Friday, December 3, 2010

Crude oil and gold reach new nominal highs

Crude oil hit a new post-recession high today. As the second chart shows, in real terms oil is now back to the levels we saw in the early 1980s. Oil prices were shockingly high back then, having surged over the previous 10 years. Yet expensive oil didn't stop the economy from enjoying a boom, and the surge in exploration activity that followed the surge in oil prices soon brought forth a gusher of oil which in turn drove the price back down. Rising oil prices already have resulted in a 116% increase in the North American Rig Count since the middle of last year, according to Baker Hughes, so there are some interesting parallels between now and the early 1980s that are promising. The third chart compares real crude prices with the worldwide rig count, which hasn't risen quite as much as the N. American count; still, note how drilling activity responds to changes in real crude prices. It would be surprising if drilling and exploration activity didn't continue to rise given the current level of prices.

As a reminder, even though oil today is quite expensive in real terms from an historical perspective, there is reason to believe that it won't pose a serious obstacle to growth. Thanks to conservation and technological advances, the U.S. economy uses about half as much oil per unit of output as it did in 1980. As a result, consumers today spend about half as much of their income on energy as they did in 1980.

As the fourth chart shows, gold hit a new all-time high of just over $1400/oz. in nominal terms, but is still below its previous high (which was about $2250 on an intra-month basis).

I've shown this last chart several times before, but it's worth updating. What it shows is that gold has been a good leading indicator of non-energy industrial commodity prices, and it appears that the rally in both isn't over yet. Sooner or later the higher prices of gold, oil and commodity prices will find their way into the CPI (which is plagued by tons of inertia in the form of long-term labor contracts and leases) and we will see inflation rising. But by then it will be old news. You don't wait for the CPI to go up before you realize that inflation is rising; the CPI is the last place that the dollar's ongoing loss of value will show up.


Public Library said...

And there are rumors of even more than $600B from the giddy Fed. The next several years are primed for serious tectonic movements around the globe. None pretty in my opinion.

Benjamin Cole said...

Fascinating to look at real gold prices--still well off from 1980s highs. If you bought gold then, you are still down, and waiting.....after 30 years waiting.....

These charts also remind us we have been through worse. Higher inflation, higher gold prices, higher oil prices etc. Man, if you lived through the 1970s, you saw inflation, stagnation, double-digit interest rates, record high oil, a complete rout in Vietnam, rising urban crime, and lousy US made cars and ugly styles of all kinds. Now, except for disco, that was a bad decade. Seemed like our cities were dying.

Instead we had huge rallies in nearly everything, except gold. Cities rebounded. Real estate up, Dow way up. Crime way down. Hard to believe if you had lived through the 1970s.

Might be a re-play ahead--big rallies in real estate and equities. A couple good breaks, and we may be setting up for a 20 year secular boom. Gobs of capital on the sidelines, and interest rates low. Any good sustained news, and I say blast-off time on global exchanges.

I agree with Grannis that oil is much less important now. Indeed, in the last 30 years huge advancements made in natural gas exploration and production, and electric cars.

Steve Fulton said...

If the unelected entity that controls the supply and thereby the value of dollars, publicly and repeatedly states that their policy is to reduce the value of the dollar relative to goods (ie: inflation is too low) it seems a relatively poor idea to bet otherwise. As to CPI, it's 40% housing costs. We all know the story there. It's fashionable to snicker about gold bugs, but when raw industrial materials start hitting new highs in price there is something going on. I'm pretty sure none of the gold bugs have decided to hoard tallow and scrap tin. I don't think Scott is suggesting an inflation Armageddon nor am I. I think we both think that an upturn in the economy is occurring. My concerns are two fold. The Fed cannot lower interest rates by buying ten year notes with printed money anymore than I can fly by lifting myself off the ground. Both exercises only work very temporarily. The risk is that rising rates (which is what happens when you print too much money) will choke off the bottom that seems to be forming in the housing market and actually delay the recovery-which will mean print more money etc. The other risk which seems less likely is a continued erosion of the dollar. Who knows maybe Greece Spain Ireland and Portugal wats to start using the dollar instead of the Euro. We will certainly accommodate their need to devalue more than Germany will.

Steve Fulton said...

