Wheat and the price of gold in Asia

While it might be considered a bit of a stretch to tie possible higher movements in the wheat price to the price of gold, I want to pose a scenario that I believe could at least have some connection, specifically across the Asian region and particularly in China.

Wheat prices have embarked on another tear higher fueled by a combination of several factors: surging demand for the real stuff, insufficient supply and speculative demand tied to hedge funds and managed money looking to purchase tangibles as a hedge against unlimited money creation by the Western Central Banks.

It was a mere month ago when wheat prices were trading closer to $7.72/bushel. Today, they are at $8.74 for that same bushel of wheat. That is an increase of 13% in 30 day’s time. The catalyst today was a report out of the UN group that as much as 37% of China’s total wheat crop might be affected by drought. In a market in which there is already a rather tight stocks situation, such news led to another surge higher in price.

Here is how this has the potential to tie into gold.

The Chinese as you know are fighting what appears to be a losing battle with inflation. Since October of last year, they have engaged in a series of rate hikes and bank reserve ratio hikes in an effort to somehow slow down their rapidly growing economy. Thus far it has had little effect particularly on soaring food prices.

In their efforts to ward off the unwelcome intruder, they overnight hiked one year rates to 6.06% and raised one year deposit rates to 3%. Unfortunately for savers, when the official rate of inflation in China is running closer to 5% with the government attempting to bring it down to a mere 4%, that still leaves Chinese savers in a hole as they are receiving a negative rate of return on their savings.

As I wrote in an earlier post, this is why Chinese gold demand is so strong right now. (Please see the post below for some further details).

That brings us back to wheat. One of the idiosyncrasies of the grain complex and to cereals in general, is that one grain or foodstuff generally cannot embark on too high of a price run without affecting its neighbors in the complex. Many are not aware of the fact that wheat is generally divided into two broad categories when it comes to its consumption (there are several types of wheat grown also); wheat intended primarily for Humans and wheat intended primarily for livestock feed. Feed wheat, as the latter is called, is generally lower quality wheat but it is fed to livestock because it is a good source of protein and it requires less bushels to achieve the same weight gains as an equal amount of corn. One can see that if the price of feed wheat becomes too high, even though it is less nutritious, many livestock feeders will shift to corn due to the lower cost. They can simply make up for the lower nutritional quality by feeding more and achieve the same weight gains at a better price.

When feed wheat gets too high, that then pulls up the price of corn as demand shifts to it. It works the same way in reverse. If corn is very cheap, feed wheat prices will have to work lower to entice demand. If corn is too high, and wheat is relatively cheap by comparison, demand will shift away from corn to feed wheat.

What we are seeing now is a situation where supplies of corn are much smaller than the world has hoping for due to a smaller harvest in the old crop corn in the US and drought damage to S. American corn coming mainly out of Argentina. With corn supplies already being constrained, higher wheat prices are not yet shutting off demand for feed wheat because corn is still very expensive compared to historical norms. The two are, to use a pun, “feeding” off of each other’s strength.

Rice has not gotten left out of this picture nor have soybeans, the latter which are currently at 31 month highs in price.

All of these price increases in the basic cereal, grains or whatever you want to term them, are conspiring to keep pushing food prices higher and higher. This of course continues to feed the inflation beast which is raging throughout all of Asia making life incredibly difficult for the average citizen who must be watching in alarm at what is taking place around them when it comes to the essentials of life.

Based on what I can see of the current demand/supply fundamentals in many of the grain markets, I see nothing on the immediate horizon that suggests to me that prices are going to move sharply lower anytime soon. In other words, until we get some sort of take on the new crop this year, these higher food prices are here to stay.

This poses an extreme dilemma for the Chinese leaders – if they attempt to hike rates to the point of slowing their economy enough to tame the beast, they run the very real risk of putting millions of their citizens into the ranks of the unemployed. If there is one thing history has taught those who rule that nation, it is that unemployed millions coupled with soaring food prices is NOT A RECIPE FOR PEACE AND TRANQUILITY, nor it is conducive to keeping oneself in power.

