"I'm going to call my brother..."

Snowstorms, Heat Waves, Bubbles and Crashes    It takes some effort to recall that just 5 and a half months ago the Chicago area was buried by a huge snowstorms so severe it closed Lake Shore Drive. Our current heat wave looks to last all this week and most of next. It's time to retreat from the heat, stay hydrated and wait for cooler times to work on the outdoor projects.

Since the financial “storm" that froze our financial system it's now been a little over three years. Domestic equity indexes have doubled in valuation. Commodities have increased much more. Gold, silver, copper, cotton, the grain complex - nearly all are 2, 3 or more times their price of just a few years ago. We have a commodity asset bubble, and it’s huge. The price patterns and volatility illustrate an overheated situation, and these never end well.

Our political officials and advisers are so busy defending their actions and protecting their turf they are failing to see the cliff at the horizon that we are approaching with increasing speed. The Federal Reserve, with help from the European and Chinese central banks have flooded the world with paper money and artificially low interest rates. The fuel to overheat commodity prices is already in the system. What's going to happen is kind of like this story about the apprentice yardmaster.

Once upon a time an apprentice was taking his final exam to become the yardmaster for a major railroad. The examiner described the final scenario: two trains were entering the rail yard from opposite directions at a high rate of speed. What do you do?

"I'd throw the switches in the control station and route them to two side tracks."

"Good answer" said the examiner. "But what would you do if the switches were stuck?"

"I grab the red flags, run down to the tracks and try to wave off the trains."

"That's the right thing to do, but what if they don't see you?"

"Then I'd call my brother" said the apprentice.

"Call your brother? What could he do?" asked the examiner.

"Nothing, but he loves to watch train wrecks!"

It's a lot safer to watch a train wreck from the sidelines than to be in one.  Commodity prices as an asset class are going to correct-and sooner rather than later. Bubbles never end well. Here are some steps to take between now and mid-September.

Don't be greedy-if you own commodities now, scale out of your positions. If you must stay in, liquidate 80 percent of your position, and get back and after the prices break down, and at least 30 days after you close on your positions. But remember Jesse Livermore was right about the market going down but got back in too early and lost a fortune.

Stay liquid-don't take new positions. Put your money in short-term money market instruments that are safe and insured if possible.

Price inflation bad, price deflation good.  For those that guard their capital, the reduction of commodity prices will produce investment opportunities for the prudent. Exercise patience and you will find the right investment for you.

Stay away from long term bonds. As long as real interest rates are below the rate of inflation bonds yield a negative return.

August, September and October look to be a time when most commodity assets will be drastically repriced- be careful when you hear people saying this time it's different-it never is. If I'm wrong you will have sacrificed a percent or two in exchange for the peace of mind that comes from protecting yourself from the price contraction of a burst asset bubble. You will be able to re-establish long-term investment positions with a better identified base. If I'm right you're looking good!


Until next time

The Instigator