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Saturday, October 30, 2010

Commodity Prices

The CNNMoney article Fed's Tax on the consumer highlights the rising commodity prices of corn and cotton prices in the last two months. Corn and Cotton prices have skyrocketed by 35% in 8 weeks.

From WebSufinMurfs FinancialBlog2

The knee jerk reaction is doubt there is unprecedented demand for these commodities, making it an organic price rise in the current world economy climate. The obvious question is what is then driving prices to rise?

The article highlights the Federal Reserve Banks loose monetary policies and links the rising prices to loose money. While I do agree with this conclusion somewhat, reducing complex marketplaces to a single simple analysis can be dangerous.

The logic goes that with loose monetary policy the large banks and investors are cautious to put their money into stocks and other assets that have already risen dramatically in the last year. And placing investments in physical assets, such as corn and cotton, is a safer "pile on" for the next asset bubble to be blown.

Again, I am not dismissing this argument, but I do challenge that this is the primary driver.

To look for other drivers, lets look at corn and cotton, how do these commodities differ than say, Lima beans? Corn is used as food......oh yea, and due to Mr. Bush's wisdom it is used for fuel now, funded BY the government money.

Therefore as the government pumps trillions of dollars in the economy through poor spending decisions, one of them is to pump money into backing the idea that Corn is fuel.

Farmers are in fact, investors, and choose crops with the brightest outlook for profits. As oil prices have stabilized and start to rise, the cost for ethanol becomes a cheaper alternative. When oil was at 60 bucks a barrel, ethanol has less of a competitive advantage. Couple the price of fuel rising with government handouts to promote the consumption of ethanol.......is it a wonder corn will get more expensive over time?

So how does this affect cotton......if demand for corn goes up, and there are more "consumers" for corn, farmers switching crops have to drop the next biggest cash cow crop, cotton. Plus there are arguments for global demand in third world countries etc. Again, I want to avoid presenting that we can simplify the cost driver to just "two" things.

But I do want to avoid the over zealous froth I am starting to see that the Federal Reserve Bank is the cause of all market issues. While I agree, the Federal Reserve Banks unholy access to the financial system is by far one of the biggest drivers of financial bubbles and financial dislocations, I also want to avoid simply placing all blame for any bubble that forms in the private sector.

What does this have to do with investing? Next week is the Fed's big QE2 announcement. And I hope that Mr. Bernanke reads the CNNMoney article and views it according to answering problems with what you know. For while I caution readers to avoid classifying all problems derived from the fed, I do encourage Mr. Bernanke to view it as such, and curb his market interference.

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