Friday, July 24, 2015

Commodity prices in perspective

Consider this post a public service announcement. The objective is to put recent commodity price trends into a long-term, historical perspective. I think that what it shows is that despite significant declines in the past few years, commodity prices are still holding up quite well relative to where they've been in the past.

We start the review with "Dr. Copper." Copper prices have been extraordinarily volatile in recent decades. Copper has declined 40% from its early 2011 all-time high, but it is still 290% above its 2001 low.

The CRB Raw Industrials index is my favorite commodity index. It doesn't include any energy or precious metals. It includes mostly just basic commodities of the sort that don't lend themselves to speculation or stockpiling. This index has fallen almost 30% from its 2011 high, but it is still almost 110% above its 2001 low.

The chart above shows the inflation-adjusted value (in today's dollars) of the CRB Raw Industrials index. Here we see that despite the huge increase in commodity prices since their all-time lows of 2001, prices today are still about 30% below their early 1980s level in inflation-adjusted terms. I don't include prices going back to 1970 because the composition of the index changed, but most commodity indices show almost no change in real terms from 1970 to 1980. Similarly, commodity prices in the 1960s were largely unchanged in real terms. In the end, what becomes apparent is that commodities tend to become cheaper over long periods. Presumably that is because of technological advances in exploration and extraction techniques. This vindicates the late Julian Simon's view that the only scarcity that exists in the world is human ingenuity. There has demonstrably been no scarcity of commodities.

The CRB Spot Commodity index consists of the Raw Industrials index featured above, plus the CRB Foodstuffs index. After adding in notoriously volatile food prices, the picture remains essentially the same.

The chart above extends the CRB Spot index back to 1970. Note that commodity prices were relatively stable from 1980 through 2000, then they surged from 2001 to 2011.

The chart above converts the index from nominal to real terms. Note that prices in the 1970s were volatile, but ended the decade relatively unchanged.

Finally, the chart above compares the price of gold to the CRB Raw Industrials index. Note how closely they move, but also note how much more volatile gold prices are than most other commodity prices. Both are in a weakening trend.

Are lower commodity prices bad? Are they symptomatic of the onset of deflationary conditions? Do they reflect a weakening of the global economy? Or do they simply reflect more abundant supplies and reversals of the very strong commodity prices that we saw in the years leading up to 2011? I tend towards the latter explanation. After, all, as the saying goes, "the best cure for higher commodity prices is higher prices." Higher prices elicit more supply. We know that for sure is the case with oil:


John McCormick said...

Scott, maybe you are right. Maybe this recent decline hasn't brought us back to the price level of the 70's, BUT the trend scares me. With all the stimulus that has been put in place, price levels are falling.

Q2 GDP next week... QE4 is coming!

Benjamin Cole said...

When global commodities prices rise, it is a sign the U.S. central bank, the Fed is way too easy, promoting hyper-inflation....

When global commodity prices fall for five straight is a sign the hyper-accomodative, super-easy wide-open Fed is failing to boost prices.....

At any time in the last 30 years has the Fed been "too tight"? If not, then why are we presently in headline deflation, and why is the outlook for below-target inflation (below 2%) for at least the next five years?

Institutional investors who buy 10-year Treasuries are essentially saying inflation is below 2% for the next 10 years....

The truth is, never before have the world's major central banks explicitly stated (as they do now) that their first job is holding prices at or below a target. The ECB and the Fed have become inflation targeters first. The results are poor. Hey, I am just saying what I see.

Recently, the Bank of Japan has moved to QE-stimulus, with superb results for the island economy and stock and property markets.

Now we see Singapore also sinking into deflationary recession. Why do I mention Singapore? Of all the nations of earth, it may be the best when it comes to free markets and an open economy. It is famous for that.

If you want to see a nation with small structural impediments, Singapore is it.

No matter. It is suffocating too. The monetary noose of Singapore's central bank has cut the windpipe there.

Every nation should improve its structural impediments. But any nation can be suffocated by tight money.

William said...

I think it would be interesting to place the REAL S&P 500 chart on the same graph with the REAL CRB Raw Industrials index since 1970 for comparison. It might suggest where REAL investment values are as compared with which index has been inflated over the years due to speculation.

