Supply, demand and commodity prices

This basic relationship has little to do with prices in the past few years. So what does?

By Jim Cramer Apr 18, 2013 9:11AM

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Commodity Exchange report Fotog, Tetra Images CorbisIs there suddenly too much of everything? Or has there been too much of everything for a long time and we just didn't know it? Was there too much of gold before its collapse? Are we now discovering that there was way too much copper all along? Did we always have too much oil and we didn't know it?


I think everyone has to be thinking along these lines right now because of the sudden declines in so many commodities that seem to all have gone from some tightness to equilibrium to glut in a blink of an eye.


Let me offer you my theory.


In the past two decades we have seen an unprecedented financialization, if you will, of all commodities. Pretty much everything is traded either through glibly created ETFs or through futures backed up by warehouses somewhere or through physical hoarding via tanker ships. The pools of money that have chosen to make commodities as an asset class is much larger than we can ever know because those funds aren't registered anywhere and pretty much report to no one.


I am sure at one time, before the ETFs and the large pools of capital, you might have traded these commodities on actual supply and demand. But if you look at the excellent work that Alcoa's (AA) done on commodities you would know that supply and demand have had little to do with any of the prices of metals in the last few years.


What mattered was the financial buyer not the natural buyer. Right now, for example, when Alcoa looks at all the smelting facilities that are open, when it looks at how much aluminum is available vs. pretty constant needs -- as opposed even to the accelerating ones we are seeing -- supply, after overwhelming demand, is finally getting tight. But it has done nothing at all to the price of aluminum, which is very weak.


That shouldn't be. But it is. Trying to understand how it can be requires you to think like a hedge fund manager, not an aluminum merchant. And here's how you think: China's going to reaccelerate growth so I will take down a lot of aluminum and when China does reaccelerate I will make a killing. In the meantime, interest rates are so low I can afford to warehouse the stuff.


That's been the case for several years now.


Unfortunately, as we read in the papers, the Chinese economy is downshifting. So now you have this financial glut where you know your marginal buyer is going away and the possibility of rates going up (end of Fed pumping) is upon us.


So what do you do? You unleash the aluminum on the market and close down the warehouse.


I don't think copper is any different. Hedge funds bought copper to market up and sell it to China. Pension funds put commodities in the allocation menu and bought copper, perhaps the physical but also through the copper ETF.


Again, you read the papers, you think OK, that allocation is going to get killed, dump it.


You can even make the same case with gold. The Chinese economy is slowing and the nominal buyers -- the great but now struggling middle-class -- aren't buying. At the same time gold failed to spike at the time of Cyprus, so when the heck would it spike? Might as well sell that too, before you lose money on it.


I think the latter, by the way, is crucial to the thinking of all the financial minds here.


"This trade hasn't made us money and it is about to cost us money" would be the way I would look at it.

The last glutted market? Oil. Here, again, giant financial buyers have controlled the market, making it tighter than it should. But unlike all of the other markets, there have been breathtaking discoveries of oil that have distorted world flows and that has caused the price to actually come to make sense. Think about it. With economic activity actually down, double digits in many of the fuel using industries in Europe, did it make any sense for Brent to be more than $100, especially after the zeal with which they approach their hatred of renewables?


Come on, does that make any sense at all? Yes, if you think China is reaccelerating and not conserving. Yes, you would want to hoard it.


But not now. Not with the papers reading the way they are. So the financial buyers are dumping Brent at the exact same time that the actual producers in the United States are getting their product to the world market instead of having it landlocked in the Midwest.


The result? The world price is coming down. Now, of course, unlike all of the other markets there is a swing producer here in Saudi Arabia. The Saudis may not know about all of the oil discovered here or can't game it because we do not have a government with an energy policy, so you don't know what will be used -- Canada tar sands -- and what will forever be locked into the ground because of the lowered price.


But they know Iraq is starting to pump much more than it used to and that Libya is back on line. They know that the big Nigeria-to-U.S. oil trade isn't slowing. Neither is the Algeria trade. So it is possible that they cut back and make the market tight again. Remember the tug of war there. They must keep the price tight enough to maximize profit without encouraging more drilling or conservation.


