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    Default Next Amaranth Roils Commodity Brokers Anticipating Price Drop

    Next Amaranth Roils Commodity Brokers Anticipating Price Drop
    October 10, 2006 (Edward Robinson - Bloomberg)

    At 7:55 a.m., five minutes before the opening bell, Anthony Compagnino and Michael Ragazzo huddle in their office on the New York Board of Trade floor -- a booth with a dozen telephones and no chairs -- to plot their next move in the cocoa pit.

    "I should have picked a less stressful job, like bomb defusing," says Ragazzo, a commodities broker at East Coast Options Services.

    After five years, the rally in commodity prices has hit a wall. For two days, Ragazzo and Compagnino, his boss, have been selling cocoa futures as prices have plummeted 15 percent. Hedge funds that have been riding the richest commodities boom in a generation have dumped cocoa en masse, upending the market.

    The fate of a single futures contract is just one worry for New York Board of Trade brokers and their counterparts around the world. The Reuters/Jefferies CRB Price Index, which tracks a basket of 19 commodities, sank to 295.13 on Oct. 3, its lowest level since March 9, 2005. Since May, the index had lost almost 12 percent as crude oil fell to less than $60 a barrel and gold slid below $600 an ounce. After doubling to a 24-year high of 19.3 cents a pound on Feb. 3, sugar has plunged 40 percent.

    For traders like Compagnino, that was no small milestone. The decline marks the market's first reversal since 2001, when China's voracious appetite for raw materials and trades by the $1.2 trillion hedge fund industry combined to send prices soaring.

    The question now is whether the drop is nothing more than a hiccup in a bull market that still has years to run -- or the start of a commodities bust.

    Bears like Stephen Roach, New York-based chief global economist at Morgan Stanley, say the bust is already under way. ``The megarun for commodities has run its course,'' Roach, 61, says.

    Bulls like Jim Rogers, who co-founded the famous Quantum Fund with George Soros, say commodities have plenty of steam left. The previous bull market ran for 14 years, from 1968 to '82, and this one will last at least that long, Rogers, 63, says.

    Rogers, chairman of Beeland Interests Inc., a New York- based investment firm, says the recent slump is a short-term correction. "The idea that this is a bubble is laughable," Rogers says.

    Over the long haul, China and India will devour raw materials as they emerge as economic powers. Supply won't be able to keep up with demand, he says. Just look at oil. As recently as 1992, China was self-sufficient in oil. Today, it's importing 40 percent of its needs.

    Caught in the middle of all this are pit traders like Compagnino. They make money either by buying and selling on behalf of trading desks, money managers and companies that produce or use commodities or by wagering their own money in the markets. Futures -- agreements to buy or sell specific securities or commodities at a specific price on a certain date -- are part of the $8.7 billion-a-day market in exchange-traded commodity derivatives, a family of instruments that also includes options.

    AntiSpin: I'm with Rogers. An important point that Rogers makes in the interview we had with him May this year is that when a recession happens during a commodities bull market, producers cut production ahead of falling demand and prices can continue to increase, in both real and nominal terms. I believe there will be a global recession, probably starting Q2 2007, and demand for commodites will decline, but producers will cut ahead of it. If OPEC is successful at cutting supply to maintain oil prices around $60 as the cartel states is its intention, what is likely to happen to oil and other nominal commodity prices when the Fed expands credit again to rescue the economy?

    This is a perfect opening to address an interesting thread posted by Blaze,
    Is it profitable to ride the bubble? That is what iTulip is all about.

    Success at playing bubbles is the reason I can fund and run iTulip, Inc. (a Mass S Corp.) instead of pulling down a paycheck at another CEO job. Selling tech in Q2 2000, going to cash and bonds until 2001, and taking a position in PMs 2001... if that isn't playing bubbles, I don't know what is.

