Dave Nadig, assistant editor, HardAssetsInvestor.com (Nadig): 
Kevin Kerr is one of the most recognized traders in US commodities. He is the Editor of the Global Commodities Alert, available at www.kerralert.com, and he is a frequent television commentator on commodities trading. Kevin’s going to join us each week to take a quick survey of the commodity investing landscape from a trader’s perspective.
Welcome, Kevin.

Kevin Kerr, KerrAlert.com (Kerr): Well, good to be here, thank you.

Nadig: So Kevin, I have to tell you: I was reading the papers and checking my wire, and what the heck is going on with copper? As far as I can figure out, this is about the most dismal time to be in base metals in recent memory.

Kerr: Yeah, we’ve really seen a big pullback in all the base metals. All the things that have surged over the last few years have really pulled back with this global slowdown, and I think it’s unprecedented in this pullback. So we have to really take a deep breath and try to figure out where we go from here.

Nadig: But how real is it? Certainly we’ve seen a lot of headlines and a lot of analysts talking about the end market demand just going away, like China never happened and nobody is ever going to build a house again or put in any plumbing. How real is the demand and how much of this is really just market panic?

Kerr: No, I totally disagree with that analogy. I think that the demand is still there. What we’re seeing is a liquidation of a lot of the assets of these funds that have climbed into commodities. They’ve quickly had to withdraw their cash and will probably come back just as quickly. So I really wouldn’t get too bearish on a lot of the fundamental commodities.

Oil, the base metals, the grains … a lot of these commodities we will probably see recover fairly quickly. I really just don’t buy into the whole idea that this was a bubble; that this is the end. I think it’s actually just a fraction that was probably overdue and there’s actually some good buying opportunities now.

Nadig: So if this is funds [causing the downturn], I assume you’re really talking about hedge fund players more than anything here, right?

Kerr: We are, yeah, of course. A lot of these funds have been pressured to take their cash off the table, rein in the spending, and kind of reassess. When they reassess I think they will see that the value of a lot of the commodities that they bought is still there and probably even cheaper now. So we probably will see that money come back in within the next six to twelve months, no doubt about that.

Nadig: So let’s spin a tale. I’m a hedge fund manager, I’ve been playing copper really heavily. Maybe I rode it up perfectly until the peaks earlier this year, and now I’m capitulating and I’m pushing these assets back out into the market. Would we expect to see that really show up in things like the LME [London Metals Exchange] stocks levels, or is this just going to be the kind of thing that we see mostly in the futures markets?

Kerr: I think in the physical market you won’t see it as much. I think you will definitely see it in the futures markets. You’re seeing the pressure already across the board in aluminum and copper and everything, and you will continue to see that until those margins are covered. The bottom line is a lot of these buyers will come back in when those base metals bottom out. I think we’re getting close to that. I think it may have further to go. The fear of an industrial slowdown is affecting everything from silver to copper and everything in between. But at some point you will see value buying come back in. Like I say, it’s about probably six months out.

Nadig: You opened the door here; you mentioned silver. So if we move away from some of these base metals towards gold, in this kind of panic, should we expect gold to just keep piling on or do you see that as being played out too?

Kerr: Yeah, I do actually. Gold is really having a strong time right now. It’s been very volatile. Basically gold is now an inflation play, and silver has become an industrial play. We have to be really careful as investors to get too overanxious about gold. Longer term I think gold will do just fine, but I think as the dollar strengthens we’ll see gold weaken for probably the next couple years, and so this is not an area I would be involved in. I would see silver or the base metals probably recovering faster than gold. But right now, it’s looks like the gold bulls have the market.

Nadig: That’s a pretty bold call that gold is perhaps headed for a relative decline over the next couple years. When I hear that, and I’m not world’s smartest gold bug, to me that makes it sound like well, OK, if gold’s going to be going down then that means other stuff’s going up, right? That implies that we see increased investment in the stock market, all the things that people invest in gold to get the counter correlation for would be going the other way.

Kerr: That would be the inclination. Nothing is at all relative to how it used to be. We used to say if the dollar was going higher, gold would go lower. We’d never compared sugar to crude, but now we have to do that. So the markets have really changed. I don’t want to discount gold too much. On the other hand, I will say that gold has had an incredible run and is probably correcting now off its high.

Nadig: OK, that makes sense. What’s your take on the near-term volatility issue? We’ve talked about some of these funds getting out of copper and perhaps just getting out of the commodities game, getting out of anything that touches the CRB [Index] for a while while they try to figure out how many of their assets are actually walking out the door versus whether or not they’re going to be pulling any new assets. Do you think that we’re heading for a time of perhaps lower volatility as those players actually exit the market?

Kerr: No, I think we’re heading for a time of higher volatility and actually the CRB index and these markets will do very well. Higher volatility of course for options traders is going be very successful. It’s really not a time for the average investor to take higher risk. It’s really a time to be more conservative but to look for opportunity when it presents itself.

Nadig: So you mentioned the difference between, say, an industrial investor who’s been watching the commodities boom versus perhaps a sophisticated options trader who might have some real interesting opportunities with this kind of volatility. But if I’m just an average industrial investor and my exposure to commodities has been primarily through exchange-traded funds, what am I going to be looking for here? What do we see these indexes doing as we go through this period of shifting the players?

