The Coming Global Commodities Crisis

by Clif Droke,

The last few weeks has seen a startling rise in fuel and food prices. This has been a key contributor to the political and economic instability overseas; it’s also paving the way for an even bigger crisis for the U.S. and the world economy by 2012.

Indeed, the oil price has been on a rip-and-tear largely owing to the Middle East crisis. The fear and uncertainty overhanging North Africa and the Middle East has also benefited the gold price. Our favorite gold proxy for instance, the SPDR Gold Trust ETF (GLD), recently made a new high and is still above its key immediate-term trend line.

The recent fuel price spike was a consequence of the political turmoil in the North African and Middle Eastern region. This in turn was caused by high food prices…which is mainly a consequence of a weak U.S. dollar since commodities are priced in dollars. Ever since the Bernanke’s Fed decided to pursue its second quantitative easing strategy (QE2) beginning last November, the dollar has been weakening while commodities prices have strengthened. This has put tremendous pressure on developing economies, particularly in the Middle East. Thus it could be argued, as some economists have, that the Fed’s QE2 program has been a major contributor to the Middle East revolutions as well as the rising cost of fuel.

The news media is trying to dismiss the high food prices by blaming it on weather related supply shortages. As Steve Forbes recently observed, “Droughts and floods have hurt the food supply, but at best these are only partial explanations and are about as convincing as North Korea’s blaming famines on the weather. Such acts of God were routinely trotted out to excuse food shortages in the old Soviet Union and Ma Zedong’s China.”

The stated reason behind QE2 was to stimulate the U.S. economy and help bring down the unemployment rate. While the Fed’s stimulus program has had a definite impact in terms of improving the financial market and in at least stabilizing the economy, it has done little to improve the structural condition of the economy or to bring down unemployment. What Bernanke & Co. have succeeded in doing with their super aggressive monetary stance is to create something akin to the 2006-2008 commodities bubble. The Fed has succeeded in pushing the oil price to an unsustainably high level and have also made food prices inaccessibly high for hundreds of millions of underprivileged people in the developing worlds.

In his latest Special Edition, entitled “Crisis High,” Samuel J. Kress makes the following pertinent observation: “Since the Great Depression of the ‘30s, the federal government has increasingly intervened in the economy thereby increasing the national debt to astronomical levels with the numerous social entitlement programs. Will the government’s addiction to OPiuM, squanderous spending of Other People’s Money, ever end? Recent QEs defy logic and reason – how can incurring additional debt cure the ills of excessive debt? Is this not equivalent to giving an alcoholic with sclerosis of the liver a case of scotch for the holidays and wishing him a healthy new year?”

By persisting in its loose monetary policy, which should have been slowed down last year when the recovery had achieved a sustainable momentum level, the Fed is also sowing the seeds of the next major financial crisis. The next crisis will likely be global and could rival the credit crisis in terms of its severity. The fact that the 6-year cycle is up until later this year should help stave off this crisis until perhaps 2012, but the path toward another crisis has been paved and the Fed isn’t likely to reverse course at this juncture. If Bernanke is true to his word in continuing QE2 until spring, the Fed will very likely have gone too far in its loose money policy, just as it went too far in its tight money policy heading into the credit crisis. By the time the Fed recognizes its mistake the damage will have been done and the consequences will have to be paid.

History, it seems, always repeats when it comes to the Fed.

Turning our attention to the metals and mining stock market, the fear and uncertainty concerning North Africa and the Middle East has definitely benefited oil but has also been of some benefit to the gold price. Our favorite gold proxy, the SPDR Gold Trust ETF (GLD), recently made a new high and is still above its key immediate-term trend line.

Gold stocks are in a less strong position than the metal itself, however. As we examined in last week’s commentary, many of the larger cap gold stocks have badly lagged the high-flying silver stocks and smaller cap gold shares in recent weeks. High profile examples of this relative weakness include Newmont Mining (NEM), Freeport Copper & Gold (FCX), Kinross Gold (KGC) and Agnico-Eagle Mines (AEM), all of which are closer to new lows for the year-to-date than new highs.

For a gold stock bull market to be considered strong and healthy, it should be joined by all segments of the market: small-cap, mid-cap and large-cap. When the bigger capitalized mining companies are badly lagging the rest of the group it means the market isn’t firing on all cylinders. If the large cap gold stocks don’t soon reverse their declines it will eventually compromise the broader market’s uptrend. For this reason we’ll need to watch our remaining long positions closely for signs of potential weakness in the near term and hold off on making new purchases until these negative internal divergences have been reversed. As of Mar. 9, both the XAU and HUI indices are below their dominant immediate-term moving averages as we await an improvement in the gold stock internals.