The Great Relevering
by Daniel Aaronson and Lee Markowitz
One of the biggest problems for long positions in gold and commodities generally in 2008 was the leverage used by investors in the futures market. Of course, as prices increased so did the profits and the equity of these investors. The additional equity was levered further by buying even more futures contracts. This was a recipe for disaster as delevering took full force.
Furthermore, in 2008 the other common trade was to be short long-term treasuries. The decline in commodities that wiped out so much equity forced a massive short squeeze in treasuries reinforcing both trends. That was 2008.
In 2009, commodities have now stabilized and some have even risen. Long-term treasuries are falling once again. Both of these trends, combined with all of the cash on the sidelines, are laying the groundwork for what lies ahead.
The Federal Reserve is fighting deflation aggressively in an attempt to create inflation - when it wins the battle it will make the aftereffects of the 2003 battle with deflation look like child's play. In 2004-2006, leverage was used to speculate in housing. In 2009 and for the foreseeable future, leverage will be used to build futures positions in all types of commodities. As profits begin to accumulate, greater and greater amounts of leverage will be used in the futures market. After all, animal spirits never die and speculating with cheap capital is what central banks are enticing investors to do. This "Great Relevering" will be even more powerful than the delevering that took place in 2008.
Since financial assets were the old leadership, it is clear that real assets will be the new leadership making this opportunity overwhelmingly favorable. Inflation-adjusted commodity prices are near all time historic lows as cash waits on the sidelines searching for a home. The buying of levered commodity positions sounds like home sweet home.
Lee Markowitz CFA
Continental Capital Advisors, LLC
Continental Capital Advisors, LLC was formed to offset the destruction of wealth caused by the global devaluation of currencies by central banks. The name Continental Capital symbolizes the 1775 US Currency, "the Continental", which was backed by nothing and quickly became devalued.
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