“Anyone in the commodities world is experiencing a perfect storm as correlations suddenly shot to 1, which is never a good thing,” Zoltan Pozsar wrote, in yet another ambitious missive, the latest in a string of provocative notes.
Commodities are experiencing a historic rally that’s manifesting in wholly anomalous moves in everything from wheat to natural gas to nickel. Last week, wheat prices surged more than 40%, raising the specter of societal upheaval in food insecure locales. On Monday, European gas prices staged a terrifying 80% rally, underscoring the cost of procrastination vis-à-vis reducing dependence on Russian energy. Then, on Tuesday, the LME was forced to suspend the nickel market amid a 250% two-day squeeze.
It’s chaos, for lack of a better word. And that chaos is driving a bid for cash, Pozsar said. There are three issues. First, non-Russian commodities now command a premium to Putin’s contraband, and that’s set against a backdrop of ever higher prices. So, leveraged commodities traders have to borrow more from banks to facilitate the commodities trade. Second, Zoltan noted that if “you’re long non-Russian commodities and short the related futures, you’re likely having margin calls that need to be funded.” For evidence of that, look no further than the linked articles (above) or the endless deluge of Bloomberg headlines documenting a dizzying spiral across seemingly every raw materials-related futures contract on Earth. Third, anyone short Russian commodities and long the related futures is probably getting margin calls too, and those likewise need to be funded.
Just yesterday I was having a discussion with someone outside of finance who was shocked at the extent to which the commodities market poses an existential threat not due to the fact that human beings need to eat, travel and keep warm (there’s that too, but that part’s self-evident), but rather due to the potentially disastrous domino effect of margin calls and, dare I suggest, defaults and exchange blowups.
In his latest, Pozsar underscored the point. “The commodities market is much more financialized and leveraged today than it was during the 1973 OPEC supply crisis, and today’s Russian supply crisis is much bigger, much more broad-based, and much more correlated,” he said. “It’s scarier.” He proceeded to pose a series of questions, as he’s wont to do:
The aggressor in the geopolitical arena is being punished by sanctions, and sanctions-driven commodity price moves threaten financial stability in the West. Is there enough collateral for margin? Is there enough credit for margin? What happens to commodities futures exchanges if players fail? Are CCPs bulletproof?
There are no answers to those questions. We don’t know. And that’s the problem.
Pozsar then outlined what he called “the birth of Bretton Woods III, a new world (monetary) order centered around commodity-based currencies in the East that will likely weaken the Eurodollar system and also contribute to inflationary forces in the West.”
He returned to a familiar set of talking points and analogues established across his last several notes. Commodities are now fragmented or, more aptly, bifurcated. There’s Russian commodities and then there’s everything else. The former are now like subprime mortgage products and the latter like AAA collateral. Pozsar wrote that,
Commodities used to trade at tight spreads until now. There was one global market across all commodities that the large commodities traders arbitraged, much like a bond RV hedge funds arbitrage the cash-futures basis. Mortgages were like that too before 2008 — public or private, prime or subprime, they all traded at par, until they didn’t. Commodities no longer trade at par. There are Russian commodities that are collapsing in price and there are non-Russian commodities that are rallying — this rally is due to the 2022 Russia supply shock that we referred to above, which, once again, is driven by present and future sanctions-related stigma. Russian commodities today are like subprime CDOs were in 2008. Conversely, non-Russian commodities are like US Treasury securities were back in 2008. One collapsing in price, and the other one surging in price, with margin calls on both regardless of which side you are on. The “commodities basis” is soaring!
Ultimately, there has to be a backstop in a crisis. In 1997 it was the IMF. In 2008 and 2020, it was the Fed. In 2022, a year Pozsar suggested will be remembered for a “crisis of commodities,” it may be the PBoC.
I’ve repeatedly emphasized over the past several days that the West (and its allies, which is pretty much everyone sans Beijing, Tehran, Kim’s hermit kingdom and Maduro’s “paradise”) can’t and, more importantly, won’t, close spreads in commodities because the whole point is to isolate Russia and turn what it sells into contraband. Of course, a formal ban on Russian energy isn’t ideal because Europe might freeze to death (something Alexander Novak was keen to point out on Monday), but an explicit embargo is to some extent superfluous because traders have effectively imposed their own sanctions on Russia’s raw materials, hence the now widely-publicized “buyers’ strike” and accompanying basis blowout.
As Pozsar put it, “Western central banks cannot close the gaping ‘commodities basis’ because their respective sovereigns are the ones driving the sanctions.” Obviously, traders can’t help either because every reserve currency-issuing country is participating in the measures which have now made Putin’s Russia the most sanctioned nation on the planet.
Enter the PBoC. “It banks for a sovereign who can dance to its own tune [and] to make things more complicated, China is probably thinking deep and hard about the value of the inside money claims in its FX reserves, now that the G7 seized Russia’s,” Pozsar went on to say, before detailing what he said are Beijing’s two options. To wit, from Zoltan:
Sell Treasurys to fund the leasing and filling of vessels to clean up subprime Russian commodities. That would hurt long-term Treasury yields and stabilize the commodities basis and would give the PBoC control over inflation in China, while the West would suffer commodity shortages, a recession and higher yields.
The PBoC’s second option is to do its own version of QE — printing renminbi to buy Russian commodities. If so, that’s the birth of the Eurorenminbi market and China’s first real step to break the hegemony of the Eurodollar market. That is also inflationary for the West and means less demand for long-term Treasurys.
From there (and I’ll be generous), Pozsar ventured into speculative waters — figuratively, but also literally.
His idea is to go long freight rates on the notion that “renting boats is like renting balance sheet at a dealer to fund inventory.” Beijing, he said, might print yuan in order to effectively monopolize… well, boats, on which China could store massive amounts of Russian commodities in the event Xi runs out of storage space on the Mainland.
Zoltan closed with a flourish. And I do mean a flourish. It’s simply impossible to paraphrase his conclusions without losing something in translation, so here they are, as written:
Do you see what I see? Do you see inflation in the West written all over this like I do? This crisis is not like anything we have seen since President Nixon took the US dollar off gold in 1971 — the end of the era of commodity-based money. When this crisis (and war) is over, the US dollar should be much weaker and, on the flipside, the renminbi much stronger, backed by a basket of commodities. From the Bretton Woods era backed by gold bullion, to Bretton Woods II backed by inside money (Treasurys with un-hedgeable confiscation risks), to Bretton Woods III backed by outside money (gold bullion and other commodities). After this war is over, “money” will never be the same again. And Bitcoin (if it still exists then) will probably benefit from all this.