Tuesday, April 19, 2005

the goldman sachs commodities index

I am still long one goldman sachs commodities index contract. I have lost a bunch of money, but I like this investment, and it turned around today, which shrunk my loss a lot. It had been going down last week, but today it went back up substantially. The index consists of 24 commodities, weighted by annual volume traded. This index is 70% energy, with the remaining sectors being grains, livestock, and industrial metals, and precious metals. The way that futures accounts are set up, they make it easy to get into a contract on very low margin requirements, but the account is highly levereaged, and very volitile. I made an error, in buying into this when energy was near a peak. But in the long term, say the next two decades, I think all of these commodities will rise in price, some of them a lot. I like the fact that the index is 70% energy, because energy is the most fundamental commodity class, and will be subject to increasing shortages going forward. So that is why I want to be long on Goldman Sachs contract all the time.

While I’m on the subject of commodity inflation, I’ll just point out the very high energy input of industrial agriculture. The high yields which give us cheap corn and soy are the result of intensive fertilization. Our grain comes from intensive fertilization with nitrogen, which comes from ammonia based fertilizer, which is made from natural gas. If natural gas increases in price, this will result in increases in the cost of food production.

At some point, I predict, grains will rise in price, and then livestock will rise faster, because of the large amount of grain it takes to produce meat. Grains periodically have surpluses due to good crop yields, which has caused the price to fall, but now these surpluses can be converted to fuel (gasahol and bio-diesel) profitably. Thus grains now have a natural floor price, and won’t be able to drop. Because everyone needs grains, grains will become a larger percentage of the index, and food will become more expensive. But because meat is (at least in historical terms) a luxury item, people will consume less, and then producers will raise less livestock, and this sector will shrink. This is as it should be: meat is far too cheap in the USA.

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