Bloomberg.com: Australia & New Zealand

Bloomberg.com: Australia & New Zealand

It is interesting to hear folks say silly stuff. For example, many folks think the major airlines have been foolish for not hedging their fuel costs. The attitude is a bit like asking the 50 year old widow whose husband recently dropped dead of a heart attack why she did not buy a 5 million dollar life insurance policy the week before he died.

It is true that after the price of a commodity spikes to new levels, users tend to start hoarding. While the price was very low, the users saw no benefit in hoarding. Of course, this pattern is exactly opposite of rationality. If you can buy very cheap, before a substantial increase in price you are ahead of the game. However, commodities tend to revert to the mean price.

In 1999 oil was too cheap. The drilling industry suffered. Oil traded as low as $12 per barrel. The industry recovery took a very long time. Oil finally traded around $18 per barrel by 2002. For about 10 years, it would have been foolish to hedge. Once the price jumped to $60 per barrel the thought ran wild of why don't we hedge against additional increases. There is a financial cost to hedging so the $60 hedger only "wins" if oil trades consistently above $62 during the duration of his hedge.

Again, the oil price will eventually trade below the mean price. Because the supply demand curve for oil follows the unstable coweb pattern similar to the pattern for farm products, no one can estimate the mean price very well. Even the best in the business can only wildly guess at the future price.

When volatility is high the risk is high and the cost of "insurance" is high. The price of volatile commodities will decline just as rapidly as the recent increases.

Bloomberg reports that the price of copper dropped today. While one day does not make a trend, the world wide stock markets are suggesting slower growth ahead. The combination of slightly higher long bond rates and declining stock prices suggest that inflation is going to consume a slightly larger portion of nominal growth and that growth is going to slow.

It may take another bump or two in the fed funds rate to turn the pattern around. Another bump or two in cooperation with bumps in other nations (South Korea raised rates a couple of days ago), should be enough to slow inflation, rally the bond market and set stocks on fire. I am tempted to suggest ten year bonds at 4.45%.

With the slowing of the hot economies (such as Australia, China, and New Zealand), the potential exhist that ten year rates will decline below the fed funds rate. Should this happen, in addition to making a profitable bond trade, the investor should be able to catch the exact market bottom. In other words the news of the inverted yield curve could cause a wave of panic selling.

As usual, one should guard against getting too cute. Short term moves are impossible to call. Intermediate term moves are easier and long term moves are no problem. From here, long term investors should be in stocks, intermediate term investors should be as much as 70% stocks and short term investors should stick with money market accounts.