charleshughsmith

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: Hard Times Ahead for Assets

Are commodities topping out? Since we know commodities are physically limited in supply even while demand continues to rise, common sense suggests that commodities will outperform over the long term for as long as industrial civilization continues its consumption of those commodities.

However, it is also clear that the global economy is either slowing or entering an actual recessionary contraction. Thus it behooves us as investors to ask what that contraction of demand might do to the prices of commodities over the near term (i.e., the next 24 months, 2012-2013.)

In Part I, we examined the connection between stock markets and demand for commodities as reflected by the chart of the Reuters/Jefferies CRB Index, the commonly used bellwether for the commodities market. We determined that if the stock markets of China and India are indeed leading indicators of demand for commodities, then the market for commodities will likely weaken.

We also found that margin debt seems to be far more closely correlated to the US stock market than demand for commodities as reflected by the CRB, meaning the US stock market may not be an accurate leading indicator of commodity demand or pricing pressure.

In Part II, we examine a key technical correlation that has withstood the test of time, that of copper and the stock market, and explore a potential key dynamic which may exert outsized influence on the demand and pricing of commodities over the next few years.

As a side benefit, our examination of the commodities may also shed light on the direction of the stock market — another key interest for many investors.

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: How Low Will Housing Prices Go?

It’s a truism that “all real estate is local,” and to the degree that the ultimate price of a property is only truly “discovered” when a specific buyer purchases a specific property at a specific point in time, this is certainly true. It is also true that many key inputs to real estate valuation are locally derived, such as employment, wage levels, demand for rental housing, the attractiveness of neighborhoods, and so on.

But to say that interest rates managed by the Federal Reserve or subsidies provided by the Federal government have no influence on real estate valuation is clearly untrue. Valuation is directly influenced by global, national, and state economies, and by the policies of the central bank and government.

In attempting to answer the question When will housing hit bottom? we might start with the coarse-grained systemic inputs and then move to the more fine-grained local inputs.

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II – The Transition to a Post-Friction Economy

In Part I, we pursued the idea that much of the US economy is, in essence, unproductive friction that is overcome with vast borrowing — itself a form of friction — and the importing of fossil fuels. We also noted that the Central State/cartel “capitalism” partnership has greatly expanded the unproductive, uncompetitive “friction” segments of the economy and has limited consumer “choice” to purposely-selected menus designed to appear like a “free market” while benefiting State fiefdoms and private-sector cartels.

Entrenched Interests Keep Our Markets From Being Free

Looking at the sources and costs of friction gives us some insight into issues that are often seen as political — for example, the costs and benefits of borrowing trillions of dollars into existence every year and the costs/benefits of State regulation. Once we recognize how rising systemic friction will eventually freeze the system, then we also recognize that the path we’re on is unsustainable, and the political “rightness” or “wrongness” of increasing debt to fund the forces of friction becomes irrelevant.

The same can be said of State regulation. Given that one of the purposes of government is to protect the nation’s “commons” — air, water, public lands, and other shared resources — then some regulation is necessary to limit exploitation and predation of the commons by either private parties or the State itself. 

But we have confused productive regulation with regulation that achieves little beyond diverting funds to unproductive segments of the economy. There are hundreds, if not thousands of examples in every sector from criminal justice to farm subsidies to health care.

How about the enormous expense of the “war on drugs” and the resulting prison complex and criminal justice system? Are the benefits being reaped — marginal, or even counterproductive, in many analyses — worth the expense? Those employed in these systems naturally feel the benefits far exceed the costs. But self-interest is simply not an accurate measure of friction; ultimately, only a free market of free citizens can make that assessment.