The data for commodities and commodity related stocks over the last decade plus has covered an incredible range. It seems that we will now face one of two futures: (1) the collapse of a commodity bubble or (2) the spreading of even more rampant inflation into the world economy. The fiscal and monetary policies of the past decade have either been insufficient to stem the repeat of a collapse such as the world saw in the 1930s or more than sufficient and leading to inflation. The sweet spot in the middle seems way too tiny to ever be hit, let alone maintained.
This article reviews the incredible commodity related data of the past 10+ years and shows why, if there is to be an inflationary outcome, there may first be a colossal collapse in commodities and related stocks.
In your reading travels, you may have come across the occasional economist who suggests that the true top in the equities markets didn’t really occur in 2007, but in 2000. Michael Clark thinks that’s the case and will be presenting his studies here on EW Trends and Charts in the near future. I’ve seen Mish Shedlock make a similar claim, as well as others. There is enough compelling evidence that I too think the last real economic cycle ended in 2000 with a major transition becoming evident in 2002-2003. There comes a time in the larger cycles when ‘growth’ ceases to gain its main inputs from true economic expansion but instead gets most of its ‘juice’ from liquidity and not much else. At that point, it’s no longer really growth but just illusion. There a literally dozen ways of measuring when this might be occurring but for this exercise we’ll look at the story from the perspective of commodities, specifically ‘commodities only’ related stocks.
To be honest, I never did start doing this type of analysis with the purpose of finding out ‘when’ any particular major transition would occur. Quite the opposite, simply by doing this type of analysis I accidentally stumbled upon more and more evidence showing that a strange transition started to take place during the 2002-2003 period. At first I didn’t even know what was causing it nor what it meant. This transition wasn’t something that happened overnight either and it was a phenomenon that probably would never have been spotted by analyzing any particular market on its own. But when I compared one market to another using various meaningful pairs, time after time it became apparent that there were some pretty obvious ‘disconnects’ that started to occur in the years 2002-2003.
The chart below shows prices of 4 things we’re all familiar with: equities, oil, gold and the dollar. I show this chart mainly because it provides a good ‘pictorial’ of the transition I’m referring to. It is not the main focus of this discussion but does display the type of ‘sea change’ that starts to take place about a decade ago. The key area is within the brown vertical bar.
Click on graph for larger image.
Now that you can see what it is we want to analyze here (what happened in the 2000-2003 era?), we first have to decide which would be a reasonable ratio to use. No doubt you’ve seen all kinds of them: equities priced in oil, equities priced in Yen or Aussie dollars, the S&P related to the TED Spread, etc. The picture of equities priced in silver is devastating but there would be too many people who (until the recent silver slaughter) could have argued “That isn’t fair! Silver is on a tear… it isn’t real! You can’t use gold either… gold is useless stuff with no intrinsic value!” Lol – people actually say things like that. But fair enough, using silver would have been a bit extreme and might have even instilled suspicion that I have a bias toward making a case.
I assure you, I don’t. I just want to know the truth. So what would be fair? Can we make a case by comparing equities to oil? I already presented that argument here. Some might even argue that that particular presentation was somehow ‘invalid’ or ‘biased’ as well, claiming that the oil market is also manipulated and too wild to trust. (They’d be wrong, but just for the sake of offering an entirely new perspective, we carry on…)
So, what if we knew which stocks were related to commodities only? What if we could round them up in one basket and then use that basket to measure the effects of inflation on commodity stocks, and in turn how that affected the overall equities market? That would be very fair, wouldn’t it? And it would make sense since every commodity in the world represents “real things” that get more expensive for all of us when inflation is in play. Things we eat or consume in one way or another… gasoline, cattle, pork bellies, lumber, goats, cotton, corn, electricity, goats, sugar, eggs, goat eggs, chickens, orange juice, coffee… everything we consume. Did I mention goats?
As luck would have it there ‘is’ such an index. It’s called the Morgan Stanley Commodity Related Equity Index ($CRX) which features 20 large companies that are related directly to commodities. The list of who’s who in that index is available by clicking here. The basic premise is that if inflation really began to take off in year 2000 and has accelerated ever since, then that phenomenon should show up if we compare a basket of companies who deal in commodities to the entire broad spectrum of equities. So we put together a ratio of $CRX:$SPX to see if our theory holds water. What resulted more or less blew my socks off… a WOW chart if I’ve ever seen one.
You could go out and spend $20,000 on a top notch lie detector and it wouldn’t produce results as conclusive as this chart does. If the candlesticks on this chart are rising, it means that within the entire world of stockdom, the equities related stocks are rising at a faster rate than the rest. This would be true whether equities were rising or falling as long as the ratio is climbing. And it is equally true even in the current situation where the S&P has doubled in the past two years. I realize the following chart might look a bit ‘busy’, but the annotations help tell the story and guide you through it. When you look at it, I really want to draw your attention to one main theme here… acceleration of the yellow trend line. It proves one fact beyond dispute… that the puppet’s nose grows a foot longer each time he opens his mouth:
Click on graph for larger image.
Ok, so we now have evidence that inflation really started to take off in the latter half of 2002. As an interesting side-note, the $CRX actually telegraphed this reversal late in 2000, as seen in the chart above. Notice how it slowly began to accelerate even more in 2003 with the start of huge money flows into commodities, then steepened even further in 2007… right up until the horror of the Lehman collapse. What happened that day was the beginning of the fastest and scariest bout of ‘deflation’ the world has ever seen, nearly collapsing the entire global financial system. It was also the first time these trend lines had ever been broken.
