Tano Capital Commentary: November 2010 - Melt Up!

by Chuck Johnson

Our primary thesis, our “raison d’être”, our theme song here at Tano, is being rung from every bell, and shouted from every rooftop. “The dollar is sinking, the dollar is sinking......” we hear, and it’s a veritable “melt up” in the commodity world.  Our explanation: The seemingly inexhaustible amounts of fertilizer emanating from our vaunted capital, Washington D.C. Yes, it’s a veritable greenback fest out there now, and time to get while the getting is good!!! The presses are rolling, money creation is in full swing, and all that lovely paper is chasing hard goods six ways to Sunday.  It almost doesn’t matter which chart you choose, they are all starting to look the same. Here for your enjoyment and edification are but a few:

Copper 01/01/2008 – 11/09/2010:

Sugar 01/01/2008 – 11/09/2010:

Coffee 01/01/2008 – 11/09/2010:

Cotton 01/01/2008 – 11/09/2010:

Silver 01/01/2008 – 11/09/2010:

Soybeans 01/01/2008 – 11/09/2010:

And of course, the big dog, Gold 01/01/2008 – 11/09/2010:

So, what’s happening? The simple answer is a commodity melt-up, which is, in essence, a “dollar” melt down. The almighty buck is fast and predictably losing its luster as a store of value.

100 bucks nowadays just isn’t what it used to be. In fact, if you look back to the creation of the Federal Reserve Bank in 1914, one dollar created then is now worth 5 cents today, in terms of relative purchasing power.

Purchasing Power of US Dollar 1914-2009

Source: Ned Davis Research Institutional Hotline 02/10/10

The graph above basically says that it now takes $ 100 worth of 2009 dollars to buy the same basket of goods that you could buy for $ 5 in 1914 value dollars. That is basically a 95% debasement in purchasing power over a 95 year period. That long term debasement trend now appears to be accelerating rapidly, although we still have a long way to go before being in danger of replicating some of the more spectacular 20th century examples of currency debasement:

Zimbabwe Currency versus US Dollar Exchange Rate 2001-2009

Source: Wikipedia

For many years, the US currency was pegged to real assets, such as gold, which restricted the ability of the Government to imprudently print more than the economy could justify. All that pretty much went out the window in 1914. There were attempts to keep the currency pegged to gold and silver for periods of time after that; however, the Vietnam war and its deficits in the 1960’s ended up severing our paper currency from everything but our printing presses in the early 1970’s. Since that time, the Government has been free to print as much paper as it wishes, and the only thing backing that paper is a promise to pay in more paper, which of course can be printed at will. That paper says “This note is legal tender for all debts, public and private” and “In God We Trust”. That’s all it says, and it’s only as good as people believe it will be.

 

Hyperinflation

Hyperinflation has occurred with some regularity in other countries over the past hundred years, although we tend to focus on the Weimar Republic in Germany after World War I and, more recently, Zimbabwe. In fact, since 1900, it has occurred numerous times in numerous other countries:

 

100 Years of Hyperinflations 

Source: www.economicnoise.com; www.shadowstats.com

One must indeed wonder, just what is the point of a “Hundred Trillion Dollar” Banknote?

 

Reserve Bank of Zimbabwe

It isn’t very funny to the people living through hyperinflation, however. The German hyperinflation was what enabled the Nazi political party to come to power in Germany.

Hyperinflation, Weimar Republic, Germany 1923

Source: www.Runtogold.com

The slide below shows, in essence, the purchasing power of the US Dollar reflected in terms of Gold from 1999 to 2010. I would say that looks like a trend.

Fed Reserve Board Trade Weighted US Dollar Index versus Gold Perpetual Futures 12/31/1999 - 10/08/2010

Source: Ned Davis Research Institutional Hotline 10/12/10

Of course, it’s not just the US Dollar that has been losing its sheen. Every paper currency has lost ground in terms of gold over the last 12 years. Almost all freely traded paper currencies have begun to devalue versus hard assets.

Bonfire of the Currencies 12/31/97 – 5/18-10 (log scale)

Source: Ned Davis Research Institutional Hotline 5/20/10

Globally, other central banks appear to be re-balancing their reserve currency holdings away from US Dollars into other currencies:

Forex Reserves Selected Currencies As % of Total Allocated Reserves 3/31/1999 – 6/30/2010

Source: Ned Davis Research Institutional Hotline 10/12/10

Central banks also appear to be net purchasers of gold, for the first time since 1988:

Central Banks: Annual Gold Holdings 1957 – 2009

Source: Deutsch Bank Research, IMF

The US budget deficit has blown out from 2004 to present on a massive, never before seen scale. The deficit is “financed” by printing new dollars:

US Budget Surplus/Deficit 1968 - 2009

Source: Ned Davis Research 8/27/2009 Pub #09.18

We believe that  the “melt-up” in prices now occurring across all commodity markets has more to do with a “melt-down” in confidence in the future value of paper currency than it does with supply and demand considerations about individual commodities.  Certainly, world population growth and rapid economic development in emerging economies will  continue to underpin commodity prices and keep supplies tight and inventories low, but the primary problem being surfaced in the markets now is fundamentally related to paper versus “real” assets, and paper is bound to lose that contest in the longer term.

Happy hunting.

With all best regards,

Charles E. Johnson