Tuesday, October 18, 2016

Incentivizing Supply

"The almanac says it's time to start plantin'."
--Myra Fleener (Hoosiers)

A few years back I was bullish on commodities, including the 'ags'-- i.e., agricultural commodities such as corn, wheat, beef, etc.). The basic thesis was this. Developing countries are going to need much more food as they continue to grow and there is not enough supply to feed the world's growing appetite.

While ag prices certainly had their time in the sun, the last couple of years have brought steadily declining prices. Steady price declines have certainly not been limited to agricultural commodities. See, for example, crude oil.

My mistake was ignoring one of the most fundamental theorems of economics: higher prices incentivize supply. In this article, the axiom is stated in dairy industry terms as "money makes milk."

As commodity prices lifted a few years back, unused capacity that was not economical at lower prices was brought out of dormancy. Moreover, new capacity projects become easier to justify and fund. Substitutes are also sought as buyers, for example, substitute higher priced steak with lower priced ground beef.

The kicker has been uber cheap rates which further motivate borrowing to build more potential supply.

It is possible that the other part of the bullish commodity thesis, high rate of money printing, will at some point overpower natural economic forces and jam prices of everything higher regardless of supply conditions.

Should that occur, however, ags would not be the best place to be. Gold and silver, given their innate characteristics, have proven to be the best plays on monetary debasement throughout history.

positions in gold and silver

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