The following editorial was published in Price Perceptions issue #1043 on February 11, 1995

Facts and Perceptions of Facts…

Classic price theory poses the following questions…
  • Do facts have meaning within themselves, or is it the perception of facts that determine value?

  • Do perceptions shape facts?

  • Is it facts, or perception of facts, that create reality?

The following events require a thoughtful review of these questions…

  • Over the past year, supply/demand conditions became extremely tight in several commodity markets… However, only a few markets responded with a major price advance.

  • Yields on the Dow Average are now three percent below Treasury Bill rates… Yet, stocks are approaching historic highs.

  • The US is the world’s largest debtor nation and continues to borrow nearly one billion dollars per day… But, we enjoy one of the lowest interest rates in the world.

Why have markets responded differently than indicated by the facts?

Roy Longstreet, a famous speculator in the Sixties, once told me: “People see the world not as it is, but as they are conditioned to see it.” In other words, markets respond to perceptions of the facts, not the facts themselves. The recent Mexican crisis was an excellent illustration of this principle…

The Perception…

- NAFTA would provide Mexico with strong economic growth for many years to come.

- In the eyes of Wall Street and Washington, Mexico was a sophisticated nation with a healthy economy, managed by ivy league professionals.

- Mexican debt was rated at the top echelon of developing nations by major bond agencies.

The Facts…

- It was widely known that Mexico was running an unmanageable trade deficit.

- Stability of the government was questioned when the army was called out to control rebel forces before the election.

- Two political leaders were assassinated, pointing to possible government corruption.

- Before the election, the Mexican government spent one billion dollars for voter identification cards. The reason for such a large expenditure was to assure bond rating agencies of an honest election. (It was a political imperative to impress agencies and avoid downgrading of Mexican debt.) This was the leading clue to the subsequent devaluation.

The Reality…

- Investors poured money into Mexico on the basis of favorable perceptions. (Perceptions determined value)

- The Mexican stock market soared, reinforcing favorable perceptions and stimulating economic growth. (Perceptions shaped the facts)

- The peso collapsed and required the largest foreign “bail out” in history. (Facts eventually determined reality)

Now that we see how facts and perceptions can shape economic reality, consider the following…

Following a decade of stable prices, commodities began to advance sharply in the early Seventies. First one commodity, then another, advanced to record levels over the following eight years. A general perception evolved that commodity prices would advance forever… Bankers made loans on the assumption that oil prices would eventually reach $60 per barrel… Bunker Hunt, one of the richest men in America, continued to buy silver even though world production doubled in 1979 and doubled again in 1980.

The perception of ever higher commodity prices was difficult to kill. However, chronic overproduction was finally realized and the historic era of commodity price inflation ended.

Since the mid-Eighties, another perception has evolved about commodities. The new perception is… commodity prices will remain low forever.

The Perception…

- Genetics have improved seed quality, and farming technology has become so advanced, that food shortages are a thing of the past.

- OPEC nations are so deeply in debt, they will pump oil at low prices for years to come just to meet debt payment schedules.

- The Former Soviet Union is in such a desperate state they will sell basic metals, oil, and other industrial commodities at low prices for many years.

- The Federal Reserve views commodity prices as the primary cause of inflation. Any hint of higher commodities will cause the Fed to penalize the economy with higher interest rates.

The Facts…

- The world now depends on record yields each year to meet growing food demand. New inventory practices have eliminated huge buffer stocks of the Eighties and any adverse growing conditions could lead to critical world shortages.
- The U.S. now depends on imported oil for over 50% of its needs. Any disruption in the politically unstable Middle East, or economic disruption in nations such as Venezuela or Mexico, would have a profound impact on supply and price.

- The Former Soviet Union is in desperate need of capital to maintain commodity production. Oil fields, refineries, and mines are in such a state of disrepair they can no longer produce excessive supplies of commodities.

- Commodity prices advanced during 1987 and 1988 when the Fed forced interest rates higher. Commodity prices fell into 1993 as the Fed lowered interest rates to 30 year lows. There is little evidence to support the Fed’s theory that higher interest rates lead to lower commodity prices.

Perceptions of value are difficult to change. In the early Eighties, investors continued to believe in the perception of ever higher commodity prices - even though markets were falling. Now, it’s equally as difficult to envision sharply higher commodity prices, even though they are beginning to advance. It’s time to disregard old perceptions about commodity values and realize the change is already underway.

Bill Gary
CIS, Inc.


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