 Real Commodities
Bull
Adam Hamilton
Archives
November 19, 2004
The world of commodities, long a pariah during the great stock
boom and bubble of the 1990s, is finally starting to win some
mainstream respect. Commodity-oriented funds are flourishing,
the financial media is starting to cover commodities with something
approaching regularity, and mainstream investors are gradually
growing interested.
Not surprisingly, a few key
commodities like gold,
oil, and silver continue
to capture most of the attention focused on commodities. The
precious metals, of course, are the most romantic and storied
of all the commodities as well as the easiest to buy and store
for investment. And oil prices directly impact all aspects of
our modern lives, driving widespread interest.
The Great
Commodities Bull of the 00's is certainly not limited to
precious metals and energy though. Other commodities are also
rising over time, although these sub-bulls have gone largely
unnoticed as the headline commodities dominate most of the news.
My favorite tool to track commodities in general is the famous
Commodities Research Bureau Futures Index.
The CRB Index was launched
in 1956, and a popular futures contract based on the index has
been trading continuously since 1986. The CRB tracks 17 component
commodities ranging from the usual suspects like gold and oil
to commodities of lesser notoriety like cocoa and hogs. The CRB
can be divided into six categories of components including energy,
grains, industrials, livestock, precious metals, and soft commodities.
One of the CRB index's greatest
strengths is the fact its 17 components are equally weighted.
Equal weighting assures that no price increase in any single
commodity, like oil, can significantly skew the entire index.
Major moves in the CRB are only possible when the majority of
its component commodities are moving in unison with a particular
primary trend. The headline commodities of gold, oil, and silver
only account for 3/17th of the entire index.
The CRB has been marching relentlessly
higher since its massive double bottom carved in early 1999 and
late 2001. It has marched from a low near 183 in October 2001
to a bull-to-date high over 288 just last month. This rather
impressive 57% gain over three years qualifies the CRB for elite
secular bull
status, a major new long-term trend likely to run higher
for a decade or more.
Like all early-stage bulls
though, much of the CRB's initial ascent went largely unnoticed,
shrouded in obscurity. It wasn't until earlier this year when
the CRB majestically smashed up and out of its rock-solid multi-decade-bear
downtrend that folks really started to take notice. This CRB breakout,
while very welcome, helped spawn a school of thought arguing
that commodity prices are historically high so therefore
the new CRB bull's days are numbered.
The roots of this thesis are
easy to understand. The CRB Index's all-time high occurred exactly
24 years ago on November 20th, 1980. The index peaked just under
338. Today's CRB levels approaching 290 are only about 14% under
these all-time commodity index highs. In fact, today's CRB upleg
has taken it to its second highest levels ever, as the only other
time the CRB traded near 290 and beyond was in the early 1980s.
Since the CRB is almost within reach of its all-time highs, isn't
it reasonable to assume that this commodities bull is growing
long in the tooth?
I am writing this essay because
I believe this thesis is fundamentally flawed and almost certainly
incorrect. Yes, the CRB is not far under its all-time highs today.
Yes, in nominal terms the CRB is trading almost as high as it
ever has. But this does not necessarily mean that commodities
are expensive so therefore their bull must end soon. I believe
the fatal flaw in this thesis lies in ignoring the ravages of
monetary inflation.
Whenever a nation foolishly
opts for a pure fiat currency that is inherently worthless as
the US did in 1971, the inevitable result is the relentless erosion
of purchasing power. As a central bank runs the printing presses
to pay for government largesse, the increase in the volume of
money leads to a persistent substantial rise in the general level
of prices. When relatively more money chases after relatively
fewer goods and services, this resulting plague is known as inflation.
Analyzing any price chart over
several decades, including the CRB's, is all but pointless
when monetary inflation is ignored. A dollar today will only
buy a fraction of what a dollar would buy two decades ago. While
the US GDP grew by 333% since 1980, the broad US money supply
exploded by 407%, nearly 75% more than the underlying economy.
Every dollar you hold today is a pale shadow of its former self
thanks to the gross incompetence of the Fed. Monetary stability
and central banks are mutually exclusive.
While the CRB may look high
today in nominal terms, comparing our watered-down 2004 dollars
to those of decades past is like comparing apples to oranges.
If we look at the CRB index in real inflation-adjusted
terms, using constant 2004 dollars, a vastly different picture
emerges. Instead of the CRB index looking relatively high late
in a bull, it looks like it is relatively low near the beginning
of a bull.
Our first graph documents this
revelation over a few decades, with the usual nominal CRB graphed
on the left axis in blue while the real CRB is slaved
to the right in red. Perspective is everything in the markets,
and considering multi-decade trends without accounting for monetary
inflation guarantees that one's perspective will be hopelessly
skewed.
