Sean Corrigan's Commodities Corner
From Sean Corrigan of Diapason Securities
Regular readers may be aware that two of the author’s greatest bugbears are Malthusianism and mindlessly mathematical macroeconomics.
The two of these come into no sharper focus than when we turn to the hoary old canard of ‘Peak Oil’, especially when it cites the work of those two past masters of wrongly–applied ratiocination, Hubbert and Hotelling.
The former we have recently dealt with already, so let us say a few words about the latter—a gentlemen who was a statistician, not an economist, in an era when there was still an honourable degree of separation between the two disciplines (ironically, he was also, at one time, Murray Rothbard’s professor at Columbia before the latter had a self?declared ‘epiphany’ regarding the flimsy epistemological grounds upon which much statistics lies and quit the course forthwith).
The better to set the scene, let us first note that those who think of themselves as ‘resource economists’ all seem to think of their subject as if they were describing an Easter egg hunt.
In this, an explicitly determine number of eggs are scattered about over a given territory and the seekers are then sent off to find them. Once found and eaten, they can never be replaced. I’m sorry, boys and girls, but the fun’s over and it’s back to spinach and cauliflower from here on in.
From this gross misrepresentation of what John Bratland has tellingly called the entrepreneurial business of ‘resourcing’, the RE crowd then concocts a mathematically neat, but practically irrelevant, analysis of which the founding tenet was the so?called ‘Hotelling Rule.’
Pondering the question of how one should price a non?renewable stock of a good, Hotelling arrived at the pseudo?rigorous and partly tautologous conclusion that its price should ascend continuously at the rate of interest (by which he really meant the general rate of profit achievable in all other fields of endeavour), a result which implied that the NPV of the sale proceeds would not only equal the product of the cash price times the stock, but that—and this both an eco?alarmist’s and an asset?pusher’s dream—that the price would mount exponentially along the way to its final and utter exhaustion.
This, however, begs so many questions it is at risk of being arrested for intellectual vagrancy.
Among the many shortfalls displayed by this essentially static schema, it assumes that:?
- The stock is fixed, now and for all time
- The quantity so fixed is known to all those perfect automatons so beloved of modern macro as they uncover and distribute it
- More broadly, the usual neoclassical sine qua nons—such as perfect competition ? apply
- The costs of finding and extraction (and milling, refining, fabrication, etc., etc.) never alter
- The technological milieu never changes, whether in respect of the material’s discovery or its later use
- The expressed demand for it remains constant and no other good arises to offer the same or better satisfaction to its users
- The rate of profit (and all that effects this, such as time preference, inflation expectations, taxes, central bank policy) is invariant
- The resource has no effect upon, nor is affected by, the pricing, use, or profitability of any other goods and resources, be they competing or complementary in their application
- The resource is someone wanted in and for itself, rather than for the services it provides
- The spot price which grows in such a mouthwateringly exponential fashion appears from nowhere with no further explanation, leading one to wonder just when the causative finiteness of the resource was first recognised by our population of robotic omniscients.
Assuming the relevant real interest rate is positive, its derived guarantee to be the equal of that offered anywhere else in the world of risk and enterprise dissolves into paradox since it suggests that this fully collateralized treasure should be hoarded and not used – negating both the concept of depletion and the economic usefulness of the material!
In short, Hotelling built his little fictional Legoland according to the prevailing dogma of objectivist, aggregative reism and not with regard to a properly subjectivist, individually?centred functionalism of the kind we Austrians insist informs the real world which we all inhabit.
Far from being a special case, ‘resources’ are just goods and productive inputs and are not, in truth, subject to a different kind of calculus. To the extent that men and women can derive some pleasure, protection, or prevention of discomfort from their employment, they will be willing to swap other goods and services to acquire them.
At the point where some entrepreneur supposes that he himself can earn the means to satisfy his own wants by fulfilling those of his fellows in this regard, he will try to put the resource at their disposal: at the point this becomes infeasible, he will stop.
