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Long-Term
There have been a few commodity
booms over the past 200 years.
Not one of these booms, including
the one that unfolded
over the past decade, was fueled by real economic growth or demographic changes or the rapid
industrialisation of a country or region. They have all been fueled by monetary inflation.
Real economic growth puts downward, not upward, pressure on prices, because real economic growth is mostly about getting more output for less
input. That is, it's mostly about increasing productivity. The increase in productivity stemming from capital investment and technological change affects the commodity-producing
industries in the same way
it affects every other industry. That's why the inflation-adjusted price of a representative basket of commodities
has been trending downward
for about 200 years, despite
the world's population having
increased by a factor of 7 (from
about 1B to about 7B) over this period.
It's tempting to look at the incredibly fast industrialisation of China and the associated gain in China's appetite for commodities and conclude that it is different
this time, but the evidence
to date strongly indicates
otherwise. The fact is that there
have been several rapid
industrialisations over the past 200 years and during each one it was
tempting to conclude (and
many 'smart' people did conclude) that it was different
this time -- that the accelerating rate of commodity consumption would lead to chronic shortages and persistently higher levels for real commodity prices. However, the record of
the "Malthusians" is,
to date, unblemished by success.
The current situation is illustrated by the chart of the
inflation-adjusted CRB Index* displayed
below and can be summarised as follows: Despite the massive strides made by China over the past
decade, the real CRB Index is
in the bottom half of its 50-year range and is more than 50% lower today than it
was in 1980 (when China was still a communist basketcase).
The only viable threat to
the ultra-long-term downward
trend in inflation-adjusted commodity
prices is government intervention in the economy.
Government intervention disrupts
markets in ways that can lead to sustained shortages, even if the intervention is done with the best of
intentions.
*The CRB Index was adjusted
for "inflation" using the method outlined in our December-2010 article.
Short-Term
In nominal US$ terms the price
of the average commodity,
as represented by the Continuous
Commodity Index (CCI), peaked
in April of 2011. As illustrated below, the CCI trended lower from April-2011 until June-2012. A strong rebound then got underway.
The strength of the CCI's
rebound from its June-2012 low suggests that the downward trend came to an end at
that time. However, when we take
into account the global economic backdrop and the main
driver of the strong June-September
advance we conclude that there is probably
some unfinished business
on the downside. We are referring to the likelihood of continuing global recession
over the next 12 months
and the fact that the CCI's rebound would have been much weaker if not for the moon-shot
in agricultural commodity prices
resulting from the extreme US drought.
The following chart of
the Industrial Metals
Index (GYX) makes it clear that the drought's effect on the prices of agricultural commodities
was a big contributor to the CCI's strong rebound from its June
low. Whereas rocketing grain price drove the CCI sharply higher during June-July, in mid August the
GYX was still near its low
for the year. It then rallied for a few weeks in response to the belief that a new round of monetary
stimulus was on the way,
but has since given back
about three-quarters of its
August-September gain.
The good news is that commodities in general and the industrial metals in particular are now 'oversold' as we head into a seasonally
strong period. Also, sentiment is depressed, with all of the
"QE" enthusiasm having
been 'wrung out' by the recent
price decline. This suggests the potential for a tradable multi-month commodity rally commencing within the next few weeks.
We will be looking for short-term trades relating
to industrial metals over
the weeks ahead, especially if there is some additional
price weakness.
Excerpted from a commentary originally posted at www.speculative-investor.com on 1st
November 2012.
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