To this day, the inflation/deflation debate rages on. I should clarify: there is no debate about whether or not Bernanke speaks with forked tongue. That has already been established, as far as I’m concerned. The debate is whether or not the world truly is experiencing inflation, with the FED declaring “NO!” while the incontrovertible evidence declares “YES, OBVIOUSLY!” So much so that a third of the population of the world will starve to death if this deliberate destruction of all global currencies doesn’t stop. But in the coming paragraphs we will discuss what we’ll be watching for to help us determine which path the world will take.
It isn’t just the American dollar that’s being debased here, it’s every currency in the entire global fiat system. When compared to “real stuff”, there isn’t a solid or honest currency anywhere on the planet. Doesn’t this already prove that the only real money in the world is the precious metals sector itself and arguably even oil? True, they don’t actually qualify as a “currency” but they sure as heck do represent a store of wealth far better than any fiat paper does. I mean, what would you rather have purchased back in year 2000, $100K worth of shares on the S&P or $100k worth of oil? I’ll give you a hint here: Today those shares would be worth $89,900. Had you made the correct choice, your oil would be worth $393,000. Had you bought it a year earlier, today it would be worth $800,000. I don’t know how the evidence could be made any clearer. But as you all know… there is no inflation. Mr. Bernanke said so.
So the crucial question is this: “Which is it going to be? Is the dollar going to continue to collapse toward zero unabated or could the world endure another deflationary depression first? Could we possibly identify when that might occur?” Despite all arguments to the contrary, since 95% of all money on the planet was “loaned into existence” then by the reversal of that process, money can indeed collapse back into the imaginary void that it was born from in the first place… if only temporarily. At least that’s the theory.
Indeed, if that reversal phenomenon were impossible as some claim, then the entire deflationary depression of the 1930’s never happened. Of course it happened! The real argument should be whether or not the global cabal of banking orcs has enough power to prevent every single potential sovereign, municipal or major corporate default in the world from ever happening in the future. I say no, they don’t have that much power. But they sure can put up a mighty impressive illusion can’t they? I also fully acknowledge the possibility that I might be wrong about this. In either case, whether my opinion is right or wrong, the ratio we’ve presented here will react one way or the other. It will actually “show us”.
In the chart below, we see the same three participants, but this time I’ve prepared a panel at the top which shows the performance of each of them in percentage terms going back to when this whole mess began to unfold in year 2000. This is where some of you might think you need new reading glasses:
Click on graph for larger image.
The most shocking revelation here, almost enough to make one sick to his stomach, is the fact that since year 2000, commodity related stocks have risen 64 times as much as the broader S&P 500 has . Admittedly there are only 20 stocks in this index, plus the fact that a good chunk of that is due to the incredible rise of Potash Corp. But still, the main point remains the same… inflation as evidenced by the incredible rise in commodities prices is the root cause of the vast majority of the current illusion of prosperity. Low interest rates have spurned a diabolical explosion in the amount of wildly speculative investment using the currency carry trade vehicles. Borrow cheap Yen and cheap dollars and buy everything else basically. It’s just not real growth. But for now it just seems to continue. Whether an investor is currently long equities or not, what he needs to know is when this phenomenon is going to stop… if ever.
I don’t particularly care to debate whether or not the world is simply going to continue to drift further into the inflation twilight zone or whether it’s going to spend a year or two in the deflation grinder first. I don’t pretend to know with any certainty either. Whichever path the global currency cesspool is going to take, we want to know about it at the earliest stage possible. And this particular method of measuring the shift of money in or out of commodity stocks is one terrific way of taking the temperature. At the present time, currency destruction just continues. So we drill down a little closer and look at a weekly chart:
Click on graph for larger image.
Right off the bat we notice in the weekly chart above that the ever-rising trend line is currently being tested. A breach of this trend line would be the first important indication, considering that it has only been breached on one occasion in the past 11 years. The most important aspect to grasp here though is that if that trend line is broken decisively, we know with certainty that a market correction is virtually guaranteed if not already underway, that commodity related stocks are in for one heck of a hit and that a period of deflation would appear to be in the cards. Diving one degree deeper yet, we look at the daily chart below:
Click on graph for larger image.
And lo and behold… the first alarm has gone off. For the first time in 11 years (other than the crash of ’08), the rising trend line has been breached. At this stage the RSI has quickly become oversold (as should be expected at the conclusion of any long trend). We can expect a lot more action on the momentum indicators as well, with a lot more flirting with ‘oversold’ status as we move forward. It even appears that this initial down leg in the ratio is impulsive, possibly evolving into a nice clean fiver. That being the case, I’d expect the ratio to continue lower until we see a positive divergence in that RSI as well as in the stochastic.
The bounce from that point would go a long way to helping us discern the final outcome. Perhaps a retest of the recently broken uptrend line should be expected at that time. We’ll keep our eye on this development over the coming weeks as it appears that we might be on the eve of seeing funds starting to flow out of commodities related stocks for the first time in a long, long while. If that’s indeed what we’re seeing here, the implications of such an event are pretty clear.
In other words, commodity investors have done very well for a decade, basically holding onto the bullish theme for incredibly outsized returns. In the next decade, traders may beat the pants off investors, who may fare much less well than in the past dozen years as the ‘buy and hold’ theme going forward may prove disastrous indeed.
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About the Author
Albertarocks is the pseudonym for a talented chart analyst whose work has been published at several web sites and now appears at Albertarocks’ TA Discussions. Global Economic Intersection is fortunate that Albertarocks posts some of his very unique analysis here. 
