CRB vs. PPI: Cause and Effect

Yesterday PPI came in lower than expected giving an excuse to the deflationists to sell down anything commodity related and plunge blindly into US Treasuries!

We found this behaviour somewhat amusing given the recent behaviour of the CRB (as in the old CRB – now referred to as the CCI).

And also given the behaviour of our proprietary commodity index, which consists of just 5 commodities – wool, rubber, polyethylene, coal, and pulp. We devised this index with the intention of following commodities that were vitally important to industry but were not so easy to trade which cuts out volatility associated to speculative activity as is the case with the components of the CRB.

To us the trend in commodities is clear. The rally is broad based with even obscure commodities rallying to multi-week highs. This suggests to us that producer prices will, in all probability, lead to spikes to the upside over the coming months. Producer prices just cannot remain low when the basic inputs are moving higher week on week! Furthermore, we find it difficult to comprehend how deflationist arguments can be taken seriously given the behaviour of the two charts above. If rising commodity prices are deflationary in nature perhaps I missed something in introductory economics! As a matter of side has anyone taken note of what has been happening on the Baltic Freight Rate front AND the relative outperformance of shipping stocks? We certainly have!

Disclosure: Long DBC, SLV, TBT.

Comments

[tripleblack:]

The huge fleet of derelict freighters floating off the coast of Malaysia is still there, though a little smaller than it was a few months back.

China has mountains of goods filling its warehouses and stacked on its docks - perhaps they are starting to load some freighters as floating warehouses as well...

If there was going to be a huge, last minute Christmas rush, it SHOULD be close to pulling the trigger pretty soon, at least at the factories and primary seasonal suppliers...

But the trend in commodities is unmistakable, as you say, Mr. MacLeod. Part of this will be refilling depleted bunkers and working supplies, true, and some will be pure speculation....

But I saw oil moving up from $60 when I bought in on it, and silver moving up from $13 when I bought in there, and natural gas (OK, that one was more of a gamble, but still) when it hit $3... Of course, I was playing the contrarian to the UN Weather Model and Global Warming there, I think we're in for a cold wet winter...

I have to agree, on balance, commodities are only just beginning their long term upward trend.

Oct 21 07:27 PM

[Angel Martin:]

Thomas, I suggest you look at the "USE" matrix Table D on page 14.

www.bea.gov/scb/pdf/20...

If you look at manufacturing with $3.85 trillion in total output, about 300 billion are commodity inputs from the Agriculture and Mining industries. The CRB is up 30-40% since bottom, but the direct price impact is on less than 10% of manufacturing inputs. And Manufacturing is the largest proportional user of basic materials. The overall industry fraction is just 2%.

Compensation of employees is more than 10 times as large. (6 trillion in intermediate use out of 19 trillion total industry output.

The employment cost index annual growth is less than 2%. With 9%+ unemployment, I don't expect that will be increasing anytime soon.

www.bls.gov/news.relea...

There are reasons why those of us who do not buy the inflation scenario believe as we do.

Oct 21 08:09 PM

[Thomas MacLeod:]

Hi Angel,

Thanks for your comments - enjoying the discourse.

I appreciate your viewpoint & will respond in a more abstract manner: just ignore the naive politics.

Firstly: www.chrisjordan.com/cu...

(the same information has many different levels/viewpoints.. etc..).

Secondly: Pick any 10 objects near you at the moment. Where were they made? There is a valid and completely different viewpoint on the link you provided.

I think that you maybe placing to much confidence in yourself; and not subsiding your ego to what the markets are telling you. Of course you could also be 100% correct. No one knows.

I am a trader, not an economist. I am focused on maximising my returns whilst accepting as little risk as I can.

Emilio & I have been positioning out accounts for these trends, and slowly building our positions. Our viewpoint is the that there is no indication of a reversal anywhere, and that these trends will be with us for 18months+. Rarely have we seen such a wealth creation opportunity . Really.. pick your sector:

- oil, coal, steel, etc..
- softs
- shipping
- high yield currencies

I suspect that you could probably bore the arse of just about anyone by quoting various statistics, reports, etc.. all night. All very well, but..

What is much more interesting is how are you positioning yourself at the moment?


