The Commodity Conundrum
by James W. Paulsen, Ph.D, Chief Investment Strategist, Wells Capital Management, Inc.
A collapse in commodity prices that commenced last summer and paused briefly earlier this year, has recently reignited. Combined with the current aggressive decline in global stock markets, this has fueled widespread fears of a potential global recession and a deflationary spiral. Most perceive the signifi cant weakness in commodity prices as highly unusual in the middle of an economic recovery and more than a bit spooky.
However, commodity prices have suffered signifi cant declines in three of the previous four U.S. recoveries dating back over the last 40 years. In each of these cases, rather than signaling an impending recession, the pace of economic growth accelerated, the core inflation rate rose and bond yields increased within months of a bottom in commodity prices. In contrast with current concerns, traditionally, recessions have most often followed a surge in commodity prices whereas falling commodity prices have usually been a precursor to improved economic growth.
Chart 1 shows the S&P GSCI Spot Commodity Price Index since 1970. In three of the last four recoveries (i.e., late 1970s, 1980s and 1990s recoveries), commodity prices suffered a severe decline “during” an ongoing economic recovery. Moreover, in each of these cases, the economic recovery persisted well beyond the bottom in commodity prices. In the late 1970s recovery, commodity prices bottomed in July 1977 and the recovery did not end until January 1980. Similarly, commodity prices bottomed in July 1986 but the economic recovery continued until July 1990. Even during the 1990s recovery, while commodity prices bottomed in February 1999, the recovery did not peak until March 2001.
Falling commodity prices have not proved a good leading indicator of a pending recession. Moreover, as Charts 2 and 3 illustrate, faster economic growth, accelerating inflation and higher yields have often quickly followed commodity price collapses. In the three previous recoveries highlighted, the annual core consumer price inflation rate actually “accelerated” within four to six months and the 10-year Treasury bond yield rose almost coincidently with the fi nal low in commodity prices. Consequently, despite the severity of the current collapse the in commodity market, once it bottoms, inflation and interest-rate pressures could emerge much more quickly and much more aggressively than most now appreciate.
Read/Download the complete report below:
