How do we make money when the empire strikes back?

Politics and financial markets have interacted since the birth of human civilization and this shall continue to manifest itself till the end of times for the very foundation of markets is marred in politics. Both markets and politics share one major thing in common; they are both human endeavors and both have a degree of predictability. There is for example nothing natural about corporate laws which themselves help to define the market. While modern financial practitioners have become fixated by the increasing use of quantitative models of late, a focus on the numbers instead of the political consequences of the numbers has perhaps led to exaggerated market swings over the years. If we consider politics on a global scale, chart or no chart at hand, it becomes obvious that over the next two decades soft commodities are in for a major bull run.

Within the current global balance of power, the sole superpower, the United States has spent the best part of the postcold war world in order to strengthen its dominance and contain emerging threats to the current unipolar world. In order to contain super power candidate number one China, the United States has made sure that countries that surround China become western allies and is gradually also shifting a large part of its naval arsenal towards China’s sphere of influence. It has also made sure that China’s major sources of crude oil are countries that are either American allies or that Chinese ships must pass through sea lanes that it controls. The Unites States understands perfectly well that as long as it controls the seas of the world, the US dollar shall remain the global currency of choice and via this comes great power. The biggest advantage that the Chinese have over the West today is linked to cost. China can today produce almost any manufactured good at a fraction of the cost of other countries and lower labor costs play a key role in that.

The US has had a great year in 2012 when it comes to the geopolitical chess game. The civil war in Syria and its indirect help to the Free Syrian Army via the Saudis and Turks is bearing fruits. Iran’s rise in the Middle East is being contained and as Iraqi politicians increasingly come to realize this, the Islamic Republic’s influence in Iraq shall start to wane as they gradually turn to the Turks for regional support instead. In sum, the US and its allies are strengthening their influence on key oil producing countries in the Middle East and pushing both Russia and China to the sidelines. While China may have strengthened its influence in Africa in the meantime, the US, being late in the Africa game has chosen to make sure that the route from the East coast of Africa to China is filled with US naval bases or those of its allies/partners. Financial markets shall need to take note of such geopolitical realities over the longer term. The US is increasingly able to divert its resources from the war of terror front towards China as it now focuses on containment.

While it is true that the US Empire is today highly indebted with bond yields that have perhaps seen their bottom in recent days, policy makers via the Federal Reserve have made it quite clear that monetary policy shall remain loose for as far as the eye can see and worse, there are good chances that things could get even looser as they find more and more imaginative ways to grow the monetary base. High debt and low growth aside, loose monetary policy is having a perverse impact on the global balance of power over time. Make no mistake about it, considering the average age of farmers globally and strong demand-supply dynamics, soft commodities, cereals in particular are in for a growth spurt. However, it would be naïve to think that loose monetary policy with an aim to prevent deflation in the first place does not have an impact on financial markets and on commodities in particular.

Considering the bleak longer term outlook on many western economies, inflating soft commodity prices is not such a bad thing for those wishing to maintain a unipolar world. While everyone, especially the middle class and the poor get hurt when food prices rise, the Chinese consumer feels the pain even more for his consumption basket has a much larger food component. Higher food prices in China and India have led to rioting and wage increase demand forcing Governments in emerging economies to meet these needs. While it is true that wages naturally increase as economies grow, inflation does tend to accelerate this trend. In other words, the cost advantage of emerging market economies such as China is increasingly being eroded by forces beyond their control and as long as the US Navy can rule the waves, there is nothing much China can do about it beyond empty talk about a global alternative currency to the dollar. Looking at electricity consumption data and export data from both Taiwan and South Korea (major exporters to China), it is quite clear that Chinese growth is slowing, perhaps much more than official figures would suggest. China has a weak consumption base, a weak banking system and a big real estate bubble to contend with. The country constantly struggles to maintain some sort of order in a country where wide disparities between the areas inhabited by the Huns and the much poorer East and South West exist.

Considering the increasingly polarized nature of US politics, monetary policy in the US shall increasingly be relied on not just as a tool to inflate their way to a recovery but indirectly at least to gradually neutralize the competitive edge of its potential competitor. As investors then, chart or no chart, we know that if the world does better, emerging market consumers which account for the bulk of the global population shall be eating more and more cereals and on the downside, loose monetary policy shall ensure that prices move higher anyway over time. No matter what scenario you believe in, soft commodities are about to skyrocket this decade.

DISCLAIMER: This article is provided for discussion purposes and does not constitute, nor should it be construed as, an offer, solicitation, advice or recommendation to buy, sell or hold any securities or to employ any investment strategy discussed herein. Readers should seek professional advice regarding the suitability of any securities or investment strategies referred to herein and should understand that any statements, views, opinions, outlooks or forecasts made herein may not be realised.