If they pull back then the financial buyers have nothing to fear.


But if they don't, then oil will be in the same free fall that all of the other commodities that have been propped up by the China marginal buyer trade.


So the financial buyers are being margined out, globally, or they are giving up on the trade and what you are seeing is an unprecedented rollback in prices on everything raw.


Oh, one more thing. Don't forget that it is good for all but a handful of companies that actually produce iron, aluminum, nickel, copper, oil and the like.


It's just not good enough right now for people to realize it.

 

Cramer

 


Jim Cramer is a co-founder of TheStreet and contributes daily market commentary to the financial news network's sites. Follow his trades for Action Alerts PLUS, which Cramer co-manages as a charitable trust and has no positions in stocks mentioned.

 

 

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94Comments
Apr 18, 2013 10:17AM
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someone on another board posted their comment: 

 

>>>>> The bubbles are the result of our economy shifting from manufacturing things for profit to making profits from money transactions.<<<<<

 

i think this concept shows what sort of flux we're in.  a big transition on how to exactly "make money" in a world (or country) where we don't actually "make" anything anymore, but work "transactions". 

Apr 18, 2013 10:15AM
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I actually didn't mind this article, maybe because he isn't making a call to buy or sell just offering a theory that actually makes some economic sense.  
Apr 18, 2013 10:56AM
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So Jimmy has finally come to a conclusion that most of us did a long time ago. The Markets are being Manipulated. The Markets have little to do with Free Market. Free Market Capitalism, what a joke. It doesn't exist.
Apr 18, 2013 10:14AM
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So Jim has concluded that the FED has failed and all that debt from borrowed and printed money was wasted?  Oh we already know what they will say "it would have been much worse if we hadn't done what we did".  Much like the rationalizing $60 million bonuses for Bankers with the "we need to pay those monstrous stupid sums to attract the most qualified people".  And didn't most  of us here already know this was going to be the end result?  At some point we the citizens are going to lose confidence in these starched white shirts.  JMHO
Apr 18, 2013 10:31AM
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"Let me offer you my theory."

 

Until about 1980... the people who started our biggest businesses with hands full of blisters and $35 in their pockets were dying off. We started seeing CEOs, and no-experience college degrees put into the middle management ranks. Downsizing was a fabrication hiding the greed that didn't want to pay the guy who invested his lifetime into helping build that business- what he was promised. From that time forward... the worst pariah we could ever hatch and marginally tolerate, steadily took over everything worth anything in America. In April, 2001, we crashed because the weight of administration exceeded the strength of labor and sweat equity. That was an inevitability that the Bushes didn't want so they did what any useless pariah family that never worked an honest day would do... they changed the rules to favor their situation. Unfortunately, The Tax Reform Act that passed when Geo. HW was VP and the Gramm Leach Bliley Act that passed stuffed inside other legislation and funded Geo. H's first term election, also destroyed the supports that held up the playing field. We haven't actually had economy since 1999. So when you look at what's happening now and you assume bailing will continue to carry us along... look closely at Japan printing what it can get away with-- without any economy- without a viable workforce- without assets to anchor it- without a stable land mass... and you get... us. Europe consolidated failing currencies and its dead economies to falsify common prosperity. They don't even have the substance to re-establish some basic fundamental sustaining capacity now. Neither do we. Corporations own our farmland and the highest paying jobs in America TAKE from the economy and do not reciprocate. If there is a hole in the boat, striking up the band and distributing free Kool Aid (continuous Bull Runs) doesn't make the hole go away, it just floods the vessel until it can't stay afloat any longer. We are there now.

 

That's my theory and all it contains are facts. Can anyone NOT thumb it down and provide better FACTS to suggest this is something different? I'll bet you your future place on a street corner that you can't. Come on, Wall Streeters... if you are so "talented" 'splain it in plain English. The world is more than $1 quadrillion exposed with the same $50-$60 Trillion in viable assets that substantiated its currencies just 20 years ago. PROVE it ain't true.

