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The reflationary message of key commodity prices




Here's an interesting chart that puts key commodity prices—gold, crude oil, and industrial commodities—in perspective. I've recalibrated each so that they are equal to 100 as of Jan. 31, 1997. I chose early 1997 as a starting point, because I think that monetary, economic and inflation fundamentals were relatively stable around then. The CPI had been fairly steady at just under 3% for six years. Gold prices had been fairly steady at just under $400 for about 4 years. Industrial metals prices had been fairly steady for 2-3 years. The economy had been growing about 3% a year for 4 years. The dollar had been in a flat trend for 6-7 years.

From 1997 through 2003, we began to see the effects of monetary deflation, as the Fed tightened policy aggressively in an attempt to slow what was perceived to be an "overheating" economy. Commodities fell across the board during that period. From 2003 on, we saw the effects of monetary reflation, as the Fed responded to the deflation it had previously generated by keeping interest rates low for an "extended period." Commodity prices rose across the board during that period, not surprisingly. Then came the panic collapse of 2008, when the prices of almost everything declined as global demand evaporated But since then monetary policy has reverted to being very accommodative, demand and confidence have come back, and commodity prices are once again on the rise.

One thing about this chart really stands out: these key commodity prices have essentially tripled in the past 13 years. That works out to almost 9% inflation per year on average. Another interesting observation: gold prices and crude oil prices have risen by almost the same exact amount over this period. In addition, the ratio of gold and crude oil prices today (13 barrels per ounce of gold) is not too far off its average (17.8) for the past 50 years.

Message: these prices tend to move together over time, even though they are very distinct commodities. Gold has an intrinsic value derived from its beauty and durability; crude oil's value is purely as a source of energy; industrial metals are key inputs to most industrial processes and by extension, to economic growth in general. That they are all on the rise is a strong indication that monetary policy is increasing inflation pressures throughout the economy.

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