On Oct 21 08:09 PM Angel Martin wrote:

> Thomas, I suggest you look at the "USE" matrix Table D on page 14.
>
>
> www.bea.gov/scb/pdf/20...
>
>
> If you look at manufacturing with $3.85 trillion in total output,
> about 300 billion are commodity inputs from the Agriculture and Mining
> industries. The CRB is up 30-40% since bottom, but the direct price
> impact is on less than 10% of manufacturing inputs. And Manufacturing
> is the largest proportional user of basic materials. The overall
> industry fraction is just 2%.
>
> Compensation of employees is more than 10 times as large. (6 trillion
> in intermediate use out of 19 trillion total industry output. <br/>
>
> The employment cost index annual growth is less than 2%. With 9%+
> unemployment, I don't expect that will be increasing anytime soon.
>
>
> www.bls.gov/news.relea...
>
> There are reasons why those of us who do not buy the inflation scenario
> believe as we do.

Oct 23 03:06 AM

[Angel Martin:]

Hi Thomas

you are right about trader vs economist. This is the first market I have taken speculative positions in (currently SPY calls).

RE your link to the products people use and where they come from: inflation due to import price increases is a real risk with a devaluing dollar. Arthur Laffer got a great boost to his career by forecasting that the Nixon devaluation of the dollar would be hugely inflationary. The other economists in the Commerce Dept basically made the argument similar to what i did for manufacturing and basic materials, ie. that imports were a small fraction of the economy so a price increases would be barely measurable. Didn't turn out to be the case.

The major reason why I think the big inflation won't happen is that we appear to be in a post-war disinflation. This phenomenon has many historical parallels (the one I think is most relevant is post-WW1, but others would be 1864-73 in the USA, and 1815-25 in the UK). In these past cases, the disinflationary/deflation forces are so powerful, that what might be quite inflationary policies in other circumstances don't seem to have the same effect. (why I don't know, but that is the historical pattern. The other factor is, you need to win the war, if you lose, you get inflation, again I don't know why).

Regarding, theory and data vs what the market is telling you. I agree, I don't want to be arrogant. From what little i've read about trading, with humility comes profits; arrogance leads to losses which leads to humility.

I am always looking for counterexamples that are inconsistent with my macro view of the market/economy. Right now, the only thing I see is accelerating job losses in Aug and Sept in the household survey for USA employment. If Oct shows more of the same, then I am wrong about a strong recovery this fall.

Everything else I see is consistent with a normal, non-inflationary economic recovery. eg.

High multiple tech leads the cycle: APPL, GOOG and AMZN all reporting great results, esp yr-over-yr revenue growth.

Industrial production shows some increases.

Retail sales up (slightly) since july

Employment lags the cycle, so we wouldn't expect to see employment gains yet.

Basic materials prices lead the cycle. The trend of commodity prices is consistent with past economic recoveries, and not necessarily a precursor to a larger inflation. (but the PPI etc will tell me if i am wrong).

I think the $US will start to go up once there is some employment growth (but the FX market will tell me if i'm wrong).

I am planning on a put position for gold, probably next year, if and when we get some employment growth and if the dollar reverses the down trend due to empl growth.

Thomas, I'd be interested to know what would cause you to move out of your current longs. What is your sell signal?


On Oct 23 03:06 AM Thomas MacLeod wrote:

> Hi Angel,
>
> Thanks for your comments - enjoying the discourse.
>
> I appreciate your viewpoint &amp; will respond in a more abstract
> manner: just ignore the naive politics.
>
> Firstly: www.chrisjordan.com/cu...
>
> (the same information has many different levels/viewpoints.. etc..).
>
>
> Secondly: Pick any 10 objects near you at the moment. Where were
> they made? There is a valid and completely different viewpoint on
> the link you provided.
>
> I think that you maybe placing to much confidence in yourself; and
> not subsiding your ego to what the markets are telling you. Of course
> you could also be 100% correct. No one knows.
>
> I am a trader, not an economist. I am focused on maximising my returns
> whilst accepting as little risk as I can.
>
> Emilio &amp; I have been positioning out accounts for these trends,
> and slowly building our positions. Our viewpoint is the that there
> is no indication of a reversal anywhere, and that these trends will
> be with us for 18months+. Rarely have we seen such a wealth creation
> opportunity . Really.. pick your sector:
>
> - oil, coal, steel, etc..
> - softs
> - shipping
> - high yield currencies
>
> I suspect that you could probably bore the arse of just about anyone
> by quoting various statistics, reports, etc.. all night. All very
> well, but..
>
> What is much more interesting is how are you positioning yourself
> at the moment?

