Tuesday, March 23, 2010

Commodities update

Commodity prices continue to rise. This measure, the CRB Raw Industrials Price Index, is now only 4% below its all-time high, which was set in May '08. Note that this index contains no energy prices, and its components (see the bottom part of the chart) are not commodities typically subject to speculative activity, since they are not traded on futures markets. Are the Chinese hoarding hides? Tallow? Wool Tops? Resin? I seriously doubt it. These prices are up because the global economy is growing, demand is strong, and monetary policy is accommodative. Accommodative monetary policy does just that: it accommodates increases in sensitive prices such as these.

The message here bears repeating: deflation is not happening. Deflation is when almost all prices decline. Here we have a basket of industrial commodity prices that have risen 136% from their Nov. '01 lows, or almost 11% per year on average, and they have risen some 60% since the lows of late '08. This, during a time when conventional wisdom (including the inflation models favored by the Fed) has consistently viewed deflation as a major threat, primarily because the economy has been operating with a significant degree of "resource slack." Somebody forgot to tell the commodities market that surging prices were not supposed to be happening.

My takeaway from commodity prices: the risk of deflation is minimal; inflation risk is rising; and the outlook for the economy is much better than the "new normal" crowd would have you believe. And I say that even as I lament the passage of the healthcare bill, which means more government control over the economy, less efficiency, and lower average standards of living than we could have enjoyed if a free market approach to healthcare reform had been used.


puffer said...

I have a question regarding housing prices and inflation... Assuming inflation rises significantly down the road, mortgage rates will go up quite a bit from the manipulated historic lows. This of course will serve to dampen demand for housing and restrain prices. On the other hand, rising inflation will add significantly to material costs,
and eventually labor as well, which would serve to increase the replacement cost of a home and be a driver of increased home prices.
Which of these 2 forces would dominate in an inflationary environment... would home prices go up or down? Thanks.

Scott Grannis said...

The way I see it, interest rates are driven by economic growth and inflation. If either go up, interest rates are likely to follow. If the economy strengthens and/or inflation rises, housing will become more affordable (incomes will rise faster) and home prices will likely rise in response. If we get a big increase in inflation, then almost by definition home prices will rise significantly. Home prices are not the driver of the economy, they are the result of the forces at work in the economy.

Benjamin Cole said...


This very interesting post caused me to do some research.

It turns out there are futures markets in the commodities used on this chart--there is even a wool futures market!

"SYDNEY — Investment funds that have plowed tens of billions into commodities are now sniffing around Australia's small wool futures market for a new play as surging food prices begin to reduce land for grazing."--from the NYT.

Okay, so there is a wool futures market.

Meanwhile, there is the London Metal Exchange, where all metals on the chart are traded. See http://www.lme.com/home.asp

Rubber is deeply connected to oil prices, and we know about the NYMEX.

My understanding is that the more thinly a metal is traded, the easier it is to game the system. Ergo, some of these metals might be tailor-made for a little phoney uptrades and manipulation.

BTW, if you go to heatingoil.com, you can find a link to a story that mentions OPEC, and its stance that the current oil market is much influenced by speculation. Many in the oil sector are simply dumbfounded that global supplies are bulging, demand is falt, and yet oil prices have risen from $40 to $80 in the last year.

You may wish to reconsider commodities --long a traditional indicator of inflation and economic growth--as anything but an indicator of how hungry investment capital is to find a home, and how futures markets can be rigged. Remember the Hunts!

Scott Grannis said...

Benjamin: I think if you do some more digging you will find that almost all of those futures contracts are so thinly traded (check the open interest and then calculate how much that amounts to) that it is nearly impossible for speculators to influence the global price for those commodities. Oil and copper, yes, those can be and are stockpiled, and changes in inventory stockpiles can be a factor in prices.

A further (and important) consideration: in the futures markets, for every buyer there must be a seller. For every contract sold to a speculator betting on a higher price, there must be either a producer or another speculator willing to sell him the commodity at some future date, or willing to bet that the price drops. For every long position there must be a short.

Benjamin Cole said...


Sure, but on a thinly traded market, the buyer and seller could be the same entity, gaming up the reported price. I have no idea if the LME is excellently policed or the gong show (one might suspect the latter).

If real world prices are tied to, or influenced by, the futures price, then the gaming works.

Meaning, I agree to sell you my prize wool in a month, for whatver the price is then--to your surprise, the contract price starts going north. Because I manipulated the wool market?

But back to the chart--do we know the relative weights of the different commodities, and how the prices of those commodties are determined for purposes of the chart?

Obviously, if rubber is a huge part of the chart, and rubber is a proxy for oil, and oil is the NYMEX, then the dubious NYMEX futures market is influecing this chart.

Again, I don't know the answers, and it may be no one does. After all, if s hedge fund somewhere wants to game copper markets, and it has a $1 billion in equity and can leverage 30-to-1, they are not going to call up the WSJ and tell them of their plans--though they may try to plant a few stories about "tightening" copper markets, and how "many" traders expect copper to go higher.

I exchanged e-mails with the CFTC, and unlike equities markets, it is perfectly legal to take a position in a commodity (such as copper) and then plant stories in the media to push the price up. Sort of an "all's fair in love and war" market.

It may be that commodities market are a bit of the Wild West--treat with caution.

I have to say, if prize Beverly Hills land is selling for one-quarter the price of a couple of years ago (as it is), then inflation seems to be on the backburner for now.

Scott Grannis said...

Futures markets can influence prices if they have volume which is significant relative to the volume of world trade in that commodity. For the most part, futures markets are just very convenient ways for producers and consumers to manage their price risk.

I really don't think you're going to find that futures speculators have pushed up prices significantly for ALL commodities.

puffer said...

Do you have a chart that goes back another 10 yrs and shows what commodity prices did as a group through the very inflationary 70's? I was able to find the following chart on home prices which supports your answer to my question above ...


.... I wanted to compare the two to see just how tight the historical correlation was for such periods of high inflation (housing prices vs. commodity prices).

Benjamin Cole said...

Well...if speculators are looking to play in wool markets...what is left that is sacred?

I just get the feeling that commodities have become another asset, like property, equities, the bond market, that people (erroneously in my view) treat as an "investment." People buy gold as an "investment." Now oil. Maybe copper. They speculate in wool. It ain't like the old days.

Wasn't Mrs. Clinton mucking around in pork belly futures, or something to that effect? She cleared $100k, and I am sure it was all clean, and on the up-and-up.

Additionally, there has been a huge growth in the derivatives market, and the related need to hedge huge positions...and commodities positions can be purchased as a percieved hedge.

In any event, I enjoy this reportage of yours tremedously, even when I disagree. I can't prove commodties have become another rigged, speculative market. But the smell factor is kicking in....