It is a popular view – at least professionally - that commodity prices rise during periods of negative real short-term interest rates (RSTIR), and that is somewhat true. However, in the first two charts below you can see that even when RSTIR turned positive in late 2005, commodity prices continued to rise for three more years – with the continuing uptrend in RSTIR. They also started rising almost a year before RSTIR turned negative in mid 2002.
Commodity investors anticipate the trend in RSTIR rather than simply waiting to react to the positive or negative level in RSTIR, so the trend in RSTIR is both logically and empirically much more important to commodity prices than the level of RSTIR.
These charts also illustrate the past 10 years of the negative correlation between RSTIR cycle-trends and commodity prices, as reflected in the CRB index, especially during the past six, very cyclical years since the mid-’04 low in RSTIR.
For example, commodity prices rose from mid-’04, when the level of RSTIR was negative, through mid-‘06 when the level of RSTIR turned and remained positive for almost a year.
Then after commodity prices rose 50% from late ’06 through mid-’08 while RSTIR declined some 700 bp, commodity prices collapsed more than 55% into early ’09 while RSTIR rose over 500 bp. Following that, the trend in RSTIR declined 350 bp while commodity prices rose almost 50%. This is very clear negative cycle-trend correlation.
Thus, while commodity price momentum and QE2 lead many to believe that the recently reasserted six- to seven-month rising trend in commodity prices is supported by fundamentals and the quantitative concept of a still negative level in RSTIR, we definitely do not agree.
We believe that commodity prices are over-priced for a critically important combination of fundamental and technical reasons and that they are topping and will soon start declining in response to these forces. This includes the more powerful influence on quantitative traders and investors from recently rising nominal interest rates and the rising trend, rather than the still negative level, in RSTIR. The trend in RSTIR has risen more than 200 bp over the past nine months, despite the supposed downward pressure from the announced $600 billion of QE2.
Inflationary expectations are currently too high (see the third and fourth charts below), primarily due to anticipation of QE2 plus the “irrationally complacent” belief that the stalled, depressed level of growth in the economy will regain strength. When these unsustainable expectations peak and start declining again (much more than zero-bound nominal short-term interest rates can), the trend in RSTIR will mathematically reaccelerate to the upside, which will be much more clearly bearish for commodity price indexes, but well after their peak, like the trend did well after the bubble peaked at a much higher price level in mid ’08.
Our work suggests the CPI will eventually turn negative, not because of higher long term interest rates, which we expect to decline significantly from their highs today, but rather because goods and services deflation will reassert itself, as the first of the after-shock, double double-dip business cycle contractions fully take hold. This will cause the already rising trend in RSTIR (see the first chart) to continue to go up above zero – conditions consistent with the popularly followed theory for declining commodity prices. We fully expect commodity prices will then accelerate their decline of many months, going into a major collapse and completing the second downleg of the commodity bubble bust that we’ve forecasted. Of course, this will be belatedly signaled for trend-followers by the lagging green line crossing below the even more lagging yellow line in the oscillator panel at the bottom of the second chart below.
All of this is consistent with the inevitable end game in a deflationary economic Supercycle Winter. And for short-term technical reasons, including an incipient, one-month double top in the CRB, we now recommend selling, and selling short, commodity indexes. For less aggressive investors, we also recommend buying Treasury bills, notes and bonds – again – as we have repeatedly done for three decades during the Supercycle Autumn and Winter dating from the 1981 price lows and yield highs. See some representative charts and Supercycle summary table at the bottom here and as more fully explained in this link: As Forecasted – A 12-Year Retrospective
Resources:
1. We have documented our discussions with others over many years who have used the terms K-Cycle, Kwave or Kondratieff Wave, with Season(s), and the like. Our decades long publishing record clearly establishes that we were the first to use these terms with Season(s), as well as the first to quantify them economically or otherwise fundamentally (Kondratieff and Schumpeter did not) or even technically. Most importantly, we were also the first to forecast their applicability to the secular period dating variously from the late 1990’s through March 2000, depending on the metric under consideration. As Forecasted – A 12-Year Retrospective We more than welcome further inquires.
2. The terms “more“ and “less” refers to the combination of cyclical frequency and severity (duration times magnitude) – see SMECT: A Forecasting Model That Integrates Multiple Business and Stock Market Cycles Since 1896
3. The terms ““bull” and “bear” refer to the over- and under-performance in Supercycle (secular) trends of excess total return compared to the risk-free return and other asset classes
4. P/E includes quantification of investor mood (animal spirits) – see our earnings-capitalization stock-market valuation model: Quantifying and Forecasting an Equity Risk Factor
5. See our severity (magnitude and duration) quantification of the 33 most severe bear markets since 1895: Exhibit E in #2 above.
