Commodity Disconnect: Feast or Famine?

My broker and good friend recently put me onto the bullish breakout on the Point and Figure chart of the Continuous Commodity Index, which at Yahoo is CI-Y.NYB, or the CCI other places. An index this large begs to be further dissected, and that reveals some anomalies, which I refer to here as the MOO:COW spread; the difference between two agricultural product etfs, whose trajectories are very different. If you were long the MOO, and short the COW you have done pretty well. The MOO:COW spread is an example of government in action, I found out. The source is Gary Dorsch, http://www.sirchartsalot.com/article.php?id=120

MOO is a basket of agricultural companies, which seeks to mimic the DAX Global Agribusiness Index. COW is an etf which tracks one futures contract each, cattle and hogs. MOO holds companies like Archer Daniels, Potash, Deere. In the interest of accuracy I went to a company which does primarily meat packing, Hormel and put that up against COW. YTD the relative index, COW:HRM has dropped from 1.1 to around .743. The ratio, COW:MOO has dropped from 1.25 to .65. I know nothing about farming, but if equipment costs more, grain costs more, shouldn't meat cost more?

The MOO:HRM ratio bottomed at around .75 in March and is currently 1.15. This ratio is strongly bullish no matter how you cut it, and is it because of government intervention in the Commodities markets, and more importantly, my little ducklings, if the Bernanke/Treasury Commodity PUT, the carry trade in pork chops, turns around, can we make a lot of money on the trade?

I was buying tortillas at the express checkout at my super market, and complaining bitterly, that $4 was too much for 10 flour tortillas. The clerk, it turns out, understands the problem better than I (or as Bukowski said, "the world is full of shipping clerks, who have read the Harvard Classics".

The clerk said,"We ship our wheat overseas, and so there isn't enough to take care of our own domestic needs."

DAMN! Isn't that what happened during the potato famine? I better buy Potato futures.

So I went to the government website to check the facts, and I note that in October of this year we exported 236,552,000$ worth of beef, which was down YOY by $50M. And all this with a weak dollar to support exports! Less beef going overseas, and pricing power not in evidence. Concerning grains I found a chart at the USDA website which suggests US grain stocks remain high relative to the other grain exporting countries. Now I am confused, the US dollar is weak, but less grain and meat is being exported?

Are futures contracts being kept out of the hands of hedge funds, and speculators so the plebes can have their cake and eat it too, (and the politicians can get reelected?) Once before I blogged about the Bush administrations misuse of the SPR, and the Goldman Commodity Index to bring gasoline prices down ahead of the midterm elections, in 06. But honestly no one really cares about the politics of oil, if we are screwing the rich arab shieks out of a few bucks. At the time I thought that the only way to know if I was correct was to follow the crack spreads, and when they exploded that confirmed my thesis. Now we have a similar situation in Grain futures and AG and food producing companies, and the politics, however seemly, and anti free market, those politics don't matter if we can still get a burger someplace, for a buck.

So far the MOO:COW spread shows no signs of reversing, as it did in 2008, during the financial collapse? Did someone say, collapse? It may be that grain and meat futures are going to stay low for an indefinite period of time, (who said that?), but that the stock of the companies which process our food will profit handsomely, but if you really believe in the commodity bubble, you have to think the whole thing will turn around, just as gold rose as a reaction to Fed policy, AND China sought to add to their gold reserves. China's grain stock for export has also been drastically reduced.

To add to this here is a link.

http://www.marketskeptics.com/2009/12/2010-food-crisis-for-dummies.html

The article is long, and the stats are a bit daunting, but here are the bullet points 1) The USDA is lying about crop projections. (Gee why would the government lie to us?) However the anecdotal reporting on farmers who complain about the weather is a non sequitur. Farmers complain about the weather, although it is true that some corn crops are not fully harvested, a fact which confounds my brain. I checked the charts at the USDA site and it appears that the major grain exporting countries have lower stocks, except the United States?

The reference to Pimcos Commodity Fund going to cash also seems like a good news bad news item. Why did Pimco shift out of AG futures, and into Treasurues? Did they smell a deflationary crash, or is this just fallout from the governments manipulation of Commodity Exchange rules? Finally there is the notion of commodity derivatives. Just the term raises eyebrows. If futures prices are being manipulated lower, through government intervention in the markets, then why shouldn't we expect the market to revert to the laws of supply and demand, just as the natural inclination of interest rates is go higher when the risk premium demands higher rates of return?

My single guideline in investing in this economic moment, is to look for investment ideas which make money by simply continuing their trend in the way they have been going, such as inflation running ahead of interest rates. The questions always, which is the secular trend, and which is the cyclical trend. Inflation is the secular trend, I believe. Bernanke's primary goal when he took the office, was to maintain 'inflation targets'. Of course that was revised, for the moment, which is why when the economy turns around he may allow inflation to run higher than some like, to balance his long term goals.

The other matter that concerns me is the capacity of the American people to put their principles on hold when dealing with an emergency. Most of us thought Iraq was an emergency. We thought the financial crisis was an emergency, and we think Afghanistan is probably an emergency. We repent these decisions at our leisure, although we have a President who chooses to look forward rather than back, because he wants to sell us few more emergencies, healthcare reform, cap and trade. His robust capacity to promote economic imbalances, and distortions, is implied.

The AG markets are the next disaster brought about by distortions and unfair and unethical practices, promoted for the common good, of course.