If a second entrepreneur can bring a better or a cheaper means to bear upon his customers’ desires, he will begin to diminish the market for the first good, for it is the function of the good we require, not the tangibility of buckets of glutinous black ooze, or heavy billets of orangey metal.
The subjective nature of this can be seen in the (contested) etymology of that stock villain, the snake?oil salesman—i.e., the charlatan peddling medicinal goods of dubious efficacy whose descendants find themselves very much at home on Wall St. today.
The popular derivation is that what these hucksters were touting as a miracle cure?all was in fact Seneca oil, named for the Indian tribe on whose lands raw petroleum seeps were common enough to pollute Samuel Kier’s salt wells. Initially dumping this noxious waste in the local stream, Kier serendipitously discovered it was flammable and began a series of amateur chemical experiments which would eventually lead to his distillation of kerosene, and the building of the world’s first refinery, but not before he tried to recoup some of his costs by bottling one by?product to be sold as a patent medicine for 50¢ a go.
The point of this digression—beyond its own entertainment value—is that oil has no value whatsoever, outside of that conferred upon it by the imagination and dedication of acting men who have found ways to make it meet one of Man’s most enduring needs—for a reliable and easily transported store of energy.
The innovation involved, as well as the business acumen, legal nous, and political savvy, is what creates and spreads the wealth associated with this chemical combination of hydrogen and carbon atoms: it is neither implicit in the thing itself, nor fore?ordained to remain attached to it. While it may be part of the Green Dominican liturgy to speak mournfully of the appalling stewardship we capitalists exercise over the hermetically?sealed bubble of ‘Spaceship Earth’, the truth is that we live in an open system – both thermodynamically and intellectually.
Indeed, in a Universe overflowing with unimaginable quantities of the stuff, the fulfilment of our energy requirements – and by extension the accomplishment of anything else we care to set our hands to ? only awaits the application of that quantum of human ingenuity and husbanded capital which is commensurate with the expressed urgency of the task. Hence why it is better to speak, with Bratland, of ’resourcing’ as one particular branch of entrepreneurial activity, rather than of the fatuous ’resource economics’ as some priesthood of fashionably millennial pessimism or ’super?cycle’ salesmanship.
As we often remark, this can be summarized as the operation of the process of I³E³S³ ? “Any Insecurity of supply, any Escalation of prices, any increased Scarcity of a given productive input leads to Innovation, Economisation, and Substitution via a process of Investment, guided by Entrepreneurship and fuelled by Savings ? assuming the market is allowed to function.? This works for tin tacks as much as it does for tin, for nachos as much as for natgas, for knickers as much as for nickel.
Theoretical considerations aside, two brief examples should suffice to give the lie to the Hotelling Rule—showing it to be one which simply doesn’t check out (groan).
Take the case of copper. In 1970, best estimates had it that the global total of exploitable reserves was some 280 Mt, a viable sub?set of a putative planetary resource (loosely, the physically present amount) of some 1.6 Gt.
Move forward 40 years (and through several editions of the ludicrous ‘Limits to Growth’, first penned around that time) and the current guesstimate is that reserves sum to around 630Mt (125% greater than before) with resources up to more than 3Gt (not including oceanic sources of the metal) and this after we have mined more than 400Mt and used 500Mt (with recycling accounting for the difference) in the interim.
Now consider good ole’ crude oil itself, the main poster child of Gaian exhaustion and imminent civilizatory collapse.
Back in 1970, once more, BP tells us that estimates of world crude oil recoverable reserves (not by any means a comprehensive reckoning of the world’s endowment of hydrocarbons, you will note) amounted to 613 billion barrels—some 36.8 times then?annual use of 45.7 Mbpd. Four decades and 1 trillion burned barrels later, the latest count is of 1,383 bln bbls in conventional reserves, or 43.4 times 2010’s consumption of 87.4 Mbpd. Even if we strip out the somewhat suspicious—but not conclusively invalidated—OPEC upward revisions of the late 1980s, today’s numbers still come to 1,084 in reserves (+77%) and a barely?changed 34 times a near?doubled consumption.