Today's 290ish CRB may seem
high compared to the nominal all-time CRB high near 338. But
in real terms, using constant 2004 dollars, the all-time CRB
high leaps to a staggering 962 in early 1974! If you don't
want to go back quite that far, the real CRB hit 754 in November
1980. In both cases, today's CRB seems very low by comparison
once the relentless erosion of dollar purchasing power is factored
in.
In nominal terms, which is
the implicit assumption of those who believe the flawed thesis
that commodities are historically expensive so therefore the
end of their bull must be near, the CRB is already running about
86% of its all-time high. This is up considerably from 54% at
the latter half of the CRB's massive double bottom in October
2001. While technically true, this perspective is still very
deceptive since inflation is ignored.
In real terms however, the
CRB is now only trading near 30% of its all-time highs. This
is up only modestly from 20% at the same October 2001 CRB bottom.
Obviously a secular bull running only 30% of its best levels
in history ought to have much farther left to run yet than one
running at 86%. In real terms, it sure looks like the Great
Commodities Bull of the 00's is just barely getting started!
The gaping differences between
the nominal and real CRB are very striking in pure technical
terms too. While both languished in brutal multi-decade downtrends
since the early 1980s and finally broke out of these oppressive
trends earlier this year, this is where the similarities end.
The blue nominal CRB's downtrend
was long, but rather modestly sloped. Commodities lost ground
gradually over a couple decades but the successive major interim
lows weren't a great deal lower than their predecessors. Every
five to six years or so the CRB would carve a major new bottom,
but all of these were near or not far under 200 on the index.
Nominally the CRB's multi-decade bear looked more like a giant
sideways consolidation than a true downtrend.
In real terms the technical
picture changes radically. Rather than grinding lower for two
decades, in 2004 dollars commodities have suffered for nearly
three. The real CRB's downtrend is also quite a bit steeper than
its nominal counterpart. Each successive major low fell significantly
under its predecessor, ranging from 350ish in the mid-1980s to
under 200 in late 2001. In addition, in real terms the CRB's
recent breakout has been far more subdued, only carrying it back
up to late 1990s levels compared to early 1980s levels in nominal
terms.
When the relentless erosion
of dollar purchasing power is rightfully considered, the entire
character of the current commodities scene becomes vastly more
bullish. Instead of the CRB being well on its way to challenging
all-time highs after only a few years, the real CRB seems to
be barely getting started in a major bull move. The real CRB
index would still have to double to get anywhere close to even
its lowest levels of the 1970s and early 1980s.
And, amazingly enough, the
assumptions underlying this real CRB are quite conservative.
Rather than use true money supply growth, up 1079% since 1972,
we used the Consumer Price Index to inflation-adjust the CRB.
The CPI is "only" up by 364% over the same period of
time, far less than true monetary inflation. While the majority
of monetary inflation was absorbed by a growing economy, which
increased the amount of things money chases, true inflation is
still far higher than the CPI indicates.
The CPI is run by bureaucrats
out of Washington who are directly accountable to politicians,
not to paying customers like private research companies. For
all kinds of reasons, the politicians want reported inflation
numbers to be as low as possible. The lower the reported CPI,
the lower the cost-of-living increases for tens of millions of
Americans receiving various government checks. The lower the
CPI, the lower US interest rates can stay. And the lower the
CPI, the better the stock markets do which reflects well on politicians
seeking reelection.
All kinds of nefarious tricks
are employed to artificially lower the CPI. Items with rising
prices are excluded from calculations if necessary. Food and
energy prices are calculated separately so they don't impact
the so-called core CPI, an asinine concept that effectively considers
the cost of living for all Americans who eat nothing, drive nowhere,
and live on the streets so they don't have energy bills. Hedonic
adjustments are also used, where statisticians create fake "price
drops" out of thin air for technology like computers where
processing power continually increases. It is all madness.
In short, the CPI is the most
low-balled watered-down inflation index imaginable, nearly a
total charade. If the most conservative possible inflation assumptions
underlying the CPI are used and commodities still look
cheap in real terms, imagine how low they are in reality if true
monetary inflation is considered. The Department of Labor pays
its statisticians to lie to keep reported inflation low to please
their political masters, but even their mockery of an inflation
index shows a real commodities bull just waking up.
Speaking of just waking up,
we also took a look at the young secular bull market in the CRB
Index in Relativity
terms this week and the results were interesting. Since this
chart only encompasses about four years, inflation adjustments
are not necessary. It is only when you get into charts running
in the decades when the eroding dollar purchasing power really
becomes apparent. While not directly related to the real CRB,
this relative CRB chart offers some insight into the current
secular commodities bull. Since neither of today's CRB charts
warranted a full essay, I decided to combine them into one.
