Wednesday, July 13, 2011

Gold and commodity prices thrive on PIIGS and growth

Today gold hit a new all-time high against the dollar and yesterday it made a new high against the euro. What's driving gold higher? Gold continues to be a haven for those who worry about the health of the world's financial markets (e.g., the eurozone sovereign debt crisis), and it continues to benefit from the ultra-low interest rates and accommodative monetary policies of most of the world's central banks (with the Bank of Japan being the notable exception). Gold is a safe-haven play, and it is an inflation play. That's the way it's always been with gold.

As this next chart shows, gold has a tendency to lead commodity prices, so the continued strength in gold prices suggests we will see a renewed rise in commodity prices, after their recent selloff. In fact, as the chart below of a popular index of commodity futures prices shows, many commodities have already recovered much of their recent decline. It's the non-speculative type of commodity (many of which are in the CRB Spot index charted above) that have yet to recover, but at this point it's likely they will. 

The action combined action in gold and commodity futures is a good indication that although investors are concerned about the risk of a PIIGS default, the global economy is not being impacted much, if at all, by the recent soft patch in the U.S. and the market's jitters. As the chart below shows, China's economy has grown by a massive 9.5% in the past year, and India's economy has been growing by 7-8% of late. Global trade is growing at strong double-digit rates, and commodity prices are trading very near all-time highs in almost all currencies.

Despite all the concerns out there, Euro swap spreads are still substantially below crisis levels, and U.S. swap spreads are perfectly normal. At the very least we can say that there does not appear to be any shortage of global demand, and no shortage of money. If there were, commodities would be a whole lot weaker, swap spreads and implied volatility would be on the moon, and equities markets would be collapsing.

To put the looming PIIGS debt default crisis in perspective, consider that the market value of global equity markets is north of $50 trillion, and the liquid global bond market (investment grade and high yield) totals over $60 trillion, according to the Lehman/Merrill Lynch bond data. Given that as a backdrop, it's hard to get overly concerned about the increasing likelihood that a few hundred (or even several hundred) billion worth of PIIGS debt—less than 1% of the value of outstanding global bonds—is likely to be written off. Especially since this problem has not exactly snuck up on unsuspecting market. The PIIGS crisis first surfaced over a year ago, so markets have had plenty of time to adjust prices and investors have had plenty of opportunities to reduce unwanted exposure.


Benjamin Cole said...

It's the non-speculative type of commodity (many of which are in the CRB Spot index charted above) that have yet to recover, but at this point it's likely they will.

Interesting. It is speculators boosting commodity prices, not real users?


Public Library said...

I doubt the Greece or Euro default issues have anything to do with the 10+ year rally in Gold. That seems a little naive given the longer term facts.

Currency debasement has gone global. Hence the new high in Gold.

Public Library said...

Even more interesting is the markets rebuke of CB activity in JPY.

Where do you think oil is headed after GOVT intervention? Down? I highly doubt it.

What market is the GOVT headed into next?

The signs are starting to show up anywhere and everywhere people are willing to look.

Helicopter Ben is all in on QE3, he just needs a little nudge to pull the trigger.