Kamis, 21 Juni 2012

Are falling commodity prices a problem?

Today's Bloomberg headline: "Stocks Drop with Commodities Poised for Bear Market." A quick check shows that indeed the great majority of commodity prices are falling since their highs of last year. Indeed, many would say that commodities are already in a bear market:

Crude oil is down 31%.

The Journal of Commerce Metals Index is down 27%.

The CRB Spot Commodity Index is down 17%. (note, however, that this broad-based index of industrial, energy, and agricultural commodities is up 2.7% in the past three weeks, mainly due to rising prices for foodstuffs)

Gold is down 17%, and silver is down 44%.

Commodity investors are suffering, no question. So what does this mean? Does this reflect a global economic slowdown that threatens to become another recession? The beginnings of another bout of deflation? Is the Fed too tight? Are debt burdens killing economic growth?

The answer to these questions, I would argue, is that it depends on your perspective. 

Consider the following long-term versions of each of the above charts:

In the past 13 and a half years, crude oil prices are up 550%, or almost 15% per year.

Industrial metals prices are up 260% in the past 10 and a half years, or 13% per year.

The CRB Spot Commodity Index is up 133% in the past 10 and a half years, or 8.4% per year.

Gold prices are up over 500% in the past 11 years, or 18% per year.

Wow. Is the commodity glass half full, or half empty? Looks pretty full to me. Just about any commodity you can find is up way more than the rate of inflation over the past decade or so. Is that because global growth is going gangbusters and we simply can't produce enough of the stuff? Or could it have something to do with monetary policy? Consider this chart of the CRB Spot Commodity Index in constant dollar terms:

I think this chart shows that monetary policy can have a huge impact on commodity prices. The big secular trends in real commodity prices coincide very closely with the big trends in monetary policy. Monetary policy was easy throughout most of the 1970s, then became tight under Volcker beginning in 1979 and throughout most of Greenspan's tutelage. Policy has been overtly accommodative for most of Bernanke's term as chairman, with the big exception being the late 2008 period, when the Fed was slow to react to a massive increase in money demand, and thus became inadvertently tight until quantitative easing was launched.

Looked at from a long-term perspective, and viewed against the backdrop of monetary policy, it looks to me like commodities are still in a bull market, and the recent declines have been in the nature of a correction. As such, I don't think that the recent decline in commodity prices, painful though it has been, reflects a major deterioration in the global economic outlook.

If anything, the recent decline in commodity prices is a correction from overly-strong gains—call it a bubble perhaps—that in turn were likely driven by the expectation that monetary policy was far more inflationary than it has turned out to be. Commodity speculators—and this goes double or triple for gold speculators—are realizing that commodity prices overshot the inflation fundamentals by a lot. The future hasn't turned out to be as inflationary as they expected. Speculative excess has sowed the seeds of the commodity price drop, since dramatically higher prices have encouraged a lot of new commodity production at the same time that expensive prices have curbed demand. This is not an economic contraction we're seeing, its a market correction.

Rather than fret over "weak" commodity prices, we should be rejoicing that oil prices are well off their highs and gasoline prices are declining.

UPDATE: I thought I would add a chart of copper prices to again make the point that it's not that commodity prices are suddenly weak or suggestive of an impending or developing recession—it's that commodity prices are somewhat "less strong" than they were a year ago. Just as monetary policy is "less easy" today than it was a year ago. At today's price, which is almost 30% off its all-time high of last year, copper is still up 450% from its late 2001 low. I would argue that this is not necessarily indicative of any serious global economic weakness, since it could well be due to the simple ebbing of the speculative fever which drove prices to levels last year that were previously unimaginably high, coupled with the increased production that very prices have encouraged.

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