Popular opinion has it that the rise in commodity prices is due to China and India are mindlessly stockpiling commodities. However, when just about every commodity price is up (even in non USD terms) we would argue that there must be some fundamental factor(s) at work. Two things come quickly to mind:
- a pickup in global economic growth (as indicated by the big rise in shipping rates, the upturn in outgoing container shipments, the rise in global equity markets, and the drop in credit spreads),
- expansionary monetary policy (as seen in the extremely low level of nominal interest rates in all major economies and the very expansive growth in money supply measures).
If there are two major forces pushing commodity prices higher (e.g., renewed economic growth and expansive monetary policy), then it is difficult at this point to say that the rise in commodity prices is the start of another bubble. (Bubbles being defined as prices that are pushed to unsustainable levels by speculative demand.) It’s difficult if not impossible to say how much of the current rise in commodity prices is inflation/easy money speculation and how much is due to strong demand coming from a resurgent global economy.
The continued rise in the CRB Index prices tells us that there is definitely a large element of monetary-driven inflation at work. We think that with the CRB at a multi-week high we have now passed a critical “tipping point.” The Fed in order to “break” the crisis essentially increased the supply of US Dollars on a scale not seen in modern history. However, the worst part of the financial crisis now “appears” to have passed, the result being a decline in the world’s demand for US dollars. Now the Fed needs to withdraw money from the system; if it doesn’t, the abundance of cheap dollars will cause inflation to rise and commodities will once against enter bubble territory.
We genuinely believe Bernanke’s commitment to low inflation and a strong dollar. However, reality will likely prove to be something akin to “the truth is out there”. We think the Fed is now incapable of taking steps to tighten liquidity from both an unemployment and political perspective thanks to Obama. That leaves us thinking that the movement in the CRB Index right: inflation is going to be increasing, and commodity prices are going to continue to rise.
Rising inflation and commodity bubbles are not good for the economy in the long run, because at some point the Fed will have to tighten the monetary screws and that will likely give us yet another recession. But for now, we think it pays to bet on rising real and nominal cash flows, and rising prices for “hard assets”. That means staying long equities (SPY and EEM), commodities (DBC), long TIPS (TIP), and short T-bonds (long TBT) and the USD (long UDN).
Take a look at the “trends” below. These are very apparent in weekly terms……..all are confirming each other which suggest that they are here to stay for sometime (we think months rather than weeks):