Apr 18, 2013 10:27AM
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Financialization facilitated speculation.

I buy it, sounds like a plausible explanation to me.

Obviously what financialization cannot do is to change the intrinsic value of  commodities. All things eventualy return to their intrisic value, just a matter of time...


Apr 18, 2013 10:55AM
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AND while the smoke and mirrors of official markets continues and we are distracted by the Boston bombing, the U.S. House is busy getting ready to pass the CISPA [Cyber Intelligence Sharing and Protection Act] to further erode your liberties and privacy.

Just continue to listen and watch your master's as they gather in Boston, puppets, while the other hand gives you the reach around.

What?  Don't like that .... then you better call your Representative, if you know who that is, and let him/her know.
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What Cramer making sense for a change. Good for him.

 

Of course all commodities are over priced. Take gold they pay the gold miners in South Africa I think about $5 a day and they haul out about $100 of gold a day. That is a 20 percent increase in your investment. Of course gold is over priced if looked at as a raw material. It costs $5 to haul out $100 of the stuff the price of gold should be more like $7.5 to $100 (allowing a 50 percent profit) or 7.5/100 of what is gold today about $1480 ??? so gold should be priced at $110 to $120 an ounce.

 

Same with oil they pump it out of the ground in West Texas at a cost of $5 a barrel and $20 a barrel cost out of the Gulf of Mexico. So about $15 a barrel is an average cost so adding a 50 percent profit to the mix and oil should be at about $23 a barrel which at 42 gallons of oil in a barrel and being able to make 38 gallons oil should be about 60 cents a gallon before taxes.

 

And considering the other 4 gallons of oil get turned into profitable things like nylon stockings and plastic for i-phones and saran wrap and just about everything in our lives at a profit of about $10 a gallon the price of oil should be free as they are making enough on the by products to pay for getting the gas to our cars.

 

Pretty much the oil companies are greedy and there is not much we can do about it.

 

The scary thing to me is they are buying into the Health Care Industry like crazy right now. So expect health care costs to really go thru the roof as they pratice their pump up the price thousands of times over the cost of the product.

Apr 18, 2013 9:53AM
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Yes, we know, futures were up but, everyone knows about futures, they become the past after the opening bell; for the third time this week manipulators are taking over slowly but surely and starting to do their thing, we are in the red across the board now....Didn't expect anything less from these cheating crooks....Still early, we know but, too many of them...Oh well...More later.
Apr 18, 2013 11:48AM
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I dunno, but even with the DOW being down 40-50 points people are "sneaking back" into some commodities..?? IMO. Many are up over 1%.

Other Indices are down somewhat the same, exception the overall RUT2K.

So someone is buying?

 

I don't care about all the D&G, and the useless, usual trash talk; It accomplishes nothing.

I would rather be swinging a club or shooting some 8 ball....Life is too short.

And you gotta get out and smell the flowers...Unless it gives you a runny nose...?

I think that's what I will do, because of taking a day off to relax..

The Markets will take care of themselves....They always do.

And you guys can sit around, and "kick sand" in each other's keyboards...! 

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This is one of the bubbles the doom sayers have been expounding upon.   Too much Fed money holding up the prices and it is just getting too heavy to be supported. 

 

When the prices of oil come down to where they should be, more people will be using their vehicles for vacations and that will help the economy.   The Seculars and Environmentalists that want no carbon fuels are kicking themselves in the butt about now.  They hate it when people can do what they want, when they want to. 

Apr 18, 2013 11:56AM
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The whole investment world has turned into fast transactions. Options and puts and the way you make money is based on making transactions.
Apr 18, 2013 3:35PM
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WATERBOY..thanks for your reply, and the tip.

Probably sometimes better for me, to just put it in a straight up comment; Then sometimes everyone can share in useful investment ideas; But also considering the nature of it, maybe a wiser choice.?

 

Probably about 50-60% here do invest and others might have 401Ks, but they have few choices from their Fund Manger...And most 401s are invested only in Mutual Funds, maybe ETFs and their own employee stock of the Company they work for...A major issue of a 401k investment choices.

