Empty Stomachs

This note was originally published at 8am on February 07, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“An empty stomach is not a good political adviser.”

-Albert Einstein

 

Economic groupthink is dangerous - particularly when its policies perpetuate social stratification. With Global Food Inflation hitting its highest price ever this past week, The People are paying attention. Real-time prices are hard to hide.

 

The stark contrast between Washington Groupthink and what the rest of the world thinks about the highest food prices ever (yes, ever is a long time) is easily captured by comparing what the United Nations and the Fed had to say about it last week:

  1. United Nations – The Food and Agriculture division of the UN published its Food Price Index on Thursday at an all-time high reading of 231. To put that number in context, it was up +3.4% for the month of January alone and up, sequentially, for the 7th consecutive month. According the Wall Street Journal’s Sameer Mohindru, “the UN’s Secretary of FAO's Intergovernmental Group on Food-grains, said political turmoil in some countries, the weakening dollar” … and “adverse weather conditions...” were to blame.
  2. Federal Reserve – Chairman Ben Bernanke told the National Press Club luncheon in Washington, DC on Thursday that there is no inflation in America and added that food inflation trends have nothing to do with US monetary policy. According to him, food inflation is all about “supply and demand.”

Nope – no mention of “the weakening dollar” or the fiscal and monetary policies in America that affect it - not from The Ber-nank at least...

 

To the high-society intellectual or ordinary person gifted with common sense, this probably stands out as somewhat odd. To the person with an Empty Stomach, this has to be downright depressing.

 

So how can the Chairman of the US Federal Reserve say this with a straight face?

 

The Fed has obviously been completely politicized. Fully loaded with that politicization comes the consummate lack of accountability that’s unique to a professional politician in the modern American Empire. But, this is the kind of thing that makes people really lose whatever trust they had left in government.

 

Before I go through what happened to the rest of the world’s market prices last week, let’s take a step back and think about the simplicity of a market’s pricing structure:

  1. Supply
  2. Demand
  3. Price

Sure, we agree with Bernanke on supply and demand, but what about price? Without a market price (and the currency that it’s denominated in), you obviously don’t have a market. As Barry Eichengreen writes in the introduction to his outstanding new book on the US Dollar, Exorbitant Privilege: ”The principal commodities exchanges quote prices in dollars. Oil is priced in dollars. The dollar is used in 85% of all foreign exchange transactions worldwide.”

 

Therefore, when you debauch the value of the world’s reserve currency, you are going to perpetuate world inflation.

 

If you want to take The Ber-nank’s side on this, you’ll have to ignore the math. As of this morning’s prices, here are the immediate-term TRADE correlations between the US Dollar Index and food prices:

  1. Wheat = -0.91
  2. Rice = -0.90
  3. Sugar = -0.85

*Note: these are extremely high correlations.

 

There are a lot of ways to prove out how US Dollar sponsored inflation is hurting bond and emerging markets worldwide too. At week’s end, here were the world’s worst performing stock markets for 2011 to-date:

  1. Egypt = -20.9%
  2. India = =12.2%
  3. Tunisia = -10.4%
  4. Philippines = -7.8%
  5. Chile = -6.4%
  6. Brazil = -5.8%

Sure, a Bernanke Bull might quickly point out that 2 of the worst 3 markets have had revolutionary social unrest – that’s the point. Is that what we need to see for governments to pay attention to people who are unemployed with an Empty Stomach?

 

Some people in the US are trying to say that the US Bond market is getting hammered to new intermediate-term lows because US growth “is back.” Both the Q4 US GDP and January US Employment reports missing consensus estimates notwithstanding, some of it is growth – but some of it is inflation too.

 

On Friday, we took fresh new lows in US Treasuries as an opportunity to cover short positions in short-term bonds (SHY) and get invested where investors fear having to compete with rising bond yields – we bought a US Treasury Curve Flattener (FLAT) and Utility stocks (XLU). Both were down on the day.

 

On a week-over-week basis I drew down our Cash position from 67% to 52%. Here’s the updated Hedgeye Asset Allocation Model:

  1. Cash = 52%
  2. International FX = 18% (long Chinese Yuan, CYB)
  3. Fixed Income = 12% (long Inflation Protection and a UST Flattener - TIP and FLAT)
  4. US Equities = 9% (long Healthcare and Utilities - XLV and XLU)
  5. Commodities = 6% (long Oil and Sugar – OIL and SGG)
  6. International Equities = 3% (long Sweden – EWD)

I’m still trying my best to buy things when they are on sale. Having covered my short position in the SP500 on Friday, January 28th at 1276, I’ve moved the Hedgeye Portfolio to 12 LONGS and 10 SHORTS (see all positions below). For the last week, I’ve definitely been getting longer – but that doesn’t mean I think this will end well - nor do I think it will make the 44 MILLION Americans on food stamps have less to worry about in terms of their Empty Stomachs.

 

My immediate term support and resistance levels for the SP500 are now 1297 and 1319, respectively.

 

Best of luck out there today

KM

 

Keith R. McCullough
Chief Executive Officer

 

Empty Stomachs - vr1

 


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