    Of course it's profitable. Yes, The Boyz know full well these are asset bubbles. Yes, they do get out when the going is good. They know the score.
    I hear it all the time and have for years, although I never reveal sources. For exampe, when I was in NYC on Osborn Capital business in 1999, a seasoned–very–bond trader clued me in over beers colorfully on how Wall Street pros view equities. Mind you, I'd opened the door by telling him my theories as expressed on iTulip at the time. He said, "Stock is for assholes. Get the cash. That's the name of the game. Stock is just a way to get the cash." That's hard-boiled Wall Street cynicism that obviously not apply to all stocks for all companies, but his comments rang true at the time; selling junk to greater fools sure looked like the game to me in 1999.

    Where are we now in the latest bubble cycle? At the moment, things are so extreme in private equity I've had senior guys at major private equity firms here in Boston tell me that the debt markets are "out of control" and they see major trouble coming. The term "distressed debt" is on the lips in private equity fund managers these days.

    Hedge funds, that is, USIPs? The VCs guys I know express loathing–tinged with no small amount of jealousy–for hedge fund managers, fully expecting these cowboys to not only blow themselves up but take the financial markets down with them.

    Actually, the opposite is happening. There is zero mystery in the rally in the stock and bond markets. It's being driven by money flowing out of high risk, high yield hedge funds and back into more traditional, safer, and lower yielding equities and bonds.

    Yes, the Fed knows perfectly well that these are bubbles, but changed their policy in the mid 1990s after the Greenspan Fed wrecked the bond market in an attempt to "prick the bubble in the equity markets" (see The Bubble Cycle is Replacing the Business Cycle). Given that the bond market is capitalized at many, many times the size of the stock market, that's a big "oops."

    The lesson that the Greenspan Fed took from that experience was that the Fed is better off standing by and letting asset bubbles happen, then first playing Fire Dept. then Water Works Dept. after they collapse. The resulting liquidity is expressed in new asset bubbles. The post 1994 "hands-off" Fed approach also fit right into Greenspan's Ayn Rand-esque views, too.

    The Fed now has zero confidence that it can constructively end bubbles, will never admit when they are happening, and is–in my opinion–overly confident in its ability to clean up each bubble without the unintended consequence of creating an even more severe bubble leading to an even bigger collapse.

    Think of the Bubble Cycle as a kind of harmonic oscillation. Each oscillation grows in amplitude until, finally, the circuit burns out. Maybe that will happen (Ka-Poom) in this cycle or maybe not.

    We are stuck in the bubble
    cycle. As I said back in 1999, it's Greenspan's world, we just live in it. Now it's Ben's world, and he's got the goat job that new Fed chairmen are given. We have no choice but to play these bubbles, and that has been the case since the mid 1970s when the US started running trade deficits and the US dollar became the bonar.

    The bubble cycles will continue until they end. No one knows when or how, but my money is on Ka-Poom as the process. The next cycle of asset bubble collapse and reflation may be the one that wrecks the current international currency order, the bonar will lose its status as the world's reserve currency, and the world's central banks will have to work out a new system. But then I thought that about the end of the end of the stock market bubble, so maybe there's one more cycle left in it.

    I often remind people that there was a time during the 1997-1998 currency crisis when many industry people and central bankers were thinking "This is it. It's over." Greenspan at that moment was telling Congress the US should return to the gold standard–I'm not making this up. That's a good indication of the depths of dispair that prevailed at the time. But the system didn't fail, not that time, and compared to the 1997-1998 currency crisis, the stock market crash of 2000 was a relative non-event in terms of the continuation of the system that's producing these asset bubbles.

    In any case, there's a fine line between playing bubble oscillations and hedging the failure of the circuit itself. You can make money playing the oscillations, but if the system fails, we're all poor.

    The next real crisis will be a currency crisis that tests the system once again, as during 1997/1998. Maybe the system will hold up again or maybe not.

    A vicious Black Swan is out there, but no one can say when or where it will arrive.
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    Last edited by FRED; 10-11-06 at 08:17 PM.

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