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Gold leads commodity prices, and both respond to monetary policy

This chart covers almost 30 years of gold and commodity prices, and I think it shows an impressive correlation between the two. Moreover, it shows that gold prices tend to lead commodity prices—by as much as a year—at important turning points, which further suggests that commodities likely still have some impressive upside potential.

I think it's also important to note the strong correlation between gold and commodity prices, which speaks volumes about how important monetary policy is to both commodities. It's no coincidence that both gold and commodities trended lower throughout the 1981-2001 period, during which time the Federal Reserve was generally pursuing a policy that brought inflation down and kept it relatively low. Recall also that just the opposite happened in the 1970s, when the Fed was generally easy and inflation, gold, and commodity prices rose.

And it's no coincidence that gold turned up in early 2001, followed by commodities by the end of the year, as the Fed embarked on what would eventually prove to be the most dramatic reduction in short-term interest rates in modern times: lowering the Fed funds target rate from 6.5% to 1% over a 3 1/2 year period.

So, gold and commodity prices can be strongly influenced by monetary policy. Of course, commodity prices can also be influenced by the imbalances that arise between the growth-driven demand for commodities and their supply. But from the looks of this chart—gold and commodities were weakest in the late 1990s when the economy was so strong that the Fed worried about "overheating"—monetary policy is the more important influence.

And so the ongoing rise in gold and commodity prices is an important sign that monetary policy is easy, and thus likely to result in rising inflation.

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