Benjamin--I certainly can't say you're wrong in looking for a booming equity market in the near future, but I don't think I'd use 1981 as a parallel to today. Volker raised Fed Funds from 11% in 1979 to 22% in June of 1981 and he was pretty vocal about what the game plan was--lower inflation which had been in the 13% range to close to zero. 10yr rates hit 15.5% in late 1981 and started a long bull market to where they are today. The DOW which had hit 1000 in June 0f 1966 bottomed at 780 in August of 1983 and kept it's bull matket intact until Jan 2000 when it hit 11,800 which is more or less where it is now. Since I believe that the value of the stock market is the present value of the future earnings stream the massive equity bull market is in large part due to the discount rate falling from 15.5% down to 3%. It's also not surprising that the equity market has been a loser for the last decade since 30yr rates hit 4.70% in late 2001 which is pretty much where they are now. So it seems to me you need one of a couple things to happen for another equity bull market most of which seem unlikely !.Lower rates 2.More balance sheet leverage 3.Demographic growth 4.Productivity growth. 1 and 2 seem like no way possibilities, 3 and 4 are tougher to call but I'll take the under for demographic growth. Since I got my economics degree from a public institution I like to keep things pretty simple. Don't bet against the FED (unless what they say they want to do is impossible) and try to buy the asset class that is in high demand and short supply. So across the asset classes how do thing stack up on the supply demand front? Well there's a few things in obvious oversupply like fiat currency and IOUs (or a promise to pay you more fiat currency sometime in the future). I can't see anyone rationally arguing that either money or debt is in short supply. Productive capacity and labor seem pretty abundant as does global housing stock and commercial property. What seems in short supply is "stuff". Not "things" like cars and TVs but the stuff that goes into them. Copper, some rare earth metals, steel, zinc, energy products, and most important water which goes into everything. So I don't think I'd own much debt as an asset class and I'd probably overweight the commodity stocks vs everything else and I think I would definately own some physical commodities funds. It's tough not to see those asset classes doing well for the next decade.

Steve Fulton said...
This comment has been removed by the author.
Benjamin Cole said...

Steve Fulton--

I like your way of thinking--as for keeping things simple, clarity in thought often results in simple (ahem, "elegant") insights.

I suspect you are right; demand for commodities will be ferocious for next 20 years, as China and India et al demand more. Evidently, China is now buying more gold than India, while global production is going down (yes, down, despite the price. See recent Money Illusion blog by Scott Sumner, always a fun read).

I suspect good-quality real estate will enjoy the boom too, as usually in every region there are types of properties in limited supply. Try buying a skyrise condo in Scott Grannis' neighborhood for example. You can't--they are outlawed. Ergo, California beachside housing will rocket in value in every up cycle. As for offices, I am not so sure.

Equities may tag along, especially if earnings keep rising. Earnings held up through this downcycle, and may rise steadily in years ahead. With interest rates low, I don't see how equities can sell for less than 15x earnings. Interest rates will stay low for a long time--global capital glut. Low interest rates will also favor real estate.

Unit labor costs have been going down, so I suspect we see a long, long--very long--run until inflation. It is further away now than ever before.

I actually hope we have moderate inflation for a good decade or so, as I see no other means of paying down the national debt. Neither party has any will. Grannis keeps promising inflation, I keep hoping he is right, and instead prices are lower now than in July 2008. Core inflation has nearly become deflation--and the CPI may over state real inflation.

One word of caution on commodities---if the world does move to market-based economies, in the long run commodities prices probably go soft. Man is inventive and adaptable, and the price signal can change a shortage into a glut (not always so in constrained real estate markets).

The true investor always takes the name B. Wary.

John said...

The Eighties are an inappropriate analog in another respect: demographics.

Then, the Boomers were all about peak earnings, growing families and consumption. Now they're becoming empty-nesters and downsizing. They're growing their own produce and hunting good deals at the thrift shop.

Bill said...

Inflation has arrived in a significant fashion at the grocery store. An anecdotal example: I bought coffee for $6.65 about 4-6 months ago (on sale). The other day, I purchased the same quantity of coffee for $10.65. So, my coffee inflation index has increased by 60% in the last 6 months.

Benjamin Cole said...



I shop at Dollar Stores, and I amazed to buy toothpaste for $1 that used to cost me a few bucks--10 years ago. Plus I get a "free" toothbrush. BTW, if you have never shopped at Dollar Stores, you are in for a surprise.

My cell phone has replaced three land lines. Monthly savings about $100-$150.


I can buy a decent computer printer for under $80.

The new digital cameras take unlimited photos, work very well, and can be had on sale for under $100.

Property rents are lower, almost everywhere. Real estate prices are lower, almost everywhere.

It is true, that global (read Chindia) demand for some commodities will raise those prices--but that is not due to US monetary policy. The NYMEX and other exchanges are heavily gamed, IMHO.

Health insurance is more--too much public money going in. Military hardware only goes up in price, never down. Same problem. I will readily concede anything funded with public money becomes radically overpriced.

Unknown said...


As for one kind of risk measure which is increasing not falling, namely country risk, take a look on France CDS. While in 2008/2009 episode it topped at 100 and went down sharply six months later, the picture looks worse now. It looks like 08/09 move was just mirroring general risk aversion, while now market is slowly coming to an unpleasant conclusion of an specific risk embedded in this asset.

Scott Grannis said...

Family: Thanks for pointing that out, but let me just say that at 92 bps, French CDS may be relatively high compared to history, but it still leaves France with an investment grade rating, equivalent to a small chance of default. I think there is a lot of interest in buying "tail risk" protection these days, and that could account for the somewhat elevated spreads on just about all sovereigns. German CDS trade at 45, UK at 68...

Murp said...

Hi scott-

on an unrelated topic, what software do you use to create those charts?


Scott Grannis said...

Murp: I've been waiting for over two years for someone to ask that question. I use DeltaGraph to create the charts on my MacBook Pro laptop, and I have yet to run across anything that is able to beat that combination. DeltaGraph is also available for Windows. I use version 5.7.5 since I am not yet convinced that the newly released version 6 is stable.