Commodities: Is the Decennial Pattern Still in Effect?
In early April I wrote a commentary titled "Commodity Boom? You Ain't Seen Nothing Yet!" in which I hypothesized that commodities would maintain investment leadership through the end of the decade and the rally would end in spectacular fashion in early 2010. This would be consistent with a "decennial pattern" of leadership which began in the 1970s with each decade's winner roughly doubling the stupendous gains of the prior decade's winner.
This largely reflects the increase in the rate of money creation since the total abandonment of the gold standard which occurred 37 years ago this week. All of the money which did not flow into plant and production (or absorbed by productivity gains) had to flow somewhere. In the 1970s commodities was the winner, followed by the Nikkei in the 80s, the Nasdaq in the 90s, and commodities again this decade. With the strengthening of the US dollar and the wholesaled dumping of commodities I decided to check the performance of the Nasdaq Composite in 1998 for clues relating to whether commodities have indeed peaked and the decennial pattern had fizzled. Take a look at the chart below:
Whoa! Check out that 33% decline from mid-July to early October! Next, look at the chart of un-hedged gold stocks below:
We see a similar drop in gold stocks that we did in the Nasdaq in the "8-year" of the decade. In addition, the low occurred at support levels established two years prior to the selloff. If the chart below is indicative of what we can expect for gold, then investors should be backing up the truck:
You can see that the 1998 Nasdaq dip represented the trade of a phenomenal trading opportunity. Shares quadrupled in less than 15 months (peaking above 5200). Because each successive decade has seen a doubling in the effect of gains I think that it is possible that the HUI rises 8-fold from its ultimate low.
While the Nasdaq low did not occur until the end of October, I think that the gold stocks may be within days of reaching its low as seasonal lows tend to occur during the month of August. Gold stocks have also been correcting since March; the 1998 Nasdaq correction did not begin until well into July.
Other commodities are a tougher call, though I do expect them to also bottom within months before beginning one last rapid ascent. The rally, in my view has occurred in phases. The first phase for the commodity rally began in earnest in late 2002 and ended in the Spring of 2006. These were the "early adapting" investors. The second phase of the rally started in late 2006, ended this Spring, and was marked by the entrance of institutional investors. The final phase will be propelled higher by the retail investor much like many of you remember them piling into tech stocks one decade ago.
You see nothing really changes, especially in a fiat currency world where every country is trying to print more money than their neighbor. On a cautionary note, the deflationists who follow Keynesian economics will be able to make the case that the world's deteriorating economic situation (see my article of a week ago) will cause aggregate demand to fall off a cliff and prices for commodities to plummet. And the chartists clearly have the deflationary wind at their backs to further make the case that the commodities rally is broken.
So the case for gold and commodities requires a little faith. You have to have faith that the combined efforts of the US and other central bank government money machines will create and enact truly heroic money printing policies to combat the gales of deflation. The inflationary monetary effects should more than offset the effects of any aggregate demand destruction on price as they force investors to plough into tangible assets as a safe haven, driving their prices higher. Another potentially inflationary development is the return of the Russian menace which threatens to stall if not reverse the process of globalization and, more importantly, threatens to destabilize much the world's supply of oil and natural gas. We need to also consider the inflationary effects of increased missile defense systems and other military apparatus expenditures that we can expect to counter Russia's aggressive actions.
Some analysts and strategists called last week a "watershed event" as the game changed from inflation to deflation after US CPI was seen reaching a peak above 5% with lower gasoline prices expected to lead the index lower from here on out. I think we can expect a deflationary scare, but the bottom line is that the inflationary trend will resume and the decennial investment pattern will resume. You should be adding to precious metals positions in preparation for the final rocket-boosting phase of the rally.
Kurt Kasun is strategically located in Washington, D.C., a key to maintaining contacts and relationships which help Kurt understand global policy and economic factors as they emerge. His investment approach has always been macro in nature largely due to his undergraduate studies at the U.S. Military Academy at West Point (B. S. National Security, Public Affairs, 1989) and his graduate studies at George Mason University (M.A. International Commerce and Policy, 2006).