Oct 23 10:45 AM

[Thomas MacLeod:]

Hi Angel,

Sorry for the delay in replying.

We don't have one sell signal. You would probably find our methods lacking in sophistication, as do we. We gave up trying to outsmart the market, and simply trade the capital flows that we observe.

We determine our outlook, then trade this outlook. Every week we perform activities similar to the below article, to determine if the outlook should change.

seekingalpha.com/artic...

We look for relationships between bond, equity, commodity, and currency markets. Once a trend is in place, it usually stays in place for a long period of time, months and years.

To change our outlook we usually look for 90 day Rate of Change. Changes of trend rarely happen quickly (exceptional events excluded of course).

We trade with quite strict rules to protect our capital, scaling into a position, stop-losses, scaling out of a position, etc. So we have usually exited out of our positions long before our outlook changes.

We don't always stick to our trading rules, but it does takes an exceptional circumstance to break them. Occasionally we will take very long term positions and hold them for 2-5 years or even longer regardless of short term events. Other times we will take highly leveraged short term speculative positions (usually currencies). These never represent more than 5% of our capital, yet have been responsible for over 50% of our wealth accumulation over the last 15 years.

Even in light of the recent downwards movement, we are still essentially bullish. Up, down, & sideways moves are normal in a market. Next week we will go through the outlook process again.


On Oct 23 10:45 AM Angel Martin wrote:

> Hi Thomas
>
> you are right about trader vs economist. This is the first market
> I have taken speculative positions in (currently SPY calls).
>
> RE your link to the products people use and where they come from:
> inflation due to import price increases is a real risk with a devaluing
> dollar. Arthur Laffer got a great boost to his career by forecasting
> that the Nixon devaluation of the dollar would be hugely inflationary.
> The other economists in the Commerce Dept basically made the argument
> similar to what i did for manufacturing and basic materials, ie.
> that imports were a small fraction of the economy so a price increases
> would be barely measurable. Didn't turn out to be the case.
>
> The major reason why I think the big inflation won't happen is that
> we appear to be in a post-war disinflation. This phenomenon has many
> historical parallels (the one I think is most relevant is post-WW1,
> but others would be 1864-73 in the USA, and 1815-25 in the UK). In
> these past cases, the disinflationary/deflation forces are so powerful,
> that what might be quite inflationary policies in other circumstances
> don't seem to have the same effect. (why I don't know, but that is
> the historical pattern. The other factor is, you need to win the
> war, if you lose, you get inflation, again I don't know why).
>
> Regarding, theory and data vs what the market is telling you. I agree,
> I don't want to be arrogant. From what little i've read about trading,
> with humility comes profits; arrogance leads to losses which leads
> to humility.
>
> I am always looking for counterexamples that are inconsistent with
> my macro view of the market/economy. Right now, the only thing I
> see is accelerating job losses in Aug and Sept in the household survey
> for USA employment. If Oct shows more of the same, then I am wrong
> about a strong recovery this fall.
>
> Everything else I see is consistent with a normal, non-inflationary
> economic recovery. eg.
>
> High multiple tech leads the cycle: APPL, GOOG and AMZN all reporting
> great results, esp yr-over-yr revenue growth.
>
> Industrial production shows some increases.
>
> Retail sales up (slightly) since july
>
> Employment lags the cycle, so we wouldn't expect to see employment
> gains yet.
>
> Basic materials prices lead the cycle. The trend of commodity prices
> is consistent with past economic recoveries, and not necessarily
> a precursor to a larger inflation. (but the PPI etc will tell me
> if i am wrong).
>
> I think the $US will start to go up once there is some employment
> growth (but the FX market will tell me if i'm wrong).
>
> I am planning on a put position for gold, probably next year, if
> and when we get some employment growth and if the dollar reverses
> the down trend due to empl growth.
>
> Thomas, I'd be interested to know what would cause you to move out
> of your current longs. What is your sell signal?

Oct 26 07:11 PM