[DEBATE] : The Real Reason Commodities Are Tumbling

[Riaz K Tayob]

The Real Reason Commodities Are Tumbling

By John Heinzl
The Globe and Mail, Toronto
Wednesday, September 10, 2008

http://www.reportonbusiness.com/servlet/story/RTGAM.20080909.wheinzl0910...

To hear Donald Coxe tell it, the commodity selloff ripping through 
Canada's stock market is no accident. It is the result of a deliberate, 
brilliantly executed plan hatched at the highest levels of the U.S. 
Federal Reserve and Treasury.

Mr. Coxe is no paranoid conspiracy theorist. As the chairman and chief 
strategist of Harris Investment Management in Chicago, he is one of the 
most respected investment authorities in North America. He also happens 
to have lost about 10 per cent of his personal wealth in the commodity 
rout, which came at the worst possible time for his Coxe Commodity 
Strategy Fund, which started trading in June.

"This has done more damage to my personal wealth than anything in the 
last 20 years," he said in an interview yesterday. But he has too much 
respect for how the U.S. authorities engineered the collapse in 
commodities -- a move he said was necessary to shore up the global 
financial system -- to be bitter.

"My attitude is, 'Goddamn it, they're good -- it was brilliant.'"

To understand why commodities are plunging now -- the S&P/TSX plummeted 
another 488 points yesterday -- you have to go back to mid-July, when 
the U.S. Federal Reserve and Treasury announced steps to support 
mortgage giants Fannie Mae and Freddie Mac.

The move, which led to the Treasury taking control of Fannie and Freddie 
this week, touched off a chain-reaction of market events that culminated 
with the wrenching decline in commodities.

According to Mr. Coxe, the Fed's goal was to trigger a rally in 
financial stocks, which would, in theory, help banks hammered by the 
credit crisis raise fresh capital and repair their balance sheets. To 
accomplish this, the decision to support Fannie and Freddie was 
deliberately announced on a Sunday, which had the effect of maximizing 
the reaction from thinly traded financial stocks on overseas markets.

Because many hedge funds were using massive leverage to short financials 
and go long on commodities, when North American markets opened and banks 
initially rallied, the funds were forced to cover their short positions.

At the same time, the U.S. dollar was rallying because the risk of 
holding Fannie and Freddie paper had diminished. The rising dollar, in 
turn, made commodities less attractive, giving funds that were already 
scrambling to cover their financial shorts another reason to dump oil, 
grains, and other commodities.

The losses were swift and dramatic. On the Friday before the July 11 
announcement, crude oil closed at $145.18 a barrel. Over the following 
five days, it plunged 11 per cent. "Leverage was being unwound 
dramatically," Mr. Coxe said on a conference call last week. "We had a 
true panic."

As oil and other commodities were tumbling, fears about the slowing 
global economy were mounting, giving resources another push downhill. 
This was also in keeping with the Fed's wishes, because lower commodity 
prices would help quell fears about inflation.

Mr. Coxe has no proof that the Fed and Treasury acted in concert to 
boost financials and sink commodities. He is basing his assertions on 
conversations with hedge fund managers and on years of watching 
financial markets. "There's no doubt whatever in my mind" about what 
happened, he says.

The future is less certain, however. Now that Freddie and Fannie have 
been nationalized, the credit crisis is still very much alive and 
financial stocks are looking as shaky as ever. As for commodities, once 
the current storm passes, Mr. Coxe is confident they will recover.