Thursday, September 16, 2010

Commodities are on fire, and that's good

This index of spot industrial commodity prices is up over 50% from March '09, and it is only 2% below its all-time high of July '08. I think this is highly significant, for a number of reasons.

Global growth: where there is this much commodity "smoke," there is almost surely some economic growth fire. Commodity prices don't move up strongly in the absence of demand. That almost all commodity prices are rising (and rising against virtually all currencies) is a good indication that the global economy is growing, and exceeding the expectations of the world's commodity producers.

Inflation: The world's central banks are about as accommodative as they have ever been. They are all fighting deflation, and they are all bent on ensuring that monetary policy presents no obstacle to economic growth. Short-term interest rates in many parts of the globe are at or near zero. That gold and commodity prices are rising sharply is an excellent sign that money is in abundant supply. An oversupply of money tends to increase the demand for tangible assets, since they are ultimately a hedge against the loss of value of fiat currency. Thus, rising tangible asset prices are an excellent indicator of potentially inflationary monetary policy. At the very least, strong commodity prices virtually rule out the risk of deflation.

Risky assets: Risky asset prices (e.g., equities, corporate bonds, emerging market debt) are arguably priced to the expectation that growth will be meager at best, and many are priced to the expectation that deflation is a significant risk. The action in the commodity markets says those expectations are way too timid, and that therefore risky asset prices are generally quite attractive. If instead of meager growth and deflation we in fact have generally strong global growth and at least some inflation, then nominal corporate cash flows are going to be much stronger than is currently being discounted. Growth plus inflation is a fantastic recipe for owners of high-yield bonds, for example, since those ingredients combine to deliver low default rates.


Benjamin Cole said...

I hope the world's nations are monetarily accommodative.

In the USA, we pretty much hit zero bound and they have in Japan a long time ago.

I suspect this will become a spreading problem in years ahead, due to very high global savings rates.

This may require a reexamination of what constitutes prudent monetary policy--and, course, in Japan they must seriously ask themselves that question again, as they are sinking into another deflation as we speak.

What works?

Milton Friedman advocated Japan print money and lots of it, if necessary, when he visited Japan in the late 1990s You can find his paper at the Hoover Institution here:

Milton Friedman was no deflationist, and he hated the gold standard.

Here is what MF wrote:

"The surest road to a healthy economic recovery is to increase the rate of monetary growth, to shift from tight money to easier money, to a rate of monetary growth closer to that which prevailed in the golden 1980s but without again overdoing it. That would make much-needed financial and economic reforms far easier to achieve.

Defenders of the Bank of Japan will say, "How? The bank has already cut its discount rate to 0.5 percent. What more can it do to increase the quantity of money?"

The answer is straightforward: The Bank of Japan can buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan, what economists call high-powered money. Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand their liabilities by loans and open market purchases. But whether they do so or not, the money supply will increase."

I never fail to read MF without respecting his adherence to logical principles, rather than banal conservative nostrums.

Liberal interviewers and commentators misunderstood MF, as they usually asked him about welfare programs or other rot.

Had they asked MF about the mortgage interest tax deduction, rural welfare subsidies, or quantitative easing, they would have found that MF actually believed in something a lot more substantive than right-wing platitudes.

John said...

Re risky assets,

Agree on high yield bonds. HYG has made new 52 week highs in recent days and appears poised to continue the trend.

A component of many high yield funds is Ford (F) bonds. The common got an upgrade today from Barclays and is up ~5%. With the sentiment for the common improving the bonds should remain well bid.

Only one among a large number of improving credits.

Public Library said...

Reckless monetary policy lead to the 2008 bust and we are now headed in the same direction but on a grander scale. it appears you will surely miss this bus when it flies right off the cliff again.

John said...


The difference between us is that you see a cliff and I see a mountain. It depends on the direction the bus is going. I see it climbing the mountain.

I got in HYG (too early) in '06 and '07, and added significantly in late '08 and early '09. My yield is vastly higher than the MM funds and CDs the cliff fearers are dwelling in. So far I would say I am ahead. It was not always so. Volatility comes with the territory and I have endured a lot of it. But I would say I have done OK. For the cliff fearers who own gold, you too have done well. No complaints from me. But I will not sit my money in a zero yielding deposit fearing an economic collapse predicated on an obscure (to me) economic theory forcast to come to fruition at some vague and unknowable future time while a bull market builds undenyable (again, to me) momentum day after day, week after week, and month after month. I speak for myself. I know I am in the minority and I am comfortable with it. Bull markets are always born out of deep pessimism and fear. We have been and still are in such a time.

Equities and low grade bonds are not for everyone. There are many who do not belong there. Perhaps you are one. That is fine. But I will gladly risk the cliff for the tremendous ride a real bull can give. Take a look at Scott's long term chart of AAPL. Wouldn't it be nice to have bought it at $2 ?

One other thing. When the bus appears to IMMENENTLY be heading 'over the cliff', you won't mind giving us a heads up... will you?

John said...


I misspelled "imminent".

My apologies, sir.

Public Library said...

I am more referring to the eventual collapse of the dollar and our fiat currency. Commodities of all sorts are already signaling as noted by Scott.

However, I believe it is more likely driven by the flight to physical to counter the fiat printing rather than a new glorified global demand to wrench us from our own false perceptions about sound money and finance.

John said...


Again, the problem I have with what you are suggesting is 'when?'. The dollar appears to be fine. Our bonds are in nosebleed territory and are not showing much evidence of changing. If the dollar is going to 'collapse', its going to send treasuries down hard. I agree with you that treasury bonds are a poor bet but I have watched a lot of people try to short them and they have been hurt while the S&P 500 has gone up 50% from its lows and looks like it wants to go higher. EEM has done even better. Gold has done well but I don't recall you saying much about that (do correct me if I am wrong here). For those who wish to own precious metals or quality real estate rather than financial assets I have no problem with. I just cannot see 0% in a deposit account or treasury note waiting for the world to end.

I assume (if so, I agree) you think that at some point treasuries will be a great short but no one knows when. TBT has been a loser for many quarters. If you have any insight I am all ears.

Public Library said...


It only takes a spark to trigger a wildfire. There is plenty of dry debris lying around the global marketplace.

John said...

OK, there is 'dry debris' lying around. So help me out here. You are saying everything blows up all of a sudden like? Are we talking within months, weeks, hours? How is one to gague or measure the timing?

I knew a guy once who told me with a straight face that California west of the mountains would slide into the Pacific ocean. I said "when?". He said sometime within the next 50,000 years.