Kerr: Well, I think there’s going to be a real consolidation. You have a lot of investors who probably were unfamiliar with these markets, not comfortable with the volatility, who have been in these ETFs and who now have withdrawn their money. The bottom line is, we’re going to see some volatility going forward in those indexes. Having said that, there’s a real value to these indexes and to the commodities that underlie them, so I think you will see those investors come back in gradually this time, not as aggressively but gradually. There will be value there for the rest who trade these markets.

Nadig: Let’s just stick with the base metals stuff for another minute or two. If we think that these base metals are losing some of their speculative players, at least for a while, and the price is going to return to some more basic supply-demand kind of numbers, to me that suggests that the impact of energy becomes even more important. We know for a fact that, for example, in China, the energy situation has really impacted the aluminum market there because aluminum is such an energy-intensive commodity to refine and to get out into the industrial uses. With the apparent continued decline in energy prices from where they were just a short time ago, does that imply that aluminum will stay down as well?

Kerr: Well, bottom line is energy is the key factor in all of the commodities prices, whether it’s agricultural, metals, etc. No matter what, it has impacted every commodity that’s out there. If we don’t get energy right, then all of these commodities are going much higher. So I think right now we have a little respite; we have a respite in the economy where we can say OK, now we have a chance, the last chance quite frankly, to get energy right, and if we do then maybe many of these commodities will reduce in price.

Unfortunately I don’t believe that’s the case, I think we will get energy wrong and these commodity prices will continue higher. Gold mining, silver mining, aluminum manufacturing, everything is dependent on energy, so if you don’t get that right, if we don’t get it cheaper worldwide, then we are going to see higher commodity prices within the next decade, there’s no doubt.

Nadig: Let’s talk about the impact on the agricultural side because certainly if we’re looking at things like the US corn market, energy has an interesting bilateral arrangement with corn because corn is not only heavily reliant on energy just like every agricultural commodity---just shipping it, moving fertilizer around, the energy it takes to actually farm the stuff---but it’s also an energy input now through ethanol. We’ve seen some analysts talking about a long-term slowdown in ethanol demand. What do you think?

Kerr: Well, let’s break it down. First of all, agricultural is highly dependent on energy. Most of the farm equipment runs on diesel fuel, and farmers can’t run their equipment on anything else. The bottom line is, with ethanol and corn-based ethanol, it’s been a big boom for farmers, but that is coming to the end of the line. McCain and Obama, both Administrations have said, no matter who gets elected they are against corn-based ethanol. I think that gravy train in the grain markets for corn is coming to an end. Now corn at $6, $7, $8 a bushel is much different than at $4 and $5 a bushel where we are now. Farmers who are getting paid in advance for their corn crop, I think those days are over, and also we’re already seeing ethanol plants fold all over the country. So my belief is that we will move into more of a biofuel-based country with additional alternative energy, whether it’s solar, nuclear or whatever. But I just believe that corn-based ethanol play is probably coming to an end.

Nadig: I have a hard time putting my head around that because we know that about a third of the US crop is going to ethanol. We know that the basic mix is probably not going to change. Nobody’s introducing legislation to make the default mix 2% ethanol instead of 10% ethanol, and there’s still some states rolling out their full ethanol infrastructure. While I understand we may not be heading toward a world where every car is running E85 mixtures that are more ethanol than gas, how can we say that it’s over? Do we really think that there’s a backlash coming to the extent where there’s literally less ethanol being produced every year, or is this just the end of the growth curve?

Kerr: I won’t argue with you, but I will say how many states actually rely on E85? I grew up in Minnesota. It’s one of the few states that has E85 gas stations in it, and the people that have those gas stations in their town, how many of them actually use it? There’s very few, so we’ve never really seen E85 actually take hold and pick up, and even with the ethanol plants that are supposedly going to be coming along, they’ve been privatized now and the corn costs have become so high that I believe it’s just not sustainable. It’s not that it isn’t viable, that it couldn’t be usable. At these prices it’s not functional for any part of the country. You can’t transport ethanol very easily, so for nationwide oil use or energy use it’s not very practical.

Nadig: So would you imagine that as we head into---we’re way ahead of actually seeing these numbers---but as we start looking towards next year’s planting numbers, do you think we’re going to see as big a turnaround and see fewer acres of corn planted, more soy beans planted, more wheat planted? Do you think we’re really headed for reversal of that corn planting surge we saw the last couple years?

Kerr: No, I don’t want to get ahead of myself, because the subsidies are still there as you pointed out, and you make a very good point. The subsidies have not been removed yet, so of course farmers are going to plant what they’re going to get paid for, and right now subsidies say plant corn. What I’m worried about are the younger farmers who are planting corn on corn, who are not planting enough beans, who are not planting enough cotton, who are trying to plant corn in the Southern states, it’s just not a very prudent thing. But I completely agree with you, as long as the subsidies stay in place, we will see more corn planted. Whether it comes to harvest is another question, but I think the ultimate beneficiary for traders will be the soy bean market, because I think we’ll see less bean acres planted.

Nadig: Well maybe we can hit that another time. I think we’ve run out of our time for today.
Kevin, I wanted to thank you for joining us here today.

Kerr: Thank you.