IN other words, the Chinese are attempting to fine tune or tweak a situation that requires a heavy sledge hammer using instead a finely sharpened scalpel. I would also say that as far as it goes, if they had to pick between higher food prices and higher energy prices or vast numbers of unemployed and empty factories, they will choose the former rather than risk the latter.

How does all this tie back to gold – simple – Chinese interest rate hikes are going to have to be much more severe in order to knock the rate of inflation down to a level at which the average saver is going to be able to actually receive a REAL, not nominal, POSITIVE RATE OF RETURN on their savings. They do not seem interested or willing to do that at this point hoping instead that the measures that they have taken will result in inflation moderating.

Given the fact that there is little that they can do in the way of impacting food supplies for the time being, their options appear rather limited. Yes, they can subsidize food for their masses out of their massive foreign reserves (running an enormous trade surplus has its advantages) and that remains a distinct option for them but that only tends to aggravate the supply situation since it shortcircuits the market’s attempt to move prices high enough to begin the rationing process and crimp demand. Nearly everywhere where artificial price subsidies are implemented, shortages inevitably result which just work to further compound the woes.

As long as inflation is a serious problem in China, and in other places in the region, and as long as real yields for savers there are negative, gold demand is going to stay very, very robust.

Today's Daily Commentary and Chart action in Gold

Today’s big news once again came out of China, which announced yet another rate increase in what has now been a series of hikes over the last several months. In what has to be a significant development, gold, which initially dipped lower upon the news, ricocheted higher, surging through overhead resistance just above the $1350 level. It appeared that a series of buy stops were set off which then allowed price to run into the next resistance zone centered around the $1365 level.

What I find so noteworthy about today’s performance in gold is that it also mirrored what was taking place to a greater extent across the entire commodity complex. If anything, gold took on a leadership role along with silver. You might recall that in the past, these rate hikes by China have brought in extremely heavy selling in commodities as the prevailing sentiment at those times has been that any attempt by China to rein in its inflation stallion was going to result in a slowdown in what has been the main driver of the global economic engine. That would lead to a global slowdown which would pressure commodity prices.

Copper, in particular, would get hit hard during such episodes due mainly to its historic role as a leader in the overall commodity sector. Today, copper did what it has done in the past – it moved sharply lower but then it too rebounded and while it did not make it back into positive territory, it came back well off of its lows working back to nearly unchanged at one point.

The same pattern was seen in the grains and in the meats, which were also lower overnight as the news came down the wires but those too came back off their worst levels thanks also to some help from wheat (more about that later).

Why I want to bring this to your attention is that we might indeed be seeing another one of those frequent shifts in trader/investment psychology which makes markets so interesting and fresh. To see market action like this tells me that an inflation psychology is beginning to become more entrenched in the minds of global investors who are slowly coming to realize that the Central Banks are well behind the inflation curve. I think it is also safe to say, based on the price action across these various markets, that the deflation bogeyman is losing his allies.

Perhaps this is what has been foretold in the bond market’s breakdown of last Friday. Were it not for the continued meddling by the US monetary authorities in that bond market ( they euphemistically term it “Quantitative Easing ), I suspect that the bonds would have been sharply lower today as well. Inflation is raging across Asia and in many places in Latin America and it is just a matter of time before even the worst skeptic is going to be forced into acknowledging the obvious – that it is coming to a movie theater near you. Certainly a plunging US Dollar is not synonymous with deflationary pressures!

Which brings me to the US Dollar – in yet a further development certain to rekindle investor suspicions concerning the “health” of this economic recovery, news came out of Denmark, that Amagerbanken,  the nation’s eighth largest bank in terms of lending, was toppled due to a series of failed real estate related loans. The Danish government is now on the hook for $2.8 billion worth of losses.