Probably the main reason, that many lost their azzes in 2007-2009; That and "very poor" Fund Managers or  House Mgrs, of the employee's Fund.

It really hurt a lot of people getting ready to retire, and set them back years.

 

I like some of the Oil and Tar Sand plays to the North..And had Suncor Energy(SU) for 2-3 years.

But now out; But also looking back the last few months at possibly taking some positions..?

A BIG PLUS would be the Keystone pipeline project, going South through the States..

Giving the Northern U.S. and Canada outlets to the Central US, Gulf and Refineries...And of course putting product out to the World and the Markets..

People would bitch about exporting, but never consider the "job implications" that are dearly needed.

We have interest in the oil patch now, with about 3 Companies, and have owned Pipeline stock for about 5-7 years, great dividends...So matter which way they go with the K-Line, it should be helpful to us.....Also want to thank your Country(Canada) for helping us in our quest or thirst for the "black gold".....Most people do not realize how much we get from you guys...Thanks again.

BTW...Don't worry about spelling...I understood what you meant...That's all that counts.

Apr 18, 2013 4:49PM
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I think jim is correct. The Fed should signal a rate increase, then carry it out. The entire economy is out of balance, thrift is being punished, the profligate are being rewarded.
Apr 18, 2013 4:57PM
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I am thinking the pipeline East and Keystone will both get done eventually.  The west coast one would be the shortest but the least likely to go through.  BC is by far the most tree huger province and there are many first nations tribes blocking it as well.  
Keystone would benefit the oil companies the fastest yes.
I have a brother in law who went to Alberta for work and one of my oldest friends is out there as well.  Many have had to as few in Ontario are hiring.
Apr 18, 2013 11:56AM
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Actually, they probably should thank President Obama, those that claim they need the specific types of guns, etc. because they are investments and their constitutional right; have just seen their guns, ammo, gun and ammo stocks hit all time highs. The only ones that are getting hurt are the average Americans that just want some guns for hunting, their hunting cost is gone sky high.
Apr 18, 2013 4:38PM
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Nope ABS...To wet to plow....Everyone is flooding.

But did go to Golf course today and play about 4 games of 8 ball with the Old Guys..

Nice try tho'...

Miss Lilly went to the City and got supplies today..

I'll bet that Ol' Mississippi is a fillin' up, but so is the Platte and Colorado.

Here comes Spring finally.

We live in the Swamps, but can still manage to get out....That's enough hint for today...

No Airboats for us...Just 4X4s....And one good little commuter car that gets fantastic MPG.

And Miss Lilly's Rocket...(that use to be me, back in the prime).

Apr 18, 2013 4:37PM
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Wait is Water boy Canadian as well?  I'm not alone!!!!!!!!
If oil continues to drop you may see the pipeline talk fade, it has every time the price drops as much of the oil sands are only profitable at high prices.  Of course the fact that the oil is land locked keeps the price you Americans pay us for our tar sand down.  Would really like the pipeline from Alberta Nova Scotia, that would help Canada a ton.
Apr 18, 2013 4:27PM
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Royal...Tried the other night to post back about Dividend Stocks...It didn't go, a no post.

Yes have moved into more serious dividend plays the last 2-4 years..

Getting to old to keep screwing around with risk and speculation, at least that's what "conventional wisdom" says about investments in our age group.

Almost 2 dozen plays with divs, at about an average of 6%...2-3 that are zero div. and mostly speculation..Even our Goldminer pays about 1.8% now, maybe a little more with price in the crapper?

BTW...Today that miner was up 5-6%....woooohooo!!

Investors can rake in more dividends, but we are very diversified; Trying to cover most Sectors.

And it plays into Recessions and Recoverys..

Things like GE, Tobacco,HD, Walgreens, CAG,telcom Oil,coal, pipelines, REITS, MLPs, LPs..etc..

And of course Gold....Or sometimes other PMs...I want to be able to sleep at night.

Apr 18, 2013 4:07PM
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So many Articles......So little time..

 

They, MSN.......Should concentrate on Substance and not "overwhelming journalism." for the masses that have the attention span of a Med-Fly..

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