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DEJA VU ALL OVER AGAIN?

“As we mentioned late last year, we believe Ben Bernanke was creating an inflation bubble due to his rate cuts. He was driving the dollar down by flooding the market with dollars and driving commodity prices higher. This has resulted in a wheat bubble, a corn bubble, a soybean bubble and a general commodities bubble. Gold soared to $1,000, while oil recently hit $126. We think there is a very good chance that all of these forces could come to fruition, combined with the de-leveraging of the economy to produce an enormous deflationary cycle. As we approach the election, a potential Democratic president, the likelihood of an Iraq pull-out, a balanced budget, and higher interest rates we are likely to see a stronger dollar in the second half of 2008 and into 2009. By the second half of this year a global slowdown will be well in force and a higher dollar will likely bring down commodity prices. This would be devastating for many of the commodity based economies of the Middle East and Asia. If the US is still in a slowdown (as we presume it will be) and houses are still depreciating (as we presume they will be) there is the potential for global deflation.”

I wrote that in a research note in Q2 of 2008.  If you didn’t read closely you might have a hard time deciphering between the current environment and the situation in 2008.  Of course, things are slightly different now.  We don’t have the bloated housing prices, the banks on the precipice and the lack of stimulus.   But in many ways the situation remains eerily similar.  We appear to have once again replaced a bubble with another bubble.  Naturally, it only makes sense that we move to the one asset class that has not experienced a broad and devastating bubble in the last decade – commodities.

I don’t know how long this bubble will last or how far it will expand.  It could last several years or it could last several months.  I seem to be very good (bad?) at being a few years early in calling bubbles….The two things we know for certain are:

1) Prices NEVER sustain parabolic rises.

2) The policies of the Fed and PBoC are significantly contributing to the current bubble.

Like all bubble collapses I would expect this one to be devastating in many regards.  We are already seeing its impact in Libya, Egypt and the Middle East.  There is no telling how wide ranging its impact will be.  But with much of the developed world still mired in a balance sheet recession the last thing we need now is another bubble implosion – particularly if it results in much slower growth in the one strong leg of the recovery – Asia.  Dr. Bernanke appears to believe he can contain the madness of crowds.  I think he is only fueling this madness and when the crowd turns to run in the opposite direction he will be powerless in stopping it from trampling him.

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