Tweet
Commodities have been on a 3 year run since late 2001, about a year ahead of the economy. It was not straight up, but a series of bases that sent it higher and higher. After a February breakout from its last base, the commodities indices surged to highs mid-March. That was the zenith of the long move.
Since then commodities have been on a dive with gold and copper leading the way. Oil was a holdout, but it has broken down as well now. The CRB has peeled off 35 points (11%) since then. This drop has taken the commodities index back to the longer term trendline that formed off of that bottom at the end of 2001. Having held that trendline for now, it is not a complete breakdown and capitulation. The last run (45 points) straight up after a 4.5 year climb and then the rollover to wipe away most of that gain in short order, however, certainly has the look of a blow off top.
So if commodities do break this trendline and cannot rebound, what does it mean? Commodities are the foundation of the economy, at least as far as manufacturing and building. There is a saying that economic recoveries are built with a copper roof, a reference to the importance of the metal in any building and manufacturing. Copper was leading the commodities, but they were all strong in this worldwide expansion. The plunge in steel stocks, copper stocks, and oil stocks mirrors the decline in the underlying commodities themselves. That points to economic slowing.
For example, back in the late 1990’s and into early 2000 when the Fed was tilting at imaginary inflation, we wrote about the incongruity with the Fed’s actions and what commodities were showing. Commodities were on the decline from 1996 to the second half of 1999. Recall that it was in 1996 that Greenspan uttered the infamous “irrational exuberance” phrase that set the stage for the Fed’s fight against prosperity and the crash. Corn, soy beans, metals; everything dove lower even as the Fed was really talking up inflation. It did not add up that farmers were going out of business and drought was taking crops, but their prices were falling. At least it did not make sense that the Fed was ignoring this as it raised rates to supposedly head inflation off at the pass. Commodities did manage to rally in late 1999 and into 2000, but that was part of the flood of money the Fed unleashed into the economy. That money was invested in stocks, commodities, bonds, art, wine, jewels, and just about anything else considered worth of investment. After that binge, they crashed in 2001, forming the second leg of a big double bottom that started the current run.
The plunge in commodities starting in 1996 even as the stock market rallied higher and higher was forecasting the economic weakness ahead. Now commodities are nowhere near those lows, but the idea is the same, only at a higher level. They were strong but now that the Fed is tightening they are struggling to hold their long uptrend. That tin roof is oxidizing. Indeed, commodities (and that includes oil and gold) are falling in line with the stock market and the bond market in their forecast of economic softening. The commodities are not tanking, but they are showing a lot of weakness, and a break of the trend indicates economic slowing as well.
Thus we have a pretty amazing picture developing. The economic data is overall quite solid, but as we know, current results are not necessarily predictors of the future. The leading indicators, however, still show some expansion (though a bit slower), and importantly, expansion without a lot of inflation. The gold prices are telling us that as well (gold was down another $1.40 Monday). Yet, the bond market and stock market are or have priced in economic slowing, and commodities are on the verge of doing that as well. What could be working to undermine the expansion? Well, there is the Fed that is admitting to no sign of slowing the rate hiking. There is oil that, while lower, is till about $7 to $10 from where it would really help the economy, and it has already put in a lot of time above $50/bbl, and that takes its toll on the consumer and small business.
In sum, this is adding up to more and more a slowdown based in large part on the Fed hiking rates and more importantly reducing money supply. Growth in supply is down from 7% to roughly 3%. That may seem like quibbling, but more than slicing the money growth in half is a huge impact on an economy that is already slowing some. The recovery is roughly 2.5 years old, and expansions tend to run in the 3 year range on average. So there was already some slowing baked into the cake this year, but it would be a natural thing and also help self-correct some of the modest inflation pressures that were building. Now the inflation forecasters are not showing inflation at all down the road, no doubt due in significant part to the added slowing effect of the rate hikes and falling money supply growth.
We have been here before in recent history, and thus far the Fed is showing no indication that it is going to stop the rate hikes and actually anticipate what is happening based on what very clear and historically accurate indicators are showing. We said at the beginning that the Fed would put blinders on before this was all over and hike until it hit its target (4% is likely) regardless of what the market is saying. All of the talk about watching what the economy is telling it matters less and less the closer it gets toward its target. It historically tightens too far, and we can see it starting to repeat history here. It will stop, but it will likely take the next major economic upheaval for it to do so.