Anonymous said...

All the commodity charts have break outs - down. I don't think levels always matter. If the perception is that commodity prices are deflationary it very well may be only psychological. The perception may be that exports are going to pull down GDP. Fortunately, the USD DX index isn't going up like commodity prices are going down. That could be the grace this market needs. And bonds have not really reacted.

Scott Grannis said...

Re: "With all the stimulus that has been put in place, price levels are falling."

That comment assumes that Fed policy has been "stimulative." I have argued for years that Fed policy has not been stimulative; rather, it has been accommodative. The Fed engaged in QE in order to satisfy the world's demand for money and money equivalents (i.e., safe and liquid assets). The Fed has supplied just about exactly the money the world demanded. That shows up as relatively low and stable inflation.

If the Fed had truly been stimulative in recent years (i.e., force-feeding the world with liquidity it didn't really want), then the dollars would have gone down instead of up; and gold would have gone up instead of down.

If you want to see a period during which the Fed was indeed stimulative, look no further than 2004-2008. Gold soared, and the dollar crashed, and inflation rose from less than 2% to more than 5%.

I argued in a prior post that the decline in gold and the rise in the dollar in recent years is not necessarily the result of the Fed being too tight. It is instead (arguably) the result of the market unwinding its bets that the Fed was too easy. Gold had been bid up to extremely high levels based on widespread fears of hyperinflation that has yet to materialize. Gold is now coming back down to more normal levels. Similarly, the dollar has come back up to more normal levels, as it is now roughly equal to its long-term average against a broad basket of currencies.

Johnny Bee Dawg said...

It's good to see a shout-out to the late, great Julian Simon!!
Man, was he ever right...about almost everything.
He's still making Paul Ehrlich look silly.

Anonymous said...

QE bought $3 trillion of bonds that were illiquid because nobody would even lend against good collateral for funding the banks. Banks deleveraged by $3 trillion dollars so the liquidity for sure went to the former creditors of the banks.

FRB Z.1 D3

William said...
This comment has been removed by the author.
William said...

Scott's reasoning and arguments make a lot of sense.
But still, global economies seem awfully artificial to me.

Regardless of what the Federal Reserve has been buying, the FED has held their Federal Funds rate near ZERO for a real yield of MINUS ONE. Japan, having held their interest rates to near zero for decades, has embarked upon QE and also voted a law that pension plans must hold 50% of their assets in equities thus manipulating their stock market upward. The ECB has also embarked upon massive QE (I'll do what it takes, Dragi says). Then there is China which not only has blatantly manipulated its stock market this month but confirmed, what most professional observers suspected, that it manipulates its economic data like exports, consumer purchased, GDP, etc.

We have a global economy in which investors are totally reliant upon the next revelation of their oracles, the Central Banks. Meanwhile, global governments / politicians, including the US, are polarized and unable to rationally tackle their enormous structural and demographic problems. Thus economies are dependent upon the decisions of Central Banks.

Market advisers tell us that the economies of Europe, Japan, the US are improving; the bull market has a year or two left to rise; that in the last year of a bull market stocks typically rise dramatically (don't miss it); there are no alternatives to equities; cash is trash; etc.

Personally, in 73 years, I have never experienced anything so artificial, propped up and manipulated as these markets; so I am cautious.

Benjamin Cole said...

"If you want to see a period during which the Fed was indeed stimulative, look no further than 2004-2008. Gold soared, and the dollar crashed, and inflation rose from less than 2% to more than 5%."

Scott Grannis:

I think we had some headline inflation in those years 2004 to 2008, on the strength of a speculative oil market, and ferocious China demand for everything---including gold.

The core PCE chain price index hardly budged above 2%:

From St. Louis Fed:

(These are actually annual average core PCE index figures, despite the 01-01 designation.)

2000-01-01 84.747
2001-01-01 86.281
2002-01-01 87.750
2003-01-01 89.047
2004-01-01 90.751
2005-01-01 92.711
2006-01-01 94.786
2007-01-01 96.832
2008-01-01 98.827
2009-01-01 100.000
2010-01-01 101.286

We get an 8.9% increase in the PCE core for the four years 2004-2008, or maybe 2.1% annually compounded.

