It's a nice quiet day at the beach. Blue sky, a few wispy clouds, only a slight breeze, and relatively small waves. It's been a relatively cool summer in general, cloudy more often than not, but today it's almost hot. In the past few months we have had lots of heavy surf which severely eroded the beach. Today I noticed that the sand has come back in size—more than I've seen for a long time. One thing I've learned from living at the beach is that the beach survives, even though sometimes it looks like it will never recover from the beatings. This might be a good metaphor for the commodity markets.
Here's what I think is the best long-term chart of key commodity prices, plotted with monthly data through last Friday. The first thing that jumps out is that gold and spot commodity prices do a pretty good job of tracking each other over time, with gold sometimes leading the way. Plus, gold's price swings, on average, have been more than double that of commodities—note that the right y-axis has double the span of the left y-axis. Both gold and commodities have suffered big setbacks of late: gold down 15%, CRB spot down 12% from their recent highs. But the correction in gold hardly shows up on this chart; in fact gold still looks like it's in an uptrend. Meanwhile, commodities are still higher than they were at the peak in 2008; the correction has been painful but hardly the end of the world. With the Fed in super-accommodative mode, it would be incredible if commodity prices were not the object of speculators' desire. And after having scaled heretofore unimaginable heights, it shouldn't be surprising that they get knocked down every now and then.
Let's zoom in on copper prices. Copper has dropped by a hefty 32% since its February all-time high. But it's still worth five times what it traded at in late 2001. If you had told someone in 1996, when copper was trading at $1.20 a pound, that in the next 10 years it would hit $4, they would have called you insane. Something like that could only happen if the U.S. were ravaged by inflation! And so with copper today at just over $3, we are supposed to be worried about deflation?
Crude oil prices have dropped by a sizable 30% since their late-February high, but that's peanuts compared to the collapse that occurred in 2008. And oil today is still worth six times what it traded for in early 1999. In constant dollar terms, oil today is almost as expensive as it was at its early-1980s peak.
Thanks to new drilling technologies which have hugely boosted U.S. natural gas production and proven reserves, natural gas prices have collapsed by 75% since hitting an all-time high in late 2005. That's a serious decline. But is it deflationary? Hardly. Gas is still three times higher than it was in 1992. Moreover, cheap and abundant natural gas both here and in the U.K. has the ability to transform manufacturing industries, as Mark Perry notes in a recent post.
Natural gas is now cheaper relative to oil than at any time in the past 20 years. It's difficult to imagine the eventual magnitude of the impact this could have on manufacturing and economies in general. It's certainly not something to worry about, with oil still trading at relatively expensive levels. Cheap energy is a big deal.
All of this leads me to think that it's not the recent drop in commodity prices that is a concern. If anything, we should still be focused on how expensive most commodities are relative to their historical trends. Finally, it shouldn't be surprising that commodity prices are still quite elevated, since, as the last chart shows, the dollar is still plumbing all-time lows in real terms against other currencies. Easy money, weak dollar, strong commodity prices; they all tie together, and that's still the dominant theme, even after all the turbulence of recent months.