Since then commodities have been on a dive with gold and copper leading the way. Oil was a holdout, but it has broken down as well now. The CRB has peeled off 35 points (11%) since then. This drop has taken the commodities index back to the longer term trendline that formed off of that bottom at the end of 2001. Having held that trendline for now, it is not a complete breakdown and capitulation. The last run (45 points) straight up after a 4.5 year climb and then the rollover to wipe away most of that gain in short order, however, certainly has the look of a blow off top.
So if commodities do break this trendline and cannot rebound, what does it mean? Commodities are the foundation of the economy, at least as far as manufacturing and building. There is a saying that economic recoveries are built with a copper roof, a reference to the importance of the metal in any building and manufacturing. Copper was leading the commodities, but they were all strong in this worldwide expansion. The plunge in steel stocks, copper stocks, and oil stocks mirrors the decline in the underlying commodities themselves. That points to economic slowing.
For example, back in the late 1990’s and into early 2000 when the Fed was tilting at imaginary inflation, we wrote about the incongruity with the Fed’s actions and what commodities were showing. Commodities were on the decline from 1996 to the second half of 1999. Recall that it was in 1996 that Greenspan uttered the infamous “irrational exuberance” phrase that set the stage for the Fed’s fight against prosperity and the crash. Corn, soy beans, metals; everything dove lower even as the Fed was really talking up inflation. It did not add up that farmers were going out of business and drought was taking crops, but their prices were falling. At least it did not make sense that the Fed was ignoring this as it raised rates to supposedly head inflation off at the pass. Commodities did manage to rally in late 1999 and into 2000, but that was part of the flood of money the Fed unleashed into the economy. That money was invested in stocks, commodities, bonds, art, wine, jewels, and just about anything else considered worth of investment. After that binge, they crashed in 2001, forming the second leg of a big double bottom that started the current run.
The plunge in commodities starting in 1996 even as the stock market rallied higher and higher was forecasting the economic weakness ahead. Now commodities are nowhere near those lows, but the idea is the same, only at a higher level. They were strong but now that the Fed is tightening they are struggling to hold their long uptrend. That tin roof is oxidizing. Indeed, commodities (and that includes oil and gold) are falling in line with the stock market and the bond market in their forecast of economic softening. The commodities are not tanking, but they are showing a lot of weakness, and a break of the trend indicates economic slowing as well.
Thus we have a pretty amazing picture developing. The economic data is overall quite solid, but as we know, current results are not necessarily predictors of the future. The leading indicators, however, still show some expansion (though a bit slower), and importantly, expansion without a lot of inflation. The gold prices are telling us that as well (gold was down another $1.40 Monday). Yet, the bond market and stock market are or have priced in economic slowing, and commodities are on the verge of doing that as well. What could be working to undermine the expansion? Well, there is the Fed that is admitting to no sign of slowing the rate hiking. There is oil that, while lower, is till about $7 to $10 from where it would really help the economy, and it has already put in a lot of time above $50/bbl, and that takes its toll on the consumer and small business.
In sum, this is adding up to more and more a slowdown based in large part on the Fed hiking rates and more importantly reducing money supply. Growth in supply is down from 7% to roughly 3%. That may seem like quibbling, but more than slicing the money growth in half is a huge impact on an economy that is already slowing some. The recovery is roughly 2.5 years old, and expansions tend to run in the 3 year range on average. So there was already some slowing baked into the cake this year, but it would be a natural thing and also help self-correct some of the modest inflation pressures that were building. Now the inflation forecasters are not showing inflation at all down the road, no doubt due in significant part to the added slowing effect of the rate hikes and falling money supply growth.
We have been here before in recent history, and thus far the Fed is showing no indication that it is going to stop the rate hikes and actually anticipate what is happening based on what very clear and historically accurate indicators are showing. We said at the beginning that the Fed would put blinders on before this was all over and hike until it hit its target (4% is likely) regardless of what the market is saying. All of the talk about watching what the economy is telling it matters less and less the closer it gets toward its target. It historically tightens too far, and we can see it starting to repeat history here. It will stop, but it will likely take the next major economic upheaval for it to do so.