 News like this tends to remind those who are looking through rose-colored glasses, that beneath the apparent tranquil surface there still lurks issues that have been essentially plastered over with money printing. This sort of thing is what brings buying into gold across a wide assortment of various currencies as investors become fearful of the erosion of the value of their currencies. It did not help the Dollar any for the current Chairman of the Federal Reserve to be out leading the cheerleading squad to warn the Republicans that they had better not mess with NOT RAISING the debt ceiling from its current cap of $14.3 TRILLION.

I can see it now – Ben is dressed in a cheerleader’s costume with pom-poms:

2 bits,

4 bits,

6 bits a dollar,

all for raising the debt ceiling,

stand up and HOLLER…..

yea…….

I find Ben’s comments particular obscene seeing that the mass of the nation is seriously worried about the US debt level. The recent election blowout was due in large part of concerns over the economy and rising levels of national indebtedness and here we are treated to the pathetic spectacle of what should be a beacon of frugality and responsibility thinking he is leading the charge in some sort of economic war:

Admiral Ben Farragut:

“Damn the torpedos – full speed ahead”.

To show you that it is not just the dollar that is a concern, the euro fell against gold. Gold, when priced in Euro terms, moved higher coming in at €999.707 at the PM Fix but actually trading above the €1,000 mark at one point during the session.

The technical posture of gold just got a tremendous boost with today’s good showing. Both the 10 day and the 20 day moving averages have now turned higher and momentum has now broken the downtrend line that has been in place for the last two months. What is now needed to put some icing on the cake is for momentum to move into positive territory. This will further encourage traders to Buy dips rather than Sell rallies.

Open interest stabilizing down near 466,000 seems to have done the trick for gold as the failure of the longs to liquidate in any further size has short circuited the bears’ attempts to break it down below $1320. All of those shorts slammed on below $1320 in anticipation of another move lower were snared by Chinese buying and are now taking their medicine as those positions are all deeply underwater. Only the strong handed shorts can handle that sort of loss.

A quick comment about silver – those of you who have been tuning in to my weekly radio interviews with Eric King over at King World News have heard us discuss its technical price chart. I am still watching for a strong close above the $30 level for a sign that this market is ready to kick up another leg higher. One can see the action of the Bears attempting to hold it down below this level by watching the 3 minute bar chart, as they realize what such a close would mean to their positions. Going into the close, it is apparent that they failed. If silver can stay above $30 the rest of the day, odds now favor a test of the recent high in short order. Keep in mind, as we discussed on our recent radio interview, the COT report shows that last week the hedge funds (managed money) finally began increasing their net long exposure after having whittled that down for the last couple of months. They are now returning to this market and doing so from a sharply reduced long side exposure. There is plenty of room available for them to begin piling back in and that is what leads me to believe that the recent high is going to fall. Also, a lot of guys sitting on the sideline waiting for silver prices to move lower so that they could buy are now realizing that they had better get in. That is what buying does – it begets more buying.

On the food front, wheat, notched yet another 30 month high as it moves ever closer to the $9.00 mark. It seems like just yesterday when we were talking about watching for wheat to make a run towards the $8.00 level! The impetus for its move higher today was news out of China (not about rate hikes) that severe drought could be affected as much as 37% of its entire wheat crop. Great goggly moogly – the news on the food front just keeps getting worse with each passing week it seems.

Platinum and palladium were both strong today.

  

Bonds are beginning to give up their artificial gains as I finish this commentary up. We will see how they fare going into the close this afternoon.

China hikes Rates - Leaves savers at the mercy of inflation

Big news overnight is the hike in interest rates by the People's Bank of China.

If you want to know the reason behind the phenomenal Chinese gold demand, look no further than this:

Here is the full story from Bloomberg's web site:

http://www.bloomberg.com/news/2011-02-08/-heavy-lifting-to-come-as-china-leaves-deposit-rate-below-inflation-pace.html

Note in particular that they raised one year lending rates to 6.06% while hiking deposit rates to 3%. The official rate of inflation is calculated to be somewhere just below 5%. In other words, savers are losing money when measured in real terms.

