Global Liquidity’s Impact To Food; Divergences Between Stocks and Commodity Prices

``The gold standard makes the money's purchasing power independent of the changing, ambitions and doctrines of political parties and pressure groups. This is not a defect of the gold standard; it is its main excellence." - Ludwig von Mises, Human Action
Yet, global liquidity continues to impact the real economy.

Figure 4: Brad Setser Dollar Reserves versus US Current Account Deficit

Figure 4 from Brad Setser exhibits how world foreign exchange dollar reserves growth continues to explode to the upside as global central banks, broken down into emerging markets (green), industrial economies (yellow) and total reserves (blue line) continue to heavily accumulate US dollars in excess of the US current account deficit (red dotted line). This signifies the tremendous flow of global liquidity even amidst the ongoing credit crunch in the US and in other parts of the world.

To quote Brad Setser, ``The basic story of 2007 is that central banks were buying more of everything.” (highlight mine) The increase in emerging world’s share of global reserves, more purchases of euros, pounds and other currencies but importantly more dollar purchases which dwarfed all.

The point is that the massive surge of global forex reserves appears to flow into commodities or that the commodity spectrum has been functioning as the “lightning rod” in absorbing the flush of liquidity generated by global central banks.

Yet, all is not equal in the world of commodities. Hard assets have clearly outperformed the stock prices of companies engaged in them as shown in Figure 5.

Figure 5 US Global: Hard Assets versus Paper Assets

Stock prices of natural resource companies have been weighed by sentiment, forced selling and investor redemption as investors worldwide pulled out nearly $100 billion of equity funds during the first quarter despite better earnings prospects.

Eventually when the turmoil subsides we should expect a return to reality. ``The value of resources equities will eventually catch up to the underlying commodities, so we believe this divergence creates an excellent opportunity for investors to acquire natural resources stocks at bargain prices” wrote Evan Smith of the Global Resource Fund.

Once again, the commodity cycle is a long process shaped by repeated government’s attempt to control the marketplace. Such distortions eventually surface through the disequilibrium in the demand and supply equation which gets to be reflected in prices as seen today.

Earlier it had been manifested through rising oil and energy prices. Next, precious metals and industrial metals caught up. Today, it has spread to “food” or agricultural or soft commodities. Will a US Dollar Crisis be next?

This also means that all attempts to restrict trade will ensure an extended crisis. With marginal global reserves at the lowest level since 1976 and where several countries are reportedly joining the fray to secure grain supplies in Africa as Liberia, Nigeria Senegal and Ivory Coast (Financial Times), rice prices continue to climb to the stratosphere (guardian.co.uk).

Thus any form of disruption (such as unexpected climate changes) could further exacerbate today’s shortages.