I do not think 2.1% inflation is anything to worry about---and the Fed then stomped on the brakes in 2008, throwing leveraged property markets (commercial and residential) into a deathlike tailspin.

The facts simply do not bear out that there was serious inflation running into 2008. There were very prominent and vocal FOMC members--Richard Fisher and Charles Plosser come to mind---who continuously thundered about pending runaway inflation. Both have stated they wanted either no inflation, or even mild deflation (Plosser).

Frankly, even 4% inflation is not that much to worry about--when Volcker was Volcker, he eased up when the CPI got down to 4-5% from double digits. Milton Friedman (in 1992) bashed the Fed for being too tight, when the CPI was about 3%.

The Fed just put the monetary noose on an economy struggling for air in 2008. But it is the tenor of the times---there is a hyper-sensitivity to inflation these days.

BTW, this guy (see link below) has a nice graph showing the PCE core flatlining through the 2004-2008 period, a just more than 2% (see bottom of his post) This is a website sponsored by Vanguard. I cannot graph in this space.

McKibbinUSA said...

Wiping out commodities is the tacit intermediate objective of central banks -- the deeper and longer that commodities can be hammered into deflation, the better for bonds and equities, and ultimately currencies -- annihilating commodities in detail is what currency wars are all about -- commodities are currently losing to the druthers of the central banks...

Benjamin Cole said...

Headline today:

"The Bloomberg Commodity Index extended a 13-year low as corn sank with nickel and copper."

So, the PCE core is running at 1.3% YOY, commodities hit 13-year low, wages are up 2% YOY...and the Fed wants to raise rates?

Just when would the Fed not want to raise rates?

The Fed sounds like a crackhead discussing his next coke fix....

William said...

Also reported today by Yardini:

"The CPI headline and core inflation rates among the major industrial G7 economies were only 0.2% y/y and 1.4% y/y during May. The volume of world exports rose just 1.0% y/y during May, while the value of those exports is down over 10% y/y through April.

Lower commodity prices including oil plus falling export prices coming out of Asia, especially China. Good news for consumers!! Not so great for sales and income for producers.

William said...

When I wrote that markets were artificial, please note the following:

"The global economy may need....a restraining order imposed on the major central banks and central planners. All of their meddling is resulting in bad vibrations for the global economy. Consider the following:

(1) Eurozone debt. Loans outstanding at Monetary Financial Institutions (MFIs) in the Eurozone rose €3.75 trillion to a record €10.87 trillion from January 2004 through January 2009. That borrowing binge helps to explain why loans have been essentially flat since then.

The 7/22 FT reported: “Across countries that use the euro, average debt to gross domestic product reached 92.9 per cent in the first quarter of 2015, up from 92 per cent in the previous quarter and 91.9 per cent in the same period last year, according to figures from Eurostat, the EU’s statistical agency.”

On 7/14, the Central Bank of Italy reported that Italian public debt has risen upwards of 2.2 trillion euros in May, a new record for the Eurozone’s second-most indebted country after Greece. Italy’s debt is now at 132% of GDP, compared to Greece’s 175%. Both countries find themselves far from the 60% debt-to-GDP ratio target set by the European Commission.

(2) Chinese debt. China’s bank loans rose to a record $14.5 trillion during June, up a whopping $9.8 trillion since the start of 2009. They exceeded US bank loans for the first time ever during September 2010, and now are 76% greater.

The 7/15 BloombergBusiness reported: “While China's economic expansion beat analysts’ forecasts in the second quarter, the country’s debt levels increased at an even faster pace. Outstanding loans for companies and households stood at a record 207 percent of gross domestic product at the end of June, up from 125 percent in 2008, data compiled by Bloomberg show.”

(3) Japanese debt. Japan’s gross debt is equivalent to 234% of its GDP. Its public debt was equal to about 85% of its GDP during Q1, up from 23% 20 years ago. A country report released by the IMF this month on Japan warned, “Japan’s public debt is unsustainable under current policies.” It projected that the debt ratio will rise to 290% by 2030.

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