It is exciting to note that
the CRB index, even though it represents 17 equally-weighted
commodities, is behaving as all other bull markets do in relation
to its key 200-day moving average support. During uplegs within
its bull it stretches far ahead of its 200dma until sentiment
waxes too euphoric, then it corrects. During these periodic healthy
bull market corrections the CRB retreats back down near its 200dma
support before embarking on another major upleg.
The result of this familiar
behavior manifesting itself in the CRB is an interesting rCRB
range. The rCRB, or relative CRB, is calculated by dividing the
CRB index by its 200dma. It gives us a precise constant-percentage
comparison of where the CRB happens to be in relation to its
200dma over time, removing visual distortion. The idea behind
a relative CRB is to go long when this indicator nears the bottom
of its range and go short or ratchet up trailing stops when it
nears the top of its range.
Bull to date the CRB has carved
major interim bottoms at 0.978x and 0.996x its 200dma. Following
both of these 200dma support approaches in mid-2003 and mid-2004,
the commodities rallied up strongly to new bull-to-date highs.
So if you are watching commodities in general, and are looking
for a buy signal, wait for the CRB to retreat just under its
200dma. Like all secular bulls, it tends to periodically retreat
back to its core 200dma support in corrections before catapulting
higher in dazzling new uplegs.
Conversely the CRB's major
interim highs thus far have also been remarkably consistent in
relativity terms, all very close to 1.13 or so. When the CRB
manages to stretch 13% above its 200dma support, it tends to
either consolidate sideways until its 200dma catches up or it
corrects down to its 200dma outright. These necessary corrections
ensure that sentiment doesn't get too euphoric too soon and threaten
the long-term viability of the young commodities bull.
The first 1.13 approach in
mid-2002 did witness a minor sideways consolidation for a quarter
or so, but the CRB took off again well before it retreated to
kiss its 200dma. Its second 1.13 approach in early 2003 did indeed
signal a major interim top though, after which the CRB corrected
rather sharply. Rather than short commodities outright on these
rCRB highs, I would tend to just raise my trailing stops on longs
instead. Bull markets always have far more potential for upside
surprises than downside surprises as this initial rCRB 1.13 approach
reinforced.
The third rCRB 1.13 approach
in early 2004 perfectly matched a major interim top in the CRB
right before a consolidation running nearly two quarters in duration.
Once the CRB kissed its 200dma again following this consolidation
though, it wasted no time at all leaping back into full-on rally
mode in a new bull upleg. If this latest upleg follows bull-to-date
precedent, the CRB ought to march about 13% or so above its 200dma
before it corrects again. If considered in the context of today's
200dma, this yields a potential current upleg target of 311 or
so on the CRB.
Watching the rCRB specifically
would be most useful for anyone trading CRB futures directly,
but this indicator may also be of use for investors and speculators
dealing in commodities in general. Used as a secondary indicator,
rCRB highs or lows could provide welcome corroboration of major
long or short signals triggered in other commodity-specific indicators
like rGold,
rSilver,
or rOil.
I suspect that a major buy
or sell signal in any individual commodity would have a higher
probability of proving profitable to trade if it coincided with
a congruent major buy or sell signal in the CRB index itself.
If both an individual commodity and the CRB were likely to enter
a strong upleg simultaneously, the risk of a long trade in the
individual commodity should be lower and the odds of winning
higher. I hope to study this thesis in detail in the future,
comparing relative buy and sell signals in individual CRB components
with those in the broad CRB index itself.
The bottom line is the real
commodities bull remains young and very cheap historically. While
it is tempting to use today's rising nominal CRB to compare with
similar levels over two decades ago, in reality these comparisons
are fundamentally flawed. The Fed's relentless fiat inflation
has vastly lowered the purchasing power of each dollar, so multi-decade
comparisons are only relevant in constant dollars adjusted for
this monetary inflation.
And while the inflation-adjusted
real CRB index suggests this secular commodities bull is just
beginning, it is interesting to note that our technical relativity
tools are already revealing tradable consistency in the major
uplegs and corrections of the broad CRB index itself. Commodities
investors and speculators should definitely consider adding major
long positions in individual commodities or related plays when
the CRB itself has retreated back down near its own 200dma to
regroup.
We will try to integrate this
new CRB insight into our own trading strategies discussed in
our newsletters for our subscribers
as we launch new commodities-related trades going forward. Considering
the state of the CRB uplegs and corrections may prove useful
in farther refining high-probability-for-success moments to throw
long or short in key individual commodities markets including
gold, oil, and silver.
Far from nearing an all-time
high as intrinsically flawed multi-decade nominal comparisons
suggest, the historically very low levels in the real
inflation-adjusted CRB suggest that we instead probably have
many years left to run yet in this powerful secular commodities
bull. Thus there ought to be countless stellar trading opportunities
in the commodities arena in the years ahead.
The real commodities
bull is still likely quite young!
November 19, 2004
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
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