Gold ALWAYS thrives in negative real term interest rate environments. Why is that? Because savers come to understand that in order to keep up with the rate of inflation, they require an investment vehicle that is moving higher at least at the same rate as inflation. That is where gold's historic role as an inflation hedge comes into play.

One of the problems that seems to afflict many gold "pundits" located here in the West is that they continue to view gold through the prism of the Western economies. Maybe in times past this was understandable but with the emergence of China and other rising economic powerhouses, such a narrow US-centric or Western-centric view is outdated and yields faulty conclusions as to the yellow metal's fortunes.

As long as inflation is a major concern in the East, gold is going to continue to attract buying from that corner of the globe.

Concerning China and the Gold ETF

Eric King's sources are generally reliable and it would make sense for a buyer of large size to attempt to source their gold from one place. It all comes down to availability. 

One thing about the report however is that it serves to reinforce the idea that Chinese demand for the metal is very strong. Keep in mind that China is a huge producer of gold and yet at that, apparently that supply is insufficient to keep up with their own internal demand. That speaks volumes.

I have long advocated that the way to end the gold price suppression scheme would be for the longs to stand and take delivery at the Comex and force these sellers of paper gold to come up with the actual metal. One of the problems going this route is that there are delivery month position limits at the Comex which work to prevent a large buyer from coming there and using a large number of futures contracts to secure the metal. By large I mean someone who might be buying in the size that China has been buying in the recent past.

It could be done but the potential buyer would have to repeat the process every month, month after month, using the maximum number of contracts going into the delivery period and just moving from month to month. Obviously for some entity to secure a large amount of gold at one shot it would make things very difficult if not impossible. (See how the exchanges work to protect the shorts).

If the story is true, there are no such restrictions that I am aware of on getting gold out of the ETF although I admit I have not read through its prospetus in some time.

This is also the reason that buyers of gold in large size love to see officially sanctioned sales of gold by Central Banks or by the IMF. It provides them the opportunity to acquire large amounts of the metal at one price and at one time and very quietly I might add so as not to alert the broader market as to what they are up to until after the fact.

The Chinese undoubtedly are well aware of the games begin played in the gold market by the western monetary authorities and quite frankly it is in their interests to let them keep right on sitting on the price until they (the Chinese) can acquire all the gold they wish at a discounted price.

They can read the tea leaves and see the importance of having sufficient gold reserves as the global economy begins to look at serious alternatives to the current system based on the US Dollar as the sole reserve currency. The old adage: "He who owns the gold makes the rules" is certainly appropos.

Back to business as usual in the Bond market

Once again the bond market "miraculously" was resuscitated after breaking down technically in Friday's session. It is evident that the monetary authorities are extremely concerned about its picture on the technical price charts and are fearful of the move lower attracting momentum based selling from the speculative community. That is at complete odds with their plans to bring down rates on the longer end of the yield curve. So out come the usual culprits to bid them back up even as the equity markets continue their rocket ride higher.

In spite of the move higher today, which as you can see on the accompanying price chart has been on mediocre volume indicating the lack of conviction and skepticism among partcipants, traders are going to be looking to sell rallies in this market unless price moves back to well within the previous 7 week long trading pattern. Even at that, they will then look to sell up towards the previous ceiling near the 122 level.

The bond market appears to be living on borrowed time with the only buyer of any size being the Fed through its primary dealers. There is a tremendous amount of supply coming to the market this week and it will be interesting to watch the Fed's balance sheet continue to grow as they are forced to step up to fill any lackluster demand.

That being said, the key to watch this week will be Wednesday's auction of 10 years where the Treasury will be peddling $24 billion. The next day, Thursday, $16 billion in 30 years go up for sale.

Daily Gold Price Action Chart

Trader Dan on CBS Marketwatch

DJ MARKETWATCH VIEW: Gold Watchers See Positive Signs On Outlook

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Mon Feb 07 08:28:52 2011 EST

   By Peter Brimelow
   A DOW JONES COLUMN


  Has gold turned the corner? Gold watchers see several positive signs.

