even if you have money in the bank (I had enough cash to buy my condo twice); even if you have a good credit score, no bankruptcy; even if you have a home you own outright and in addition have rental property with income, Bank of America thinks you are risky. All for $144,000.

"That is why we all have learned to hate the banks. Even my loan officer was upset, because when she tried to talk to management, they told her to quit whining — which tells me the employees hate their own banks as much as the general public. So the upshot is that they are so hated that their stocks are probably a good buy now. I might just buy to have the last laugh when I make money off them.

"Always read The 5, which is saying something, as I get about 100 investment emails a day. And tell Byron King I appreciate all his work. I am loading up on the dark horse, but kudos to the rest of you too."

"Being self-employed was my problem during my working years," adds a charter Reserve member. "Being retired is my current problem.

"My credit score is way over 800 at all three agencies, my bank accounts are stuffed, my home is free and clear, but I can't get a mortgage either. I have tried both large and small banks. The small bank (my personal bank) will lend, but wants outrageous interest (7% in today's market). Large banks don't even respond.

"What's a mother to do?"

"After more than 10 years owning an independent mortgage broker/banker business with 25-plus employees," writes another, "where our business model was to charge only a flat $750 origination fee for our compensation, and not accept back-end rebate YSP [yield spread premium] commissions, I've reluctantly closed the doors.

"This was a difficult and expensive decision, especially after pouring my savings into the business for the last two years. With all the new regulations and risk requirements, effectively, only the big banks can afford to be in the mortgage business.

"This is exactly what the big banks wanted. Of course, the big banks are exempted from most of the onerous regs.

"What most miss is that the banks and mortgage-backed security investors do NOT want the housing market to recover, because early mortgage payoffs kill their returns. Having homeowners stuck in 6%-plus mortgages is profitable business.

"Free market? Not a chance since Dodd & Frank conspired with the banksters."

"Never thought about it much," writes a reader after Wednesday's issue, "but Yemen's 1,354 years of history is a pretty long time to me. I wonder in a thousand years or so what will the death of Osama bin Laden mean to anyone living in the current United States?

"Will anyone even remember, or will his death be a national holiday like Presidents Day, perhaps Death of Osama bin Laden Day (DOOBLD); it is a bit long.

"The point is the last 235 years are filled with lots good history and the next 1,100 years will probably be just as rich, or even richer, than the last 235 years. I hope we do not spend a bunch of time in our future history books talking about Osama bin Laden. I just think he is a black mark on our country's rich history.

"We should focus on the good everyday people do and the sacrifices that they make for our country's way of life."

The 5: In our travels, we're struck by how short a time horizon Americans have compared with the rest of the world. For many Americans, history began in 1776… or, even worse, when their own memories kicked in at the age of 4.

Still, it's hard to wrap your mind around a conflict stretching back 1,354 years… and how it might have a profound impact on the markets today. It's one of the reasons we've published this presentation, through several revisions and updates reflecting current events, for nearly a decade now. It continues to prove its relevance.

Next week, we're off to a place where people's concept of history stretches back even further. Look for our dispatches from China. We'll be in both Beijing and Shanghai, followed by a brief tour of some startup enterprises in Laos and Cambodia.

Until then, have a great weekend,

Addison Wiggin
The 5 Min. Forecast

P.S. On Tuesday evening in Beijing, along with Bill Bonner, we'll be hosting a cocktail party… followed by another the following Saturday in Shanghai.

P.P.S. "The nuclear renaissance is dead," Chris Mayer declared on the radio yesterday, more convinced than ever that the Fukushima disaster has stuck a fork in atomic power.

Chris took part in a weeklong series of discussions on Maryland's NPR station about energy, our future sources of it and the potential costs. Also taking part was Patrick Cox, who made a compelling case for thorium-powered nuclear energy — the kind that can't be turned into a weapon.

True to form, Patrick also shocked his fellow guests several times, including with a description of the uranium rock he keeps on his desk.

Today, Byron King weighed in on what forms of "green" energy are truly viable, now and in the future. The whole series of programs is archived here. Download and enjoy while you're out and about this weekend.


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