Alpha Hunter Chris Brodie Talks About 20 Years’ Worth of Commodities

By Hamlin Lovell

Chris Brodie has been trading commodities for 20 years. In his opinion, the current markets are best traded on a discretionary basis. Tomorrow’s markets are another day. Are macro or fundamentals driving commodity prices this year?

Chris Brodie: Fundamentals are great and set to get tighter in many markets. A weaker macro story could start to compress contango calendar spreads, which we look at to judge the strength of the market. A full blown recession is the only thing that will stop another leg up in commodity prices. There will probably be a recession by the end of next year. Now it is too early to tell if economic weaknesses are just due to an unhelpful US political leadership, or something more serious.

The US government seems increasingly  schizophrenic – it want banks to be stable, but also wants to fine them hundreds of billions of dollars (alluding to Freddie Mac recent lawsuits alleging mortgage backed securities mis-selling). Either you go after the banks, or you have stability. Joined up thinking is needed to do one or the other. The government should not risk bankrupting the banks or they will need another bailout. Could emerging markets permanently decouple and escape recession ?

Chris Brodie: There has been a rebalancing of growth between emerging markets and the developed world. Emerging markets are getting richer and more active, while the indebted world grows slower as it is highly indebted.

China’s currency appreciation raises some interesting possibilities. If the renminbi continues to   rise, commodities get cheaper for China to buy – and China could then ease off from monetary tightening. This hasn’t been tried yet but it could happen: the renminbi has continually traded at the top of range, aided by moves towards liberalizing the currency. The appreciation of many other Asian currencies is also positive, for the same reasons. Which commodities look strongest, and have this year’s natural disasters and political unrest had any relevance?

Chris Brodie:You have to be very bullish on softs and grains as the fundamentals are so good. Inventories are incredibly low and production has been badly hit and surprised to the downside. Rationing through price is now inevitable.

The earthquake in Japan has exacerbated the situation. A tremendous area of Japan has lost grain growing capacity as it’s contaminated- and people have not yet factored in the implications. The Japanese will need much bigger imports of grains such as their staple rice, as they lose pastures, and lose grazing land.

High grain prices are one factor behind livestock prices, as cattle herd sizes are evaporating due to feed costs. Droughts have also not helped, shrinking the supply of pasture land. Killing cattle prematurely is eating into supply.

No comment to make on political unrest. Do you buy the  Peak Oil theory ?

Chris Brodie: There is a structural deficit in oil, even Including the Libyan supply issue: by the time it is resolved, demand will have increased again. Big finds in Norway and Brazil are never enough due to the compounded nature of oil demand. This is best explained by a you-tube video called “Arithmetic Population and Energy” or “the most important video you will ever see” , where a Boulder Colorado Physics Professor talks about  the nature of compounding. When you compound demand, you need more and more production to maintain adequate supply. Its not about “peak oil”, because supply could carry on growing and still not meet demand –  it’s about structural supply deficits. Is currency debasement inevitable and good for commodities, commodity currencies and precious metals ?

Chris Brodie: The problem with currencies is that debasement is always the easy way out. Politicians normally favour it as it’s the least politically expensive option. It seems certain in the US. It might not be needed in the Eurozone if the PIIGS (Portugal, Ireland, Italy, Greece and Spain) are ejected from the Euro.  But it seems likely in the UK and other highly indebted countries

Gold prices are the inverse of confidence in paper money.  If you are confident about paper money gold prices should be low. If not they act as a refuge from paper money. The question is simply how much printing happens. If the US don’t print any more maybe gold won’t make new highs, but  QE3 now seems inevitable not due to US jobs, but simply in order to pay the bills.

Commodity currencies such Brazil’s Real and the Australian Dollar are going up, but only really as the obverse of other currencies going down. Are electronic high frequency trading, commodity indices, and moves to increase transparency in physical markets, significant market forces ?

Chris Brodie: Nearly all commodities are now electronically traded, but this has not changed the way we trade at all. It changes the way you execute, not how you not trade.

The money tracking long only indexes didn’t stop market going down in 2008, and  is not a major driver. Inventories not “paper” are more important. Indices have only a short term impact,  whereas fundamentals are more important for the overall direction of the price.

On physicals we will have to wait and see. As more commodities such as iron ore and emissions migrate from over the counter to exchange trading, are you increasing your investment universe ?

Chris Brodie: We are not looking at iron ore. We are looking at minor commodities that have picked up on open interest and liquidity. In the past, we were unable to trade them due to liquidity. Examples include wheat and rapeseed on the French commodities exchange MATIF.

We did briefly trade emissions but stopped as the fundamentals were changeable at the stroke of a pen and at the whim of whoever decides to issue more permits. Since fundamentals were unknowable, we didn’t want to be reffed out of it. Emissions seem almost a fake market, and we don’t want to participate in markets that are fake. Are discretionary or systematic strategies best suited to the current environment?

Chris Brodie: If you trade purely commodities, today’s market is better for discretionary, but this can change one month to the next…

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