The implication of this is that even if, after all we have argued above, you still suspect that Hotelling’s calculations do somehow hold water, the cold, hard fact is that these two commodities (among many) are anything but a depleting resource, in any case!
Another needless reinvention of the wheel—albeit as one with bent spokes and a buckled rim—was the NY Fed researchers’ ‘revelation’ that they couldn’t fit a ‘model’ to forecast the price of commodities and that this somehow meant that their bosses were justified in ignoring their rise in setting monetary policy!
Well, we may have a lower standard of statistical certitude than such eminent doctors of the wizard’s art, but it is pretty obvious that commodity prices broadly follow the ups and downs of world trade and industrial output, albeit with varying degrees of sensitivity—as well as with the occasional over– and undershoot: these, in turn, depend upon the prevailing monetary conditions.
Then again, the business cycles which largely determine the ’real’ side fluctuations in industry and commerce are themselves a monetary phenomenon, meaning that changes in money influence changes in real activity (and, naturally, the prices at which these take place). Feedbacks from these can also affect money creation, in their turn, often in a destabilizing manner.
Commodities are obviously subject to such fluctuations directly and can also feature among the channels through which a swollen supply of money and credit may preferentially flow. Since commodities, too, are part of the matrix of inputs and outputs which constitute ‘real’ activity, they cannot fail to leave their own mark upon a topology within which are laid out the so?called ‘fundamentals’ of supply, demand, and inventory upon which so much attention is focused – quantities which we are therefore never justified in considering as somehow independent of all that goes on around them.
Thus, even when the ebb and flow of commodity prices seem to be at their most closely synchronised with demonstrable variations in ‘real’ output, we must never lose sight of two possibilities: that it is the commodities which may occasionally be the drivers, rather than the driven; and that the real is often no more than a reflection of the sometimes dominant vicissitudes of monetary activity.
The web we weave is a tangled one – we should never practice to deceive ourselves, of all people, that it can ever be otherwise.
Markets, as we started by saying, are trying to rally and are being aided by powerful shift out of fixed?income. We have to respect that, but we are also at a loss to see whither the selfsustaining flow of positively reinterpretable news will emanate in the coming days.
Agriculture has come right down to the old TWI?weighted high we saw as key last week, as the reports turn bullish for crops and bearish for stale longs. We got our projected wheat slump on the H&S violation, too, as an added bonus. Whether that support will give way only time will tell, but if it does… Tim?berrr!
Despite the rally in energy, WTI has still not been able to trace out a pattern which would preclude a continued slide to our old $85 area. Brent is more equivocal, but could just as easily move down from the post?peak high?volume/ POC line it has regained as move decisively above it. It must surely be worth a re?set short with a tight stop while we find out which sentiment prevails.
Copper, likewise has cast off its bearish tint and is probing towards the mean of the winter balance area around $9580 even as the contango, paradoxically increases. We have to be out for now until more clarity can be had.
One commodity we still cannot be sanguine about is silver which should be revelling in the current predominance of the Risk?On herd (UST5yrs up 50 bps in as many days!). Having broken trend, and having failed to stay above it in the retest, May’s $32.31 is still all that stands between us and a possible $26 handle.
A good deal of liquidation has taken place in the last month or two— and the drop in positioning has been magnified by the resulting fall in prices. Even so, this only appears to have taken the market back to the exposures typical of those we saw before QEII began, with no individual commodity actually showing a net short (excepting that perennial Aunt Sally—natgas).
Whether that is a sufficient base upon which to build a lasting rally— absent some Big 4 central bank encouragement—is perhaps not as evident as the permabulls would have us believe.
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