  Gold had its first up week of the year, but Friday was a disappointing day. A
spectacular rise on Thursday, $20.90 in the CME April contract, broke the
downtrend that set in at the end of last year. But a further rally attempt
fizzled and April gold closed down $4, on low volume. Both gold and gold shares
(as represented by the Arca Gold Bugs Index) seem to have broken their New Year
downtrends--but strong confirmation was tantalizingly lacking.

  However, another part of Friday's market activity greatly excited two very
experienced gold followers: the Treasury sell-off.

  At JSMineSet, Dan Norcini stressed on Friday evening:

  "The big development in today's market session was the breakdown in the long
bond ... bonds have been carving out a five-week old sideways trading pattern
... the longer a market runs in a sideways pattern, the more significant the
breakout tends to be when once it occurs ... In the case of the bonds, the
breakdown was to the downside. I should also note that volume on the sharp move
lower was very heavy, always a good sign that the move is legitimate."

  Australia's The Privateer was even more direct on Saturday in a commentary
cheerfully entitled, "Look At Those Treasuries Go!"

  "Regardless of anything else going on around them, the yield on Treasury
paper is inexorably rising and the pace of that rise is accelerating ... As The
Privateer has pointed out MANY times, the REALLY BIG bull markets in precious
metals come when the yield on their 'substitute' as money--government
bonds--show rising yields and falling prices. The rising yields show an
increasing unwillingness to hold them."

  Despite Friday's misfire, the week saw other concrete positive news for gold.
It started with the influential Gartman Letter increasing its model portfolio
gold holdings on Monday. It continued with several reports of buying of
physical gold from India, both on Le Metropole Cafe, which always stresses the
premiums over world gold in the country it likes to call the world's largest
gold importer, and from Edel Tully, the gold analyst at UBS, a major bullion
dealer.

  On Wednesday, UBS published a valuable chart of an index of the bank's gold
shipments to India, clearly showing a recent surge, and offered the remarkable
comment:

  "We struggle to recall a month when our total physical sales have been
stronger."

  In fact, the reason for this is not so much India as China, as UBS makes
clear. In early December, the chairman of the Shanghai Gold Exchange revealed
that gold imports into China had quintupled in 2010, being already 209 metric
tons by the end of October, a very serious number in the context of gold.

  On Wednesday, the Financial Times published a story quoting bullion dealers
saying China imported another 200 tons in the following three months. Many
observers are amazed.

  China is currently celebrating the Lunar New Year, which lasts until
Wednesday. It is possible that this buying, while unprecedented, is highly
geared to this important holiday. But UBS reports that Chinese importers have
been seeking shipments for after the holiday.

  So it appears from a macro and a very gritty physical trade level, the
outlook for gold looks great. But will the price notice?


  (Peter Brimelow is author of "The Wall Street Gurus: How You Can Profit From
Investment Newsletters." He writes for MarketWatch. He can be reached at
415-439-6400 or by email at AskNewswires@dowjones.com.)


  (END) Dow Jones Newswires

  02-07-11 0828ET

  Copyright (c) 2011 Dow Jones & Company, Inc.

JP Morgan confirms the obvious - Gold is real money

DJ JP Morgan: First Tri-Party Agent To Accept Gold As Collateral

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Mon Feb 07 10:00:47 2011 EST

  LONDON (Dow Jones)--JP Morgan Monday said it has become the only tri-party
agent to accept physical gold as collateral against securities lending and repo
obligations with counterparties.

  The company said in a statement that it expects to accept additional precious
metals and commodities as collateral later in the year.

  "The ability to finance and leverage the broadest range of asset classes is
important to our clients. Many clients are holding gold on their balance sheets
as an inflation hedge and are looking to make these assets work for them as
collateral," said John Rivett, collateral management executive at J.P. Morgan
Worldwide Securities Services.


  -By Rhiannon Hoyle, Dow Jones Newswires; +44 (0)20 7842 9405;
rhiannon.hoyle@dowjones.com


  (END) Dow Jones Newswires

  02-07-11 1000ET

  Copyright (c) 2011 Dow Jones & Company, Inc.