Wilkinson's Edge
The Cutting Edge of Financial Analysis

Saturday, March 25, 2006
Bring out yer dead?

Dear MoneyNews Reader,

When people detect my British accent, they invariably tell me about family they have back home "somewhere" in England. And if it's not that connection, they tell me just how hilarious Monty Python's sketches are.

Recently, I had a chance to revisit one of Python's all-time best films, "The Life of Brian," in which the main character is mistaken for Jesus in biblical times.

Funnily enough, I did an interview on a radio show this week only to have Mrs. Edge call to let me know that the program opened with the theme tune from that very movie (Always Look on the Bright Side of Life).

My favorite part of the film replicates the scene from the Bible in which Jesus addresses the crowd with his "Blessed are the peacemakers" speech.

Of course standing at the back of a rather large gathering in the desert with Brian and other Jews and gentiles alike, it was hard to hear.

"What did he say?" asked one.

"I think it was: "Blessed are the cheese makers," said another.

"Aha, what's so special about cheese makers?" asked another.

Impatiently a bearded onlooker tried to explain.

"Well, obviously it's not meant to be taken literally. It refers to any manufacturers of dairy products."

This laughable scene essentially reminded me of the Monday evening speech by new Fed Chairman Ben Bernanke. It's not that it was hard to hear what he said - it's just that I'm not really sure what he said!

In his last scheduled speech before he chairs his first meeting with the governors at the Federal Reserve next week, Bernanke told his audience that the low level of long-term rates was not taken to mean that the economy is slowing down.

Bernanke reported on the economy's health and expressed the opinion that homeowners could absorb a slowdown in the housing market.

It took bond investors several hours to interpret his convoluted comments before they slowly but surely began to discount the news into higher yields following last week's bounce from what looked like oversold bond prices.

Mr. Bernanke said that the shape of the yield curve (the relationship between short and long rates) shouldn't be a factor in setting monetary policy. But now I'm left wondering whether he's trying to clear the decks as he takes office.

"Many, many variables go into making the forecast," and the yield curve alone is not "by itself a useful benchmark for policymaking," Bernanke said.

Another way of putting it: Bond traders shouldn't believe their own story.

Yields are determined by buyers and sellers who are fearful of missing the boat. If the majority chooses to believe that recession looms and then makes the decision to buy long-dated bonds, that's their call.

But if those people want to take a cue from their own script and conclude that their own buying - which has forced long yields down - is a precursor of recession, that's their problem!

As the focus turns to households' balance sheets, it's become a little clearer that with the slowdown in the housing market, the Fed will adopt an ambivalent attitude with a reining-in of inflationary pressures on the horizon.

Mr. Bernanke reminded his audience that homeowners had grabbed the shirttails of the housing boom and exchanged higher-rate consumer loans for better-priced home loans.

That means that a rising rate environment won't hurt consumers - or retailers, for that matter - as much as the market worries it will. At least that's the message I think I heard from the chairman.

Mr. Bernanke stated that with inflation expectations firmly anchored, investors are moving to price bonds at levels that were usual four or five decades ago.

Asian banks' accumulation of dollar reserves (which tend to end up purchasing U.S. bonds) was also acting as a weight on long-dated maturities.

And according to the speech, another weight comes from the fact that portfolio managers, in providing pensions for the baby-boomer generation of tomorrow, find themselves compelled to match those liabilities with ultra-long-dated assets.

That pool of assets has been fairly dry over the course of the last few years, and demand keeps yields pinned to the floor.

The real confusion begins from here. The inverted yield curve has perhaps been misread as a sign of ill economic health.

However, according to Mr. Bernanke's new rulebook, the artificial factors suppressing long rates might all along have been stimulating spending and investment.

If that's the case, pass the interest-rate hammer.

It's definitely confusing. But what's quite clear is the fact that since July 2005, sugar has shot up in price from $10 cents per pound to $20 cents
per pound. (see chart)

An office colleague pointed something out to me this week. As we noted the rally in sugar prices again this week, who'd have thought that you'd have to PAY for sugar cubes at a restaurant?

OK, I haven't seen any evidence of this yet, but the likelihood remains that one day you may have to ask for the waiter to bring you the sugar bowl - just as you would ask for an after-dinner cigar.

Readers may remember that I pointed out a specific technical formation on the German government bond recently, auguring new lows. If you do, this week I have the sniff of another good trade for you.

In the chart, can you spy a falling wedge possibly unfolding? Since the Feb. 2 peak in sugar prices, sugar has fallen back by 20% to as low as $16.91 per pound.

If you remember, a wedge formation takes shape in the opposite direction to the prevailing trend. In this case, the 18-month bull market is clearly established.

Add in the fact that we have seen an acceleration of the trend as the run-up to a peak occurred, and you have the perfect set-up for a retrenchment of prices.

To me, that seems to have played out as sugar prices have fallen sharply from the peak only to trend sideways.

Now we are left wondering whether a burst out of the declining wedge-shape formation is starting to play out. Remember that a break out of the wedge tends to confirm the original trend - which, in this case, is up. The target would be a fresh contract high at $20.

The big driver here for sugar prices has been the fact that consumption is increasingly torn between traditional use of sugar as a sweetener and as an ethanol derivative.

Brazil, which incidentally is the world's largest sugar producer, is seeing increased demand for the crop for motor-fuel usage.

As the price of gasoline has risen over the last few years, Brazil has seen an increase in the sales of cars converted to switch between traditional gas and a gas-and-ethanol mix.

Ethanol is a derivative of sugar, and although it is expensive to produce, it does present a viable alternative to gasoline.

Following several years of depressed sugar prices, which have led to underinvestment in the nation's sugar crops, farmers are only now starting to expand land devoted to rising prices.

But of course the situation won't change overnight. It'll take several years to embed supply changes into the global system.

Sugar trades on the New York Board of Trade, where a single futures contract currently trades at $16.85 per pound, giving the owner control over 112,000 pounds of sugar.

If this formation plays out, we're looking at a $3,528 move in sugar to new highs.

[Editor's Note: The bull market in commodities is far from over. Find out what the top-5 locked-in profit trends are. Go here now.]