A Commodity Bull Market

2004-JAN-06

The ongoing collapse of the US dollar is having a knock-on effect throughout many markets.

For example, as the dollar falls, commodity prices rise in dollar terms. There are many reasons to explain this relationship, but the most basic one is very simple. We use money to express the economic value of commodities, and if the money in which we express a commodity's price becomes worth less while the economic value of the commodity remains unchanged, then the price of the commodity must rise.

While the dollar has been dropping in recent months, the economic value of commodities has not, generally speaking, fallen. A pound of copper is as useful today as it was months ago before the dollar started to decline. Therefore, the price of copper in dollar terms is rising.

The following chart shows the impact of the falling dollar on a basket of commodities. It presents the month-end price of the Commodity Research Bureau Index of various commodity prices.

I'd like to make the following observations about this chart.

1. Note that from 1957 to the early 1970's, the basket of commodity prices expressed as the CRB Index fluctuated within a relatively narrow range. There were bull markets and bear markets, caused by supply disruptions and other factors of supply as well as demand. But compared to what was to come, those fluctuations were relatively tame.
2. By the early 1970's the dollar had become so debased, its devaluation against gold was inevitable. But rather than officially devalue the dollar as Roosevelt had done in 1934, Nixon took a different tact. He broke the dollar's formal link to gold, turning it into fiat currency. The net result was that the purchasing power of the dollar continued to decline, so to reflect this loss, the price of commodities rose, as indicated by the green arrow on the above chart.
3. With the appointment of Paul Volcker as chairman of the Federal Reserve, efforts were made to clamp down on the dollar's inflation rate. The consequence of his actions created the disinflation of the 1980's. In other words, the rate of inflation began to fall, and the CRB Index began to decline from its inflation-frenzied peak.
4. When viewing the CRB Index over the last twenty years, we can see it traded within a slightly falling downtrend channel, marked by the dotted red lines. Interestingly, this downtrend channel is not unlike the one that occurred back in the 1960's (which is also marked by dotted red lines).
5. Over the past couple of years, the CRB Index has been climbing once again. Note the green line, which is actually drawn parallel to the green arrow (i.e., they have the same slope).
6. Importantly, the CRB Index has broken out of the downtrend channel that has confined it for twenty years. Not only are we in a commodity bull market, we are in a new era. Look for the CRB Index to continue climbing from here, just like in did in the 1970's.

The ongoing collapse of the dollar is creating many profit opportunities. Buying commodities is one of them. Buying goldgrams is another.