The chart above is of the PPI Finished Goods(FG) to Intermediate
Materials(IG).
Note that the ratio is at an extreme and that a reasonable premium
of FG to IG seems to be around 8%, reflected by the 1.08 level
engulfed by the green rectangles.
This chart illustrates the ratio of Intermediate Goods to Crude
Materials(CM).
Crude Materials are incontrovertibly linked to commodities.
Historically, as it is happening now, huge increases in commodity
prices have brought this ratio to inordinate levels.
This chart is of the US Dollar Index plotted against the FG/IG
ratio.
At these levels it is reasonable to expect a reversal of the ratios
(FG/IG and IG/CM) shown above.
FG/IG will gradually, over many years, approach the 1.08 level.
A combination of FG price increases and decreases in commodity
prices will probably take place first.
Then a relative increase in FG vs. Crude Materials will follow.
So, at this point, I would bet on a cyclical correction in
commodity prices and appreciation of the US Dollar.
9 comments:
Thank you Will - very interesting...From a pure technical perspective too - USD is at the lower end of its long term downtrend range. EUR is conversely at the upper end and so is oil.
Also - the stock market action has been quite bullish recently (possibly one of those 15-20% bear market rallies started last week).
"A combination of FG price increases and decreases in commodity prices will probably take place first."
So will the intermediate and FG producers see margin expansion here?
Don
Second thought...did inflation increase in the 70's because of the baby boomer generation entering the labor force and demanding goods and services? If so, maybe the growth of a new middle class in BRIC can keep those numbers going in their current direction much further than past history has indicated.
Don
Will,
I'm on the same page and considering selling my energy stocks and shorting commodities. However, your charts made me study the 70's a little more. I discovered that the recovery of the very suppressed PPI FG to IG ratio was accompanied by a modest decrease in gold and no nominal decrease in oil prices, despite the 1974 recession and severe market crash. The CRB index did go down though. I'm not sure if the short commodities is a low risk trade anymore.
Ideas?
I think that there will be a cyclical decline in commodity prices. For the longer term, though, I believe that there is more room to the upside.
In the 70's, a sudden increase in oil contributed to the economic slowdown. In recent years, the strength of world economies contributed to the rise in commodities.
I expect an economic slowdown to bring down commodity prices.
Will,
you are a genius (and probably know that, too). With your gentle probing, I made that painful decision of shedding my energy stocks and and very pleased with the results so far.
I think the oil is going down because the oil trade was overheated and need to consolidate some.
This anti-inflationary move should propel the equities a la 2006, right?
Only later this summer (after olimpic games and perhaps elections), more recessionary and inflationary forces will gather and tank the economy and commodities more.
Sounds like a nice story. Do you like it?
BTW, where do you get these obscure and long term charts? This is something very unique about your blog.
Jack
Jack,
I am so glad that you benefited from the advice.
I am not a genius(sorry to disappoint you), but thank you for your kind words.
I do not "get" the charts. I obtain the raw data, crunch numbers and do calculations before charting them. You are right (modesty apart): they are unique
"I would bet on a cyclical correction in
commodity prices and appreciation of the US Dollar."
Will, I was a new reader when you posted these words. Now I more fully appreciate the wisdom of your charts and wish I had acted to reduce commodity exposure.
Thank you for your posts.
I like your article and it really gives an outstanding idea that is very helpful for all the people on web.
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