START OF A NEW INFLATION ERA?
EDITOR'S NOTE... Jeanette Schwarz Young contributed to this article. Ms. Young is a trader on the New York Board of Trade with special expertise on commodity markets. In the coming weeks, you can expect to see more joint articles from her and myself. - John Murphy
IT'S NOT JUST OIL... It would appear that the United States, accompanied by most of the rest of the world, is entering into a more inflationary environment. It?s easy to blame crude oil which has gotten the attention of the media and the Fed. But is it really the sole source for this condition? Aren't there other contributors to inflation, perhaps equally responsible? Retrospectively, we recall the hyper-inflation days of the 1970s, and the upward spike in crude oil to near $40 which was partially attributable to the Arab oil embargo. Its price gradually returned by the mid-80's to more normal levels. The Iraqi invasion of Kuwait and the "Gulf War" inspired another near-$40 spike, although its duration was more temporary. But those earlier instances of higher energy prices are insignificant compared to the post-2000 oil surge to $70. In contrast to previous oil spikes over the last twenty-five years, the current uptrend has been a lot more durable and subject only to brief, shallow retreats. After a fourth quarter pullback, crude is again testing the 2005 highs near $70. While the Fed has focused on the rise in energy prices, there have been many independent but equally dramatic price increases in other commodities. Much has been written in the financial media about gold's reaching a 25-year high (Chart 1). But gold is just the bellwether for the rises in other metals; silver, certainly has been rallying in the shadows. Silver has recently broken out to a new 22-year high (Chart 2). And industrial metals, e.g.: copper and aluminum are trading at new record highs. (Charts 3 and 4). Metals markets may have reached overbought levels over the short-run; however, long-term indicators suggest that there's a lot more upside room for all of them.
Chart 1
Chart 2
Chart 3
Chart 4
THERE ARE NOW TWO CRB INDEXES... Part of the reason for that long-term bullishness may be found in the action of key commodity prices indices. We feel obliged to clarify some changes that have been made in the CRB Index. In June of 2005, the Reuters Jefferies CRB was introduced by the New York Board of Trade, in replacement for the Reuters CRB Index. The "new? Reuters Jefferies CRB was developed to more closely resemble the Goldman-Sachs Commodity Index (GSCI) which has a much bigger energy weighting and includes more industrial metals. The new Jefferies/ CRB is more heavily weighted to the energy sector with 33% devoted to oil products and an additional 6% in natural gas. The old CRB had a 17.5% energy weight. The "old" CRB Index is comprised of 17 different commodities and is now referred to as the Continuous Commodity Index (CCI). The new version of the CRB includes 19 commodities. Two of the new commodities are industrial metals --aluminum and nickel. The Continuous Commodity Index (CCI) is an equally-weighted (5.88% per commodity) index, calculated geometrically; the RJ/CRB (CRB) is variably-weighted, calculated arithmetically. They are different! But both are trading at record highs.
Chart 5
Chart 6
OLD CRB EXCEEDS 1980 PEAK ... The Continuous Commodity Index has just traded over 364 which puts it higher than the previous record at 337.50 last seen on November 28, 1980 This puts both commodity indices, the RJ/CRB and the CCI, at new record highs. The fact that the post -2000 uptrend in commodity prices has exceeded the previous peak reached during the hyper-inflation decade of the 1970's strongly suggests that price inflation is in the ?pipeline.? The fact that the old CRB has reached a new record high with only a 17.5% energy weighting also suggests that this new high commodity level is more than just an energy spike. What is this telling us about the future? Historically, inflationary periods have usually started with upward trends in raw materials. If that pattern holds true, the upward trend in so many key commodities would seem to be warning that global economies are entering into a more inflationary environment. Investors have already picked up on that factor, which may account for superior performances in inflation-sensitive stock groups, such